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Stanford University Law School - Securities Class Action Clearinghouse
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MILBERG WEISS BERSHAD
HYNES & LERACH
WILLIAM S. LERACH (68581)
ALAN SCHULMAN (128661)
DARREN J. ROBBINS (168593)
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
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JEFF S. WESTERMAN (94559)
355 South Grand Avenue
Suite 4170
Los Angeles, CA 90071
Telephone: 213/617-9007
DYER DONNELLY & LILLEY
ROBERT J. DYER III
825 Logan Street
Denver, CO 80203-3114
Telephone: 303/861-3003
Attorneys for Plaintiff
UNITED STATES DISTRICT COURT
CENTRAL DISTRICT OF CALIFORNIA
SOUTHERN DIVISION
DARRIN J. CARAMONTA, On Behalf of ) No. CV-96-81-GLT-EEx
Himself and All Others Similarly )
Situated and Derivatively on Behalf ) SHAREHOLDER CLASS ACTION
of TOUCHSTONE SOFTWARE CORPORATION, ) AND DERIVATIVE SUIT
)
Plaintiff, )
)
vs. )
)
LARRY DINGUS, C. SHANNON JENKINS, ) CLASS ACTION COMPLAINT FOR
RONALD MAAS, KENNETH WELCH, III, ) VIOLATION OF THE FEDERAL
DONALD WATTERS, SIGMUND FIDYKE, and ) SECURITIES LAWS AND THE
TOUCHSTONE SOFTWARE CORPORATION, ) CAL. CORP. CODE; VERIFIED
) DERIVATIVE COMPLAINT FOR
Defendants, ) BREACH OF FIDUCIARY DUTY
) AND VIOLATION OF THE CAL.
- and - ) CORP. CODE
)
TOUCHSTONE SOFTWARE CORPORATION, )
)
Nominal Defendant on )
Derivative Claims. ) Plaintiff Demands A
____________________________________) Trial By Jury
SUMMARY OF ACTION
1. This is a class action on behalf of all persons who
purchased the common stock of TouchStone Software Corporation
("TouchStone" or the "Company") between May 2, 1995 and December
21, 1995 (the "Class Period"), seeking to pursue remedies under the
Securities Exchange Act of 1934 (the "Exchange Act") and the
California Corporations Code ("Cal. Corp. Code"). The class action
claims complain of a scheme to defraud or deceit on purchasers of
TouchStone stock involving defendants' dissemination of false and
misleading information about TouchStone's financial results, the
demand for and market acceptance of its software products, as well
as its future prospects, which artificially inflated the price of
TouchStone stock and enabled defendants to sell 2.3 million shares
of Touchstone stock to the public at $13.50 per share. This is
also a derivative action brought on behalf of TouchStone against
its officers and directors for breach of fiduciary duty and
violation of the Cal. Corp. Code to recover three times their
insider trading profits and to require TouchStone's officers and
directors to indemnify TouchStone for any liability it may incur
for violations of the federal and state securities laws alleged in
the class action claims.
2. Prior to 1988 TouchStone sold products known as
"connectables" but achieved little commercial success. In 1989
TouchStone began to sell software for diagnostic testing of
personal computer operating systems known as "utility software."
However, TouchStone's utility software also achieved very little
commercial success and during 1990-1993 and the first half of 1994,
TouchStone was able to achieve little earnings per share growth.
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During these years, TouchStone's stock never traded above $1.00 per
share and sold for as low as $.06 per share and neither Touchstone
nor its insiders were able to sell TouchStone stock to raise
capital or pocket any substantial proceeds.
3. During the last half of 1994, a new PC diagnostic utility
program introduced by TouchStone called WINCheckIt purportedly
achieved some success and TouchStone reported $.12 in earnings per
share in the third and fourth quarters of 1994 -- its most
successful two quarters ever. However, TouchStone's stock
continued to languish, trading between $.25 and $1.56 per share
during the third and fourth quarters of 1994.
