LAW OFFICES OF JAMES V.
BASHIAN, P.C.
JAMES V. BASHIAN
500 Fifth Avenue
Suite 2700
New York, NY 10110
Telephone: 212/921-4110

Attorneys for Plaintiff
 
 

2. Prism was a venture capital-controlled company. Virtually all of Prism's financing as a private company came from venture capital firms, who, by 1995, had invested approximately $13 million to fund Prism's development, receiving over 2.3 million shares of Prism stock. Prism's venture capital investors hoped that Prism's data warehouse products would enable the Company to capitalize on the growing demand among companies to integrate and organize their data and operational databases. However, by 1995, Prism's controlling shareholders and insiders realized that Prism's business was not developing as they had hoped.

3. In 1995, Prism's principal product, the Prism Warehouse Manager ("PWM"), was expensive -- ranging in average price from $130,000 to $150,000. The Company was encountering increasing competition for sales from competitors selling smaller scale data warehouses designed to support individual departments or business functions in a company, referred to as "Data Marts." Many of Prism's potential customers did not need the sophistication and complexity of an expensive, enterprise-wide data warehouse, but could find a solution for their needs in smaller, less expensive Data Mart products being offered by Prism's competitors. Prism had no competitive low-end product solution to offer so as to avoid erosion of its customer base, and its sales force was not equipped to compete at the low end of the market. In addition, because of the complexity of Prism's products, Prism was not achieving follow-on sales from its existing customers, who were able to expand their use of the data warehouse without exhausting its capacity so as to necessitate further purchases, thus forcing Prism to grow its sales only by adding additional numbers of new customers each quarter. Also, customers were being attracted to smaller systems because they posed less risk in case of failure. There had been several instances of significant failures of data warehouse products. As a result of these factors, Prism's revenue and earnings per share ("EPS") growth would slow dramatically during 1996-1997.

4. In or about September 1995, Prism, its insiders and its controlling venture capitalist shareholders decided to undertake a public offering of Prism stock which would: (a) raise over $38 million in cash for Prism as it attempted to compete with its existing product line and to develop new products to compete with the lower priced Data Marts; (b) shift the burden of funding Prism's ongoing operating deficits to Prism's new public shareholders; (c) allow defendants to create a public market in Prism shares, in order to: (i) sell up to 170,000 shares of their Prism stock for over $2 million in the IPO at $17.00 per share, and (ii) provide them with the potential of later recouping the rest of their investment in Prism if they were able to later carry out their plan to dump their Prism stock in the aftermarket; and (d) boost the value of their Prism shares to $17.00 per share -- a $38 million windfall based on the 2.3 million shares they owned.

5. Defendants were advised by investment bankers interested in underwriting Prism's IPO that, because Prism had suffered losses from its inception and was still suffering losses, Prism would have to demonstrate successive profitable quarters in order to successfully complete a public offering of its stock. Defendants understood that they had to make Prism appear to investors to be moving toward profitability. During 3Q95, Prism recorded a modest profit, with $55,000 net income on revenues of $4.8 million. Determined to show a profitable fourth quarter which would allow Prism to complete its IPO, Prism falsely booked revenue and income from 1996 into the 1995 financial statements and, as a result, was able to show a profit in 4Q95. The chart below reflects Prism's operating income with Prism's improper revenue in 4Q95:

6. In addition, in February 1996, in order to make the Company appear to be growing and expanding, Prism changed its sales compensation structure to increase revenue. Prism extended its 1995 sales year into 1Q96, thus creating incentives for its sales force to close sales in 1Q96. As a result, the salesforce generated increased sales in 1Q96, but at substantially increased costs. Moreover, given the length of the sales cycle, the increased revenue came at the expense of draining the sales order pipeline for the latter part of 1996. Prism would thus be unable to maintain its revenue stream and would certainly never achieve profitability in 1996. Nevertheless, because of the positive statements regarding Prism's profits and promising future prospects, including the trending increased revenue, defendants were able to successfully complete Prism's IPO and sell their own stock at the artificially inflated price of $17.00 per share in the IPO.

7. As set forth below, the Registration Statement contained materially false and misleading statements in connection with the offer and sale of Prism common stock. Prism, its corporate insiders and controlling shareholders drafted and signed the Registration Statement which misrepresented the status of Prism's products, sales and profits. Defendants James W. Ashbrook ("Ashbrook") and Samuel M. Hedgpeth, III ("Hedgpeth") promoted Prism's stock to analysts and institutional investors during "Roadshow" presentations and in private meetings.

8. The positive statements which helped accomplish Prism's IPO were false when made. The true, undisclosed facts concerning Prism's products, business and future prospects were: (a) demand for Prism's systems was declining due to increasing competition from cheaper Data Marts that provided similar functions; (b) Prism was not profitable in 4Q95 because the Company improperly recognized revenue in 1995 in violation of Generally Accepted Accounting Principles ("GAAP") and its own Revenue Recognition Policy and, in fact, Prism suffered a loss in that quarter; (c) Prism's sales incentives would result in substantially increased revenue in 1Q96 but (i) would necessarily result in substantial losses because of the increased cost of those sales through commissions and discounts, and (ii) as a result of the sales in 1Q96, the order pipeline was dry, and an increasing revenue stream could not be maintained beyond 2Q96; and (d) because of the foregoing, Prism's losses were escalating and would continue to escalate throughout fiscal 1996 and 1997.