4. During 1995, stocks which appeared positioned to benefit
from the anticipated release of Microsoft's Windows '95 computer
software performed well as market interest in companies with such
products heightened with the impending introduction of Windows '95.
TouchStone's insiders recognized that this environment presented an
opportunity for them to exploit by inflating TouchStone stock up
much higher in price so that TouchStone and its insiders could sell
substantial amounts of TouchStone stock for the first time in many
years.
5. However, TouchStone's insiders faced serious obstacles to
capitalizing on this situation. First, because TouchStone's
WINCheckIt product was not compatible with Windows '95, they knew
WINCheckIt would not continue to generate any substantial revenues
or earnings after the introduction of Windows '95. Second, there
was no way to tell if TouchStone's Windows '95 compatible product
-- WIN'95 Advisor -- would be a commercial success. Third, they
knew TouchStone's earning power was very poor due to weak sell-
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through of its products and TouchStone was in fact accruing only
minimal earnings or actually suffering losses. Fourth,
TouchStone's stock was traded in the NASDAQ "Small Cap" market
which limited defendants' ability to manipulate the stock to higher
levels. Unless these obstacles could be overcome, TouchStone's
insiders knew its stock would continue to trade at "penny stock"
levels. So, in order to overcome these obstacles, defendants
pursued a fraudulent scheme and course of business that operated as
a fraud or deceit on purchasers of TouchStone stock by falsifying
TouchStone's financial results while misrepresenting the state of
its business and the success of and demand for its WINCheckIt
product as well as for its newest product WIN'95 Advisor, thus
driving TouchStone stock higher to inflated levels.
6. For instance, defendants repeatedly represented that
TouchStone was "a leading developer and publisher of utility
software products," an "industry leading publisher," a "leader in
the industry" and a "major force in the market" due to the
"phenomenal success" of its products. TouchStone also reported
strong profits during the Class Period:
1995
1st Quarter 2nd Quarter 3rd Quarter
Revenue $2.8 million $3.3 million $3.5 million
Net Income $457,000 $404,000 $479,000
EPS $.07 $.06 $.07
Defendants represented these results included "all adjustments
necessary for a fair presentation," including adequate reserves for
product returns, which were based on TouchStone's "historical
experience." Defendants represented that the listing of
TouchStone's stock on the NASDAQ market "will definitely increase
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its value." Defendants also stated TouchStone was "very pleased"
with its early 1995 results and had avoided the normal adverse
seasonal impact in the first quarter due to the "success,"
"phenomenal success" and "continued success" of its WINCheckIt
product, which they said was "on a fast track to success," was "our
big success story" and which was enjoying "brisk demand." When
TouchStone introduced WIN'95 Advisor in July 1995, it stated it had
received a very large $1.7 million single order" for the product
and later assured the market that the sell-through of WIN'95
Advisor was "as expected," that sales of WIN'95 Advisor
unaccompanied by a sale of Windows '95 software were "higher than
expected," and that TouchStone expected to sell 220,000 to 225,000
WIN'95 Advisor's in 1995 and thus achieve earnings per share of
$.08 in the fourth quarter, $.29 for all of 1995 and $.43 for 1996.
7. Defendants' scheme was very successful. TouchStone's
false financial reports and defendants' other false statements
artificially inflated TouchStone stock from $3-3/4 per share on May
2, 1995, to a Class Period high on August 24, 1995, of $17-5/8 per
share. On August 25, 1995, defendants completed a huge public
offering of TouchStone stock at $13.50 per share in which
TouchStone sold 1.3 million shares and TouchStone's insiders sold
one million shares, thus pocketing $16.3 and $12.5 million,
respectively. TouchStone's top officers and directors unloaded
between 26% and 50% of their holdings in TouchStone in this stock
offering.