9. As a result of these falsely positive financial results, and Prism's positive statements about the strength of its business and prospects, Prism's IPO was a success and its stock price steadily rose from the $17.00 offering price on March 14, 1996 to as high as $36-3/4 in the third week of May 1996.

10. By late June 1996, defendants realized that the adverse facts regarding Prism's weakening business condition and prospects could not be concealed much longer so they began to "manage" Prism's stock price gradually lower to avoid a sharp stock drop that might expose their wrongdoing and result in their being sued. Defendants therefore leaked into the market the revelation that Prism's growth in revenues had slowed unexpectedly as a result of a few large orders failing to close, causing the results for the second quarter (ended June 30, 1996) to be less than earlier forecasted.

11. Similarly, rumors were circulated in September 1996 that Prism could not meet expectations it had created for its third quarter results, ending September 30, 1996. However, when shareholders contacted the Company during this time period regarding the Company's business and prospects, they were told that everything was fine. Finally, on October 14, 1996, before any of the defendants could sell any more of their Prism stock, the Company revealed that it expected a loss for the third quarter of $0.12 per share compared with analysts' expectations of approximately break-even results. Defendants blamed the poor results on one of its North American regions; however, the results were in fact the product of Prism's undisclosed strategy to increase revenue in the first half of 1996 at the expense of later sales.

12. As a result of these revelations, the market reacted harshly. Prism's stock price -- which was already significantly lower than its previous highs -- plunged from $23-1/2 on June 28, to $18-3/4 on July 1, and to $14-3/4 on July 2, 1996. As rumors were leaked in September 1996, Prism's stock price further declined from $14-3/4 on September 10, to $10-1/8 on September 16, and to $8-1/2 on September 20, 1996. As a result of the October 14, 1996 press release, Prism's stock price plunged from $8-1/8 to $6-1/16 on October 15, 1996, and further declined to as low as $4-1/4 by November 8, 1996. Prism's stock price has never recovered and currently trades in the $3.00-$4.00 per share range.

13. The positive statements made by the defendants in connection with the IPO regarding Prism's business, products and prospects, were false and misleading when made and failed to disclose the following adverse conditions, disclosure of which was necessary to make those statements not misleading, including:

(a) That in late 1995, Prism had improperly booked orders from future periods and, to achieve profitability, had improperly recognized revenue in 4Q95, so as to enable Prism to successfully complete its March 14, 1996 IPO at $17.00 per share;

(b) That Prism's business and prospects were being adversely affected by the availability in the market of less expensive, easily implemented Data Marts being sold by competitors;

(c) That contrary to Prism's purported warning that it "could" show a loss in 1Q96 and 2Q96, it was virtually certain that it would show such a loss because Prism had dramatically increased its compensation structure which increased its cost of sales;

(d) That Prism did not have a product that could compete effectively at the low end of the data-warehouse market;

(e) That Prism did not have a sales force equipped to compete for sales at the low end of the market;

(f) That the growth in the data-warehouse market was largely occurring at the low end of the market, where Prism's business was weak, while growth in the higher end of the market, which included the PWM, was slow and declining;

(g) That because of the size and complexity of Prism's product line, Prism did not achieve significant follow-on sales, but relied on sales to new customers to achieve its growth targets;

(h) That by the time of the IPO, as a result of the efforts to motivate Prism's sales force to close sales in the first quarter in order to report a strong quarter-to-quarter increase in revenue, Prism's pipeline of potential orders had been so drained that by early 1996 there was no reasonable basis for projecting sharply higher revenues and earnings in 2Q96 and 3Q96 and in the following several quarters; and

(i) That Prism's expenses and cost of sales were increasing dramatically, as Prism paid higher commissions to its direct sales force and paid independent contractors to increase its consulting revenues in order to stimulate revenue growth during fiscal 1996.

15. The graphs below show the price action of Prism stock from the March 14, 1996 IPO through October 14, 1996, when the truth about Prism's business emerged and the performance of Prism stock compared to an index of similar companies which shows that the action of Prism stock was due largely to company-specific events and not market forces:

17. (a) Venue is proper in this District pursuant to §22 of the Securities Act, 15 U.S.C. §77v. Many of the acts giving rise to the violations complained of occurred in this District.

(b) Assignment of this action to the San Jose Division is appropriate as a substantial part of the events or omissions identified herein occurred in Santa Clara County.

18. Defendants used the instrumentalities of interstate commerce, the U.S. mails and the facilities of the national securities markets.

(b) All of the shares purchased by the plaintiff in ¶19(a) were issued and sold pursuant to the defective Registration Statement which became effective on or about March 14, 1996. The Registration Statement expressly stated that "of [the total outstanding shares of the Company stock], the 2,170,000 shares sold in this offering will be freely tradeable without restriction under the Securities Act." The remaining shares, held by existing shareholders could, "be sold in the public market only if registered or pursuant to an exemption from registration [under the Securities Act]." In addition, as a result of Company policy and "lock-up" agreements in connection with the Offering, none of Prism's outstanding shares could be sold until the third week of October 1996. Other than the shares sold in the Offering, no other Prism stock was sold. Accordingly, all of the shares purchased were necessarily shares issued pursuant to the defective Registration Statement.