8. Each of the positive statements about TouchStone's
business as well as its financial results were materially false and
misleading when made. TouchStone's first, second and third quarter
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1995 revenues, net income and earnings per share were improperly
inflated in violation of Generally Accepted Accounting Principles
("GAAP") due to reporting sales where distributors had unlimited
rights of return and payment was contingent upon resale and by
shipping amounts of product well beyond that which reasonably could
be sold by its distributors, while at the same time underreserving
for product returns and reseller rebates. TouchStone was not an
industry leader or major force in the market but rather a fringe
company with undistinguished products, virtually none of which had
ever achieved success. Nor was TouchStone's WINCheckIt product as
successful as represented as a substantial amount of the "sales" of
that product consisted of orders where distributors had unlimited
rights of return or where they, at TouchStone's request, had
accepted shipments of larger amounts of the product than they could
sell, especially since WINCheckIt was facing sharply reduced sales
after the introduction of Windows '95, with which it was not
compatible. Also, TouchStone's large $1.7 million order for its
WIN'95 Advisor product was misleading because it included unlimited
rights of return of the product and payment for the order was
contingent upon resale. In fact, WIN'95 Advisor encountered very
weak sales at retail from the outset. For all these reasons there
was never any basis to state that 200,000 to 225,000 WIN'95
Advisors would be sold in 1995 or that TouchStone would achieve
fourth quarter earnings per share of $.08, 1995 earnings per share
of $.29 or 1996 earnings per share of $.43. Those forecasts were
all false when made, as they were contradicted by the above adverse
information about TouchStone and not genuinely believed by
defendants.
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9. Just a month after TouchStone's August 1995 stock
offering, TouchStone stock began to fall as rumors circulated that
demand for TouchStone's new WIN'95 Advisor product was not strong
and that its sell-through was weaker than expected. However, the
defendants immediately undertook to discredit and/or counteract
these rumors and support TouchStone's stock price by representing
that demand for WIN'95 Advisor was good, that the sell-through of
the product was proceeding "as expected" and TouchStone expected to
sell between 200,000 and 285,000 WIN'95 Advisors in 1995 and that
sales of that product unaccompanied by a purchase of the Microsoft
Windows '95 software product were actually "larger" than had been
expected. As a result of these false assurances, TouchStone stock
continued to trade at artificially inflated prices.
10. On October 17, 1995, TouchStone did reveal that demand
for WIN'95 Advisor was weak and that it had cut prices of the
product. However, defendants continued to inflate and/or support
TouchStone's stock by reporting strong revenues and earnings per
share for TouchStone's third quarter which materially overstated
TouchStone's actual results, and by falsely stating that they
expected demand for TouchStone's WIN'95 Advisor to pick up during
the Christmas season and that TouchStone would earn about $.08 per
share in the fourth quarter of 1995.
11. Finally, on December 21, 1995, defendants revealed that
TouchStone would suffer a large loss for the fourth quarter and
likely for the 1995 year as a whole as well, because of massive
returns of WINCheckIt and WIN'95 Advisor products, due to excessive
inventories of those products in the distribution channel.
TouchStone admitted that it had really sold only 70,000 WIN'95
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Advisors and would suffer returns of over 100,000 of previously
sold units! After these revelations, TouchStone's President/CEO
was replaced and TouchStone's stock fell as low as $2-3/4 per
share, just about what it sold for when defendants commenced their
scheme to inflate the price of the stock.
12. Defendants' fraudulent scheme involved stock manipulation
and a bailout by corporate insiders who inflated TouchStone's stock
and took advantage of their knowledge of non-public information
regarding TouchStone by selling 2.3 million shares of TouchStone
stock to the public at inflated prices, thus benefitting from the
fraud by almost $30 million, before the true facts became known and
the stock collapsed back near the levels where it had traded before
the scheme began.
13. The stock charts below show the price increase in
TouchStone stock while defendants were issuing their false and
misleading statements about the Company, defendants' stock sales at
inflated prices during that period and the subsequent collapse as
the true facts were disclosed, and illustrate that, when compared
to an index of similar stocks, the movement of TouchStone stock was
largely due to Company specific information as opposed to industry
or market factors.