20. Defendant Prism markets software and services for data warehouse management. Prism's stock is traded in an efficient market on the NASDAQ National Market System. Prism's principal place of business is in Sunnyvale, California.

21. (a) Defendant Ashbrook was President and Chief Executive Officer of the Company since June 1991, a director since September 1991 and Chairman of the Board since March 1995. He relinquished his positions as President and Chief Executive Officer on February 13, 1997. Ashbrook sold 10,000 shares of Prism stock, pursuant to the Registration Statement, for $158,100.

(b) Defendant Hedgpeth joined the Company in September 1994 as Vice President Finance and Administration, Chief Financial Officer and Secretary of the Company. Hedgpeth sold 9,000 shares of Prism stock, pursuant to the Registration Statement, for $142,290.

(c) Defendant William H. Inmon ("Inmon") was a co-founder of the Company and served as Vice President Technology from March 1991 to April 1992. In April 1992, Inmon assumed the title of Executive Vice President Technology. Inmon has served also as a director of the Company from March 1991 to March 1992, and from September 1995 to the present. Inmon sold 25,000 shares of Prism stock, pursuant to the Registration Statement, for $395,250.

(d) Defendant Norris van den Berg ("van den Berg") has been a director of the Company since April 1992. He has been a general partner of JMI Equity Fund, L.P. since July 1991. Van den Berg sold 88,000 shares of Prism stock, pursuant to the Registration Statement, for $1,391,280.

22. The defendants identified in ¶21(a)-(d) above are referred to as the Individual Defendants. The Individual Defendants' participation included the preparation, review and/or signing of the false Registration Statement and/or giving false information to securities analysts, money and portfolio managers and institutional investors on the IPO Roadshow. Each of the Individual Defendants signed the Registration Statement and sold shares pursuant to the defective Registration Statement.

24. As part of Prism's corporate planning, financial reporting and management process, Prism prepares a corporate business plan and budget for each fiscal year, as well as monthly and quarterly financial statements included in the financial reporting package reviewed by Prism's top executives and directors. This financial reporting package included Prism's financial results for each month, a comparison of those results to budget and to the prior year and a forecast of results for the remainder of 1996. Ashbrook and his executive staff, including Hedgpeth, Inmon and Cynthia Schmidt, a co-founder of the Company and Vice President of Marketing, met on a regular basis to discuss Company operations, business prospects, revenues and expenses.

25. Prism employed a sales force which worked closely with the Company's customers and which had extensive information as to the sales that could be expected and the threat posed to Prism's business by competitors' low-end product sales. The sales force communicated regularly, both in writing and orally, with the top executives, in particular Schmidt, William Binch, Vice President of North America Field Operations, Binch's predecessor Richard Cohen, former Vice President of North American Sales, and Don Taylor, Vice President of Prism's International Organization regarding anticipated sales, win/loss analysis with competitors, Prism's inability to compete at the low end of the market and how that portion of the market was expanding while the high end was levelling off. These executives, in turn, communicated this information to other defendants.

26. Defendants generally met on a bi-monthly basis. During such meetings, Schmidt presented Prism's sales results and the sales forecasts for current and future quarters to the Board, who also monitored the status of the Company's indirect channel program and key accounts. The Individual Defendants also reviewed the Company's financial statements and financial projections for the coming quarters, presented by Hedgpeth.

27. Prism's products were not as successful as the Company publicly represented, and the Company's forecast for revenue and earnings growth for 1996 and 1997 was unrealistic. In particular, as set out more fully below, (a) the Company had not achieved profitability in 4Q95; (b) competition from smaller Data Marts would result in a substantial decrease in revenue and earnings; and (c) because the Company had implemented substantial sales incentives for its sales force to boost the first quarter revenue, the order pipeline for the second half of fiscal 1996 would be depleted while expenses increased, and there was no reasonable basis for increased revenue and earnings projections for the second half of fiscal 1996 and fiscal 1997.

28. From its inception in 1991 through mid-1995, Prism was financed principally by venture capitalists through private sales of preferred stock which totaled approximately $13,107,000. By December 31, 1995, the Company had an accumulated deficit of $11,439,000. In addition, by December 31, 1995, Prism had $1,861,000 in cash, and $904,000 of working capital, amounting to a 50% decrease in cash and a 78% decrease in working capital from 1994. By late 1995, Prism was running out of money and needed to find a new source of funding.

29. In addition, during 1995, competition from Data Marts, which were smaller, cheaper data warehouse systems -- that could do most of what Prism's system could for nearly half the cost -- thus unless Prism could develop a comparable product, defendants would not be able to recoup their investments in Prism, let alone profit.

30. By mid-1995, defendants had been told by investment bankers and consultants that the Company would have to demonstrate profitability in successive quarters in order to successfully complete a public offering of its stock. Since its inception, however, despite increasing its revenues, Prism had consistently suffered quarterly and annual losses. The following chart shows Prism's results for the six quarters to June 1995:

                                           Quarter Ended                       
                      ---------------------------------------------------------
                      Mar. 31, June 30, Sept. 30,  Dec. 31,  Mar. 31   June 30,
                        1994      1994     1994      1994      1995      1995  
                      ---------------------------------------------------------
                                           (in thousands)                      
Revenues:                                                                      
License. . . . . .. .  $ 748   $ 1,303   $ 1,519   $ 2,725   $ 2,594   $ 2,337 
Services and other. . .  236       413       599       684       802       915 
                       -----   -------   -------   -------   -------   ------- 
Total revenues  . . . .  984     1,716     2,118     3,409     3,396     3,252 
                       -----   -------   -------   -------   -------   ------- 
Net income (loss) .  $(1,362)   $ (755)   $ (399)    $ (22) $ (1,317)  $(1,556)
                     =======   =======   =======   =======   =======   =======

32. In fact, Prism reported a net profit of $55,000 in 3Q95. In order to go public, Prism would have to remain profitable and appear to be trending toward greater profitability. Moreover, because the Company's fourth quarter was traditionally its most successful quarter -- having the highest total revenues and operating income of the year -- it was critical that the Company report a profit in the quarter; otherwise, the third quarter results would be seen as an aberration.

33. During the December 14, 1995 Board meeting, defendants met and reviewed Prism's revenue forecasts for 4Q95 and 1Q96. Hedgpeth confirmed that Alex. Brown, H&Q and Cowen were engaged as lead underwriters of Prism's IPO. In preparation for the IPO, the Company requested its auditor, Coopers & Lybrand, complete its audit of Prism's fiscal 1995 financial statements within two weeks of the quarter's close, by January 15, 1996. With a new analysis provided by Genesis Consulting Group, defendants determined that the Company's stock should be valued at $5.50 per share, again based on Prism's "profitable" fourth quarter and continuing improvement in its prospects. It was therefore critical for Prism to show a profit in 4Q95.

34. In 1995, Prism's Revenue Recognition Policy for software license fees provided that revenue would be recognized when Prism received: (a) an executed End User License Agreement; (b) an executed order schedule (fees to be paid, specific products and quantity to be signed by customer); and (c) a purchase order ("PO"). Receipt of a PO was extremely important to Prism's revenue recognition because acceptance by the customer of Prism's product was a crucial point in the sales cycle pertaining to whether the sale had actually been completed. Prism's policy was emphatic, however, that

[t]he order documents must be received before the end of the accounting period.

35. Although Prism's sales had tended to be weighted toward the last part of each quarter, 4Q95 was exceptional in this respect. More than 43% of the quarterly license revenues for the quarter were booked in the last week and 36% on the last day. Consistent with defendants' determination to show a profit in the fourth quarter, Prism's sales and finance personnel worked extremely hard to obtain the necessary approvals before the end of 4Q95, recording revenue from 12 contracts on December 29, 1995, the last day of the quarter. However, on at least one of those contracts, Associates Bancorp, Inc. ("Associates"), Prism improperly recognized the revenue in violation of GAAP and Company policy to do so.

36. On or about December 20, 1995, Associates executed a license agreement with Prism for a PWM for $165,550. The agreement included maintenance, training and site modules with $109,000 representing the amount of licensing revenue.

37. In accordance with Prism's Revenue Recognition Policy, before the revenue could be recognized, Prism needed a PO from Associates by the end of the accounting period, and Prism tried desperately to get one. On December 27, 1995, the salesman on the contract e-mailed Prism's controller concerning the "Associate PO." The salesman wrote:

I have calls into Jeff Donaldson [at Associates], but it wouldn't hurt for you to give him a call about the status of the PO. . . . Thanks.

38. On the following day, December 28, 1995, the salesman again wrote to Prism's Controller, via e-mail, stating:

I called [Associates'] CFO to see if he could give you a verbal confirmation on the PO. He was involved in our contract negotiation so he is familiar with the deal; however, he is on vacation this week and won't be back till the 2nd. Today was his assistant's third day at work so she couldn't help either. Supposedly, he is checking voice mail so you can try that.

I have a call into Jacques Reichenstein. I don't know who he is or what he does, but his name was on their internal purchase request document. If he doesn't call me back then we're pretty much dead until next week.

40. Prism received the Associates PO, which was dated January 2, 1996, on or about January 3, 1996. Nevertheless, Prism fraudulently recognized revenue of approximately $109,000 for a "sale" of a PWM to Associates on December 29, 1995, the last business day of 4Q95. The revenue was improperly recognized because Prism had not completed the sale until 1Q96.

41. Recognizing the revenue of the Associates contract in 4Q95 was material, and indeed critical, to Prism. With over $105,000 in gross profit (gross margin was approximately 98%) Prism was able to show an $80,000 profit instead of a loss. The difference was particularly important to Prism, since: (a) the Company had shown a profit of $55,000 in the third quarter and reporting a greater profit in the consecutive quarter made it appear that the Company was trending toward profitability; (b) the fourth quarter was traditionally the Company's strongest quarter -- revenues and earnings were the highest of the year, thus, had Prism accurately reported its revenues it would have shown a loss in its most productive quarter and the profitable third quarter would have been seen as an aberration; and (c) as a result of this track record, Prism was able to "go public" in March 1996 at a stock price/earnings multiple reserved for premier growth companies.