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TouchStone Software Corporation
December 2, 1994 - December 22, 1995
Weekly Stock Prices
TouchStone Software Corporation
vs. H&Q Computer Software Group*
April 3, 1995 - January 9, 1996
* [footnote on paper source is illegible]
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JURISDICTION AND VENUE
14. Jurisdiction exists pursuant to §27 of the Exchange Act,
15 U.S.C. §78aa, and 28 U.S.C. §1331. The federal claims asserted
arise under §§10(b) and 20(a) of the Exchange Act, 15 U.S.C.
§§78j(b) and 78t(a), and Rule 10b-5 promulgated by the SEC, while
the state law claims arise under Cal. Corp. Code §§25400, 25401 and
25402. Jurisdiction over the derivative claims exists pursuant to
28 U.S.C. §1332(a)(2) and the principles of supplemental
jurisdiction. Plaintiff and all defendants are citizens of
different states and the amount in controversy between the
plaintiff and the defendants on the derivative claims exceeds
$50,000, exclusive of interest and costs. This is not a collusive
action to confer jurisdiction which this Court would not otherwise
have.
15. Venue is proper in this district pursuant to §27 of the
Exchange Act and 28 U.S.C. §1391(b). Many of the acts giving rise
to the violations complained of occurred in this district.
16. In connection with the wrongs complained of, defendants
used the instrumentalities of interstate commerce, the U.S. mails
and the facilities of the national securities markets.
THE PARTIES
17. Plaintiff Darrin J. Caramonta ("Caramonta") purchased 200
shares of TouchStone common stock on August 28, 1995 at $16-3/4 per
share and continues to hold those shares. Caramonta is a resident
and citizen of Texas.
18. Defendant TouchStone is incorporated in California and
maintains its headquarters at Huntington Beach, California.
TouchStone has over $1 million in assets and over 3,500
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shareholders of record. During the Class Period TouchStone's
common stock traded in an efficient market, first on the NASDAQ
"Small Cap" market and later on the NASDAQ National Market System.
19. (a) Defendant Larry Dingus ("Dingus") is Chairman of the
Board of the Company. Because of Dingus' position with the
Company, he had access to the adverse non-public information about
its business, finances, products, markets and present and future
business prospects via access to internal corporate documents
(including the Company's operating plans, budgets and forecasts and
reports of actual operations compared thereto), conversations and
connections with other corporate officers and employees, attendance
at management and Board of Directors meetings and committees
thereof and via reports and other information provided to them in
connection therewith. During the Class Period and as part of the
fraudulent scheme, Dingus sold 443,000 shares of TouchStone stock
at $13.50 per share based on inside information, pocketing $5.9
million. These sales constituted 50% of Dingus' holdings in
TouchStone.
(b) Defendant C. Shannon Jenkins ("Jenkins") was
President, Chief Executive Officer and a director of the Company at
all relevant times hereto, until she was replaced after the
December 21, 1995 revelations. Because of Jenkins' position with
the Company, she had access to the adverse non-public information
about its business, finances, products, markets and present and
future business prospects via access to internal corporate
documents (including the Company's operating plans, budgets and
forecasts and reports of actual operations compared thereto),
conversations and connections with other corporate officers and
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employees, attendance at management and Board of Directors meetings
and committees thereof and via reports and other information
provided to them in connection therewith. During the Class Period
and as part of the fraudulent scheme, Jenkins sold 243,000 shares
of TouchStone stock at $13.50 per share based on inside
information, pocketing $3.2 million. These sales constituted 27%
of Jenkins' holdings in TouchStone.
(c) Defendant Ronald R. Maas ("Maas") is Executive Vice
President, Chief Financial Officer, General Manager and a director
of the Company. Because of Maas' position with the Company, he had
access to the adverse non-public information about its business,
finances, products, markets and present and future business
prospects via access to internal corporate documents (including the
Company's operating plans, budgets and forecasts and reports of
actual operations compared thereto), conversations and connections
with other corporate officers and employees, attendance at
management and Board of Directors meetings and committees thereof
and via reports and other information provided to them in
connection therewith. During the Class Period and as part of the
fraudulent scheme, Maas sold 121,000 shares of TouchStone stock at
$13.50 per share based on inside information, pocketing $1.6
million. These sales constituted 28% of Maas' holdings in
TouchStone.
(d) Defendant Kenneth Welch, III ("Welch") is a director
of the Company. Because of Welch's position with the Company, he
had access to the adverse non-public information about its
business, finances, products, markets and present and future
business prospects via access to internal corporate documents
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(including the Company's operating plans, budgets and forecasts and
reports of actual operations compared thereto), conversations and
connections with other corporate officers and employees, attendance
at management and Board of Directors meetings and committees
thereof and via reports and other information provided to them in
connection therewith. During the Class Period and as part of the
fraudulent scheme, Welch sold 82,000 shares of TouchStone stock at
$13.50 per share based on inside information, pocketing $1.1
million. These sales constituted 26% of Welch's holdings in
TouchStone.
(e) Defendant Donald Watters ("Watters") is Vice
President of Sales of the Company. Because of Watters' position
with the Company, he had access to the adverse non-public informa-
tion about its business, finances, products, markets and present
and future business prospects via access to internal corporate
documents (including the Company's operating plans, budgets and
forecasts and reports of actual operations compared thereto),
conversations and connections with other corporate officers and
employees, attendance at management meetings and committees thereof
and via reports and other information provided to them in
connection therewith. During the Class Period and as part of the
fraudulent scheme, Watters sold 70,000 shares of TouchStone stock
at $13.50 per share based on inside information, pocketing
$945,000. These sales constituted 28% of Watters' holdings in
TouchStone.
(f) Defendant Sigmund Fidyke ("Fidyke") is a Vice
President of Development of the Company. Because of Fidyke's
position with the Company, he had access to the adverse non-public
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information about its business, finances, products, markets and
present and future business prospects via access to internal
corporate documents (including the Company's operating plans,
budgets and forecasts and reports of actual operations compared
thereto), conversations and connections with other corporate
officers and employees, attendance at management meetings and
committees thereof and via reports and other information provided
to them in connection therewith. During the Class Period and as
part of the fraudulent scheme, Fidyke sold 41,000 shares of
TouchStone stock at $13.50 per share based on inside information,
pocketing $553,000. These sales constituted 29% of Fidyke's
holdings in TouchStone.
20. Defendants Dingus, Jenkins and Maas comprise TouchStone's
Executive Committee, which managed and operated TouchStone on a
day-to-day basis. Defendants Dingus and Welch are members of
TouchStone's Audit Committee which was responsible for TouchStone's
financial statements, including the false and misleading financial
statements issued during the Class Period.
21. The individuals named as defendants in ¶19(a)-(f) are
referred to herein as the "Individual Defendants." Each of the
Individual Defendants is a citizen of California. The Individual
Defendants, other than Fidyke and Watters, by reason of their stock
ownership, management positions and/or membership on the Company's
Board of Directors, were controlling persons of TouchStone and had
the power and influence, and exercised the same, to cause
TouchStone to engage in the illegal conduct complained of herein.