42. Immediately after the close of the fourth quarter, defendants began drafting the Registration Statement and preparing the IPO. On or about January 3, 1996, Hedgpeth prepared a draft Registration Statement reflecting the Company's profitable third and fourth quarters, and circulated it to each of the other Individual Defendants as well as corporate counsel. On January 9, 1996, defendants met with the underwriters at the initial organization meeting. Over the next several weeks, defendants, along with the underwriters and attorneys, drafted the Registration Statement and began to organize the Roadshow. From the earliest drafts, defendants emphasized Prism's profitable 4Q95.

43. On January 18, 1996, in anticipation of the Offering, defendants again increased the valuation of the Company's stock this time to $7.50 per share -- based upon the profitable 3Q95 and 4Q95. Indeed, the Company expressly stated that its increased valuation was based upon its having become profitable. In a February 23, 1996 letter to the SEC, the Company's attorneys explained the increase in Prism's stock valuation as having been based in large part on the Company's establishing profitability on a quarterly basis in 3Q95 and 4Q95. They wrote: The Company "believes that $0.25 per share accurately reflected the market value of the Company's Common Stock in March 1995 [when the Company completed a quarter, with substantial quarterly loss] and that the increase in value from $0.25 in March to $1.00 in September (when profitability was about to be established on a quarterly basis and the recently introduced Prism Directory Manager was beginning to demonstrate customer acceptance) is amply justified." Prism's two profitable quarters and its quarter-to-quarter revenues and earnings growth enabled Prism to plan its IPO for early 1996.

44. Having determined that the IPO would take place in 1Q96, defendants sought to increase the Company's revenues to reflect its success in the marketplace. To that end, in mid-February 1996, defendants informed their sales force that the Company was going to extend their 1995 sales year through 1Q96. Prism's commission structure was based upon the sales force reaching quarterly sales quotas. When the quota was reached, the salesman's commission would increase in the next quarter. Prism's salesmen therefore earned their largest commissions on fourth quarter sales, often around 12%. In the first quarter, the percentage would return to the 3% range. Thus, by extending the sales year into 1Q96, defendants motivated their sales force to close as many sales as they could in 1Q96. Salesmen whose yearly quotas were $1 million booked half a year's quota in 1Q96. In 1Q96, Prism was able to book $7.5 million in revenue -- $1.2 million over 4Q95, generally the Company's most significant quarter, and 100% over its year earlier 1Q revenues.

45. The sales incentive program, however, had an additional significant negative impact on the Company. Typically, it takes at least six months for the sales force to develop an order pipeline in order to reach their quotas. By establishing substantial incentives to close as many sales as possible in the first quarter, the Company's sales in later quarters would necessarily suffer since the order pipeline would be depleted. In fact, while some of the sales that did not close in the first quarter spilled over to the second quarter, by the third quarter, the pipeline was dry.

47. A principal purpose of the Roadshow was to circulate very favorable information about Prism's business that could not be included in the Registration Statement, including forecasts of dramatically increasing revenue and earnings growth throughout 1996 and 1997 and emphasizing Prism's two profitable quarters in 3Q95 and 4Q95, statements without which Prism stock never could have been sold. Thus, at the Roadshow meetings, the defendants also represented, among other things, that: "Prism is entirely focused on data warehousing," "Prism offers the market leading solution in the warehouse management tools segment" and Prism had an "[i]mpressive customer list and critical mass already accomplished." Prism also emphasized that its primary competitors were "in-house solutions" for data retrieval and storage. The Company also emphasized that "[t]he Company is growing rapidly."

48. On March 14, 1996, Prism commenced its IPO pursuant to the materially false and misleading Registration Statement. The Registration Statement presented Prism's quarterly revenues and income which represented that the last two preceding quarters, including 4Q95, were profitable.

49. The Registration Statement also stated that:

Although the Company's two most recent quarters have been profitable, the Company has never been profitable on an annual basis and, at December 31, 1995, had an accumulated deficit of $11,439,000. There can be no assurance that the Company will achieve profitability on a quarterly or annual basis in the future.

50. The Registration Statement also stated:

The Company also has experienced seasonality in its operating results, with the fourth quarter typically having the highest total revenues and operating income in any year. Further, revenues for the Company's fourth quarter have historically been higher than those for the first quarter of the following year, and the Company has historically realized substantially lower operating margins and higher net losses in the first quarter than in the immediately preceding fourth quarter. There can be no assurance that this pattern will not continue in the current quarter or in the first quarter of future years. The Company currently believes that it could experience net losses in the first and second quarters of 1996.

51. The statements made by defendants in connection with the sale of Prism stock in the Offering, including those made in the Registration Statement, were materially false and misleading. As detailed in ¶¶34-41 and ¶¶52-61, the Company improperly recognized revenue in 4Q95 which should have been recognized in 1Q96. The Company represented in the Registration Statement that revenue was not recognized until receipt of a PO in addition to other requirements. This requirement provided a measure of comfort to investors as it indicated that the Company's results were well within GAAP and, despite Prism's history of losses, investors could at least rely on the fact that the financial statements were accurate. Had defendants complied with GAAP and Prism's Revenue Recognition Policy, the Company would have, and should have, shown a loss in 4Q95. The Registration Statement was thus materially false and misleading.

52. Prism's Registration Statement contained false financial information which was presented in violation of GAAP and SEC rules, permitting the Company to falsely state in the Registration Statement that its most recent two quarters had been profitable. Prism's results for 4Q95 were materially false and presented in violation of GAAP due to the Company's inclusion of revenues from at least one sale which had not been completed as of the end of the period in which Prism recognized revenue. Due to this improper revenue recognition, Prism falsely reported profits of $80,000 in 4Q95 instead of the loss it had actually incurred in that quarter. This improper revenue recognition was material to Prism's financial statements, since it enabled Prism to represent that the fourth quarter, the quarter which traditionally had the highest total revenues and operating income, was profitable.

53. In the Registration Statement, Prism included quarterly financial statements for each of the eight quarters ended December 31, 1995, and represented the following with regard to those results:

The unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements contained herein and include all adjustments, consisting only of normal recurring accruals, that the Company considers necessary for a fair presentation of such information when read in conjunction with the Company's annual audited consolidated financial statements and notes thereto appearing elsewhere in this Prospectus.

                                                  Quarter Ended                                
                   ----------------------------------------------------------------------------
                   Mar. 31, June 30, Sept. 30,  Dec. 31,  Mar. 31   June 30, Sept.30,  Dec. 31,
                     1994      1994     1994      1994      1995      1995     1995     1995   
                   ----------------------------------------------------------------------------
                                                  (in thousands)                               
Revenues:                                                                                      
License             $ 748   $ 1,303   $ 1,519   $ 2,725   $ 2,594   $ 2,337   $ 3,711   $ 4,026
Services and other    236       413       599       684       802       915     1,071     2,304
                    -----   -------   -------   -------   -------   -------   -------   -------
Total revenues        984     1,716     2,118     3,409     3,396     3,252     4,782     6,330
                    -----   -------   -------   -------   -------   -------   -------   -------
Net income (loss) $(1,362)   $ (755)   $ (399)    $ (22)  $(1,317)  $(1,556)       55        80
                  =======   =======   =======   =======   =======   =======   =======   =======

54. The results for 4Q95, and representations concerning those results were materially false and misleading due to the Company's improper revenue recognition in violation of GAAP and SEC rules.

55. Generally Accepted Accounting Principles are those principles recognized by the accounting profession as the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. SEC 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, despite footnote or other disclosure. 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).

56. Generally Accepted Accounting Principles as set forth in AICPA Statement of Position ("SOP") 91-1, Software Revenue Recognition, require that certain conditions be met prior to recognition of revenue on the type of products Prism sold. Statement of Position 91-1 ¶34 requires at a minimum that three requirements must be met: (a) delivery has occurred; (b) other remaining vendor obligations are no longer significant; and (c) collectibility is probable. Prism's sale cycle for its data warehouse management software was lengthy and involved significant evaluation and acceptance by customers. Prior to this evaluation and acceptance, no sale had occurred as collection of the amount was not probable and Prism had not accomplished what it must do to be entitled to the revenues; Prism had not earned the revenue.⁽¹⁾

57. Accordingly, Prism's accounting policies require that acceptance be obtained from a customer prior to revenue recognition in the form of an unconditional PO. In fact, Prism represented in the Registration Statement that revenue was recognized "after execution of a licensing agreement, receipt of a purchase order and shipment of the product."

58. Prism violated GAAP, its internal Revenue Recognition Policy and stated revenue recognition method to show a profit in 4Q95. As Prism approached the end of 4Q95, it did not have sufficient sales to generate a net profit in that quarter. Nevertheless, Prism included at least one sale for which a written PO was not obtained prior to the end of the quarter. This sale should not have been recorded as Prism had not obtained a written PO, thus collectibility was not assured as of the time the revenue was recognized and Prism had not earned the revenue.

59. At the end of the fourth quarter, Prism was concerned that it had not obtained acceptance on a sufficient number of software licenses to generate a profit for that quarter. With regard to one customer, Associates, Prism needed to get a PO so that it could record revenue in accordance with its internal policy and its public stated policy. Despite their best efforts to contact the CFO at Associates or another person in authority who could generate a PO, Prism was unable to obtain such acceptance prior to December 31, 1995. The PO which Prism ultimately received for this sale was prepared and printed in 1996 rather than in 1995. Thus, Prism had missed its "cutoff" for recognition in 1995. Nonetheless, Prism recognized the revenue so that it could show a profit for the quarter as opposed to a loss.

60. 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 interim financial reporting should be based upon the same accounting principles and practices used to prepare annual financial statements (APB No. 28, ¶10);

(b) 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);

(c) The principle that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources and effects of transactions, events and circumstances that change resources and claims to those resources was violated (FASB Statement of Concepts No. 1, ¶40);

(d) 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);

(e) The principle that financial reporting should provide information about an enterprise's financial performance during a 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 of past enterprise performance (FASB Statement of Concepts No. 1, ¶42);

(f) 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);

(g) 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

(h) 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 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).

62. Moreover, because Prism misrepresented its revenue and earnings in 4Q95, its purported Registration Statement "Risk Factors" concerning Prism's future profitability were also materially false and misleading when made. For example, in the Registration Statement under "Risk Factors," the Company stated:

Although the Company's two most recent quarters have been profitable, the Company has never been profitable on an annual basis and, at December 31, 1995, had an accumulated deficit of $11,439,000. There can be no assurance that the Company will achieve profitability on a quarterly or annual basis in the future.

63. The Registration Statement also stated:

The Company has experienced seasonality in its operating results, with the fourth quarter typically having the highest total revenues and operating income in any year. Further, revenues for the Company's fourth quarter have historically been higher than those for the first quarter of the following year. The Company believes that the seasonality of its revenues results primarily from the budgeting cycles of its customers, the structure of the Company's sales commission program and the timing of the Company's fiscal year end. Since operating expenses typically increase on a quarterly basis as a result of additional hiring of staff, the Company has historically realized substantially lower operating margins and higher net losses in the first quarter. There can be no assurance that this pattern will not continue in the current quarter or in the first quarter of future years.

64. In addition, the Registration Statement described Prism's sales cycles in a materially false and misleading manner in omitting the fact that, due to Prism's incentive sales program, and the nature of its business and its sales in 1Q96, its pipeline of orders would necessarily lengthen dramatically because its sales force would close as many sales as possible in the first and second quarters thereby depleting its sales channel in the third and fourth quarters -- traditionally the periods that Prism achieved its greatest revenue and net income. In addition, the Registration Statement's statements concerning its "lengthy sales analysis" were misleading for concealing the devastating impact the lack of sustainable sales pipeline would have on Prism's revenue stream and income. For example, the Registration Statement stated that as of December 31, 1995, the Company had more than 100 active customers. However, the Company did not reveal that follow-on sales to such customers were relatively insignificant to Prism's ongoing business, and that Prism was dependent on sales to new customers to continue its rate of growth. While the Registration Statement warned that the data warehouse market was intensely competitive, the Registration Statement did not reveal the true adverse facts about the impact on its business that Prism was experiencing as a result of its sales program and the introduction by several of its competitors of smaller, less expensive data warehouse systems known as Data Marts. At the time of the IPO, numerous customers were failing to purchase or evaluate Prism's data warehouse systems, which were very expensive and complex, but rather were meeting their needs through the purchase of smaller, less comprehensive systems.

65. Taking advantage of Prism's inflated stock price on the IPO, the Individual Defendants sold substantial amounts of their Prism stock at inflated prices pursuant to the Registration Statement, as follows:

     NAME              TOTAL SHARES SOLD       TOTAL PROCEEDS
     ----              -----------------       --------------
James W. Ashbrook            10,000             $  158,100.00
Samuel M. Hedgpeth, III       9,000             $  142,290.00
William H. Inmon             25,000             $  395,250.00
Norris van den Berg          88,000             $1,391,280.00
                            -------             -------------
     TOTAL:                 132,000             $2,086,920.00
                            =======             =============

66. Each of the defendants' positive statements about Prism's business during Roadshow presentations and private meetings with investors and securities analysts and contained in the Registration Statement was materially false and misleading when made, and failed to disclose, inter alia, the following adverse information:

(a) That in late 1995, Prism had improperly booked orders from future periods and, to achieve profitability, had improperly recognized revenue in 4Q95, so as to enable Prism to sell its stock in the March 14, 1996 IPO on favorable terms;

(b) That Prism's business and prospects were being adversely affected by the availability in the market of less expensive, easily implemented Data Marts being sold by competitors;

(c) That contrary to Prism's purported warning that it "could" show a loss in 1Q96 and 2Q96, it was virtually certain that it would show such a loss because Prism had dramatically increased its compensation structure which increased its cost of sales and drained its order pipeline so that the Company would be unable to increase sales in the latter half of 1996 and its high margin licensing revenue would substantially decline;

(d) That Prism did not have a product that could compete effectively at the low end of the data warehouse market;

(e) That Prism did not have a sales force equipped to compete for sales at the low end of the market;

(f) That the growth in the data warehouse market was largely occurring at the low end of the market, where Prism's business was weak, while growth in the higher end of the market, which included the PWM, was slow and declining;

(g) That because of the size and complexity of Prism's product line, Prism did not achieve significant follow-on sales, but relied on sales to new customers to achieve its growth targets;

(h) That by the time of the IPO, as a result of the efforts to motivate Prism's sales force to close sales in the first quarter in order to report a strong quarter-to-quarter increase in revenue, Prism's pipeline of potential orders had been so drained that by early 1996 there was no reasonable basis for projecting sharply higher revenues and earnings in 2Q96 and 3Q96 and in the following several quarters; and

(i) That Prism's expenses and cost of sales were increasing dramatically, as Prism paid higher commissions to its direct sales force and paid independent contractors to increase its consulting revenues in order to stimulate revenue growth during fiscal 1996.

67. Finally, on October 14, 1996, after the close of the market, Prism issued a press release revealing that revenues for the quarter ended September 30 declined sequentially to $6 million and that Prism had posted a net loss of $1.6 million or $0.12 per share. Ashbrook blamed the shortfall on one of three geographic sales regions in North America and lower utilization rates in Prism's consulting organization. In subsequent communications with analysts, Prism claimed that they were maintaining a two-thirds or three-quarters percent win ratio regarding new customers and that stronger competition was not the source of slowing growth. Analysts did not believe these claims, however. The Cowen analyst described the shortfall as "huge" and stated that operations were "out of control." The analyst described the third quarter shortfall as "a big surprise." As a result of these revelations, Prism's stock price declined to $6-1/16 on October 15, 1996, and continued to drift downward to as low as $4-1/4 by November 6, 1996. Prism's stock price has never recovered and currently trades at about $3.00-$4.00 per share.

69. The members of the Class are so numerous that joinder of all members is impracticable. The disposition of their claims in a class action will provide substantial benefits to the parties and the Court. After the IPO, Prism had more than 2.1 million shares of stock outstanding, owned by hundreds of shareholders.

70. There is a well-defined community of interest in the questions of law and fact involved in this case. The questions of law and fact common to the members of the Class which predominate over questions which may affect individual Class members include the following:

(a) Whether the federal securities laws were violated by defendants;

(b) Whether defendants omitted and/or misrepresented material facts;

(c) Whether the IPO price of Prism stock was artificially inflated; and

(d) The extent of damage sustained by Class members and the appropriate measure of damages.

72. The prosecution of separate actions by individual Class members would create a risk of inconsistent and varying adjudications.

73. Plaintiff will adequately protect the interests of the Class. He has retained counsel who are experienced in class action securities litigation. Plaintiff has no interests which conflicts with those of the Class.

74. A class action is superior to other available methods for the fair and efficient adjudication of this controversy.

77. This Claim is brought pursuant to §11 of the Securities Act, 15 U.S.C. §77k, on behalf of the Class, against all defendants.

78. The Registration Statement for the March 14, 1996 IPO was inaccurate and misleading, contained untrue statements of material facts, omitted to state other facts necessary to make the statements made not misleading, and failed to adequately disclose material facts, as is described above.

79. Prism is the issuer of the stock sold via the Registration Statement. As issuer of the shares, Prism is strictly liable to plaintiff and the Class for the material misstatements and omissions therein.

80. The Individual Defendants named in this claim each signed the Registration Statement. None of the Individual Defendants named herein made a reasonable investigation or possessed reasonable grounds for the belief that the statements contained in the Registration Statement were true, did not omit any material fact and were not misleading.

81. Each of the defendants issued, caused to be issued and participated in the issuance of materially false and misleading written statements to the investing public which were contained in the Registration Statement, which misrepresented or failed to disclose, inter alia, the facts set forth above. As a direct and proximate result of defendants' acts and omissions in violation of the Securities Act, the market price of Prism stock was artificially inflated in the IPO and plaintiff and the Class suffered substantial damage in connection with their purchase of Prism common stock. By reasons of the conduct herein alleged, each defendant violated, and/or controlled a person who violated, §11 of the Securities Act.

82. At the times they purchased Prism shares, plaintiff and other members of the Class were without knowledge of the facts concerning the false or misleading statements or omissions alleged herein. Less than one year has elapsed from the time that plaintiff discovered or reasonably could have discovered the facts upon which this Complaint is based, to the time that plaintiff filed his Complaint. Less than three years have elapsed from the time that the securities upon which this Claim is brought have bona fide offered to the public, to the time plaintiff filed his Complaint.

84. This Claim is brought pursuant to §15 of the Securities Act, 15 U.S.C. §77o, against all defendants.

85. The Individual Defendants, by reason of their stock ownership, management position, and/or membership or representation on the Company's Board of Directors, were controlling persons of the Company and had the power and influence, and exercised the same, to cause Prism to engage in the violations of law complained of herein. These defendants are therefore liable under §15 of the Securities Act.

86. Prism controlled each of the Individual Defendants and is liable for their acts pursuant to §15 of the Securities Act.

1. Declaring this action to be a proper class action pursuant to Rule 23(a) and (b)(3) of the Federal Rules of Civil Procedure on behalf of the Class defined herein;

2. Awarding plaintiff and the members of the Class compensatory damages;

3. Awarding plaintiff and the members of the Class pre-judgment and post-judgment interest, as well as reasonable attorneys' fees, expert witness fees and other costs;

4. Awarding extraordinary, equitable and/or injunctive relief as permitted by law, equity and the federal statutory provisions sued hereunder, including the imposition of a constructive trust upon the proceeds of defendants' insider trading, pursuant to Rules 64, 65 and any appropriate state law remedies; and

5. Awarding such other relief as this Court may deem just and proper.

PRISM\DRD01676.CPT

1. GAAP, as set forth in FASB Statement of Concepts No. 5 ¶¶83-84, state that revenue should not be recognized until it is both earned and is collectable.
 
 

23 Jan 1998
Source: Milberg Weiss web site and copy of court-stamped paper document.