22. The officers and directors of TouchStone owed to it the
duty to exercise due care and diligence in the management of
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TouchStone and the duty of full and candid disclosure of all
material facts related thereto. To discharge their duties, the
Individual Defendants were required to exercise reasonable and
prudent supervision over the business of TouchStone. By virtue of
such duties, these officers and directors were required, inter
alia:
(a) To conduct and supervise the business of TouchStone
in accordance with federal and state laws;
(b) To maintain and implement an adequate system of
internal financial, accounting and inventory controls and
management information systems such that TouchStone's financial
information would be accurately recorded and reported;
(c) To supervise the preparation of the Company's SEC
filings and to approve any reports concerning the financial
condition of TouchStone;
(d) To enforce a corporate policy prohibiting misuse of
proprietary corporate information by corporate officers and
directors by trading in TouchStone stock; and
(e) To refrain from obtaining personal benefit, at the
expense of the public security holders of TouchStone, by misusing
proprietary non-public information.
23. During the Class Period, each of the Individual
Defendants occupied positions that made them privy to non-public
information concerning TouchStone. Because of their positions and
access, each of these defendants knew that the adverse facts
specified herein were being concealed. Notwithstanding their duty
to refrain from selling TouchStone stock while in the possession of
material adverse non-public information concerning TouchStone,
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defendants sold 2.3 million shares of the Company's stock profiting
from their fraudulent scheme and misuse of the material non-public
information.
FUTILITY OF DEMAND
24. Plaintiff brings Claims for Relief Nos. IV-VI
derivatively in the right of and for the benefit of TouchStone to
redress injuries suffered and to be suffered by TouchStone.
TouchStone is named as a nominal defendant in the derivative
claims.
25. Despite the Individual Defendants having knowledge of the
claims and causes of action raised by plaintiff, the Individual
Defendants have failed and refused to seek to recover for
TouchStone for any of the wrongdoing alleged by plaintiff.
26. Plaintiff will adequately and fairly represent the
interests of TouchStone in enforcing and prosecuting its rights.
27. The Plaintiff has not made demand on the Board of
Directors of TouchStone to bring these derivative claims since such
demand would be a futile and useless act for the following reasons:
(a) TouchStone's Board of Directors participated in or
approved the acts and omissions or recklessly disregarded the
wrongs which are complained herein and are named as defendants in
the securities class action and derivative claims;
(b) The acts complained of constitute violations of
fiduciary duties and violations of the federal and state securities
laws and these acts are incapable of ratification;
(c) The known principal wrongdoers and beneficiaries of
the wrongdoing of which are complained herein -- defendants Dingus,
Jenkins, Maas and Welch (four of TouchStone's five Board members)
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dominate and control the TouchStone's Board of Directors. Thus,
the Board of Directors could neither exercise independent objective
judgment in deciding whether to bring this action nor vigorously
prosecute this action;
(d) Defendants Dingus, Jenkins, Maas and Welch hand-
picked the remaining director of TouchStone for his position as a
director and thus control and dominate him and he will never sue
them;
(e) The directors of TouchStone cannot be relied upon to
reach a truly independent decision as to whether to commence the
demanded action against themselves and the officers responsible for
the misconduct alleged in this Complaint in that, inter alia, the
Board of Directors is currently dominated by defendants who were
personally and directly involved in the insider trading activities
alleged (i.e., defendants Dingus, Jenkins, Mass and Welch), and who
each approved the actions which are complained of and to whose
directives and views the Board has consistently acceded and will
continue to accede. This domination of the Board of Directors'
ability to validly exercise its business judgment renders it
incapable of reaching an independent decision as to whether to
accept plaintiff's demand;
(f) The Board members have close personal and business
ties with each other, and are, consequently, interested parties and
cannot in good faith exercise independent business judgment to
determine whether to bring this action against themselves or one
another; and
(g) If TouchStone's officers and directors are protected
against personal liability by directors' and officers' liability
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insurance, they caused the Company to purchase that insurance for
their protection with corporate funds, i.e., monies belonging to
the stockholders of TouchStone. However, any directors' and
officers' liability insurance policies covering the defendants
contain provisions which eliminate coverage for any action brought
directly by TouchStone against these defendants, known as, inter
alia, the "insured versus insured exclusion." As a result, if
these directors were to sue themselves there will be no insurance
protection for the derivative claims. Thus, this is a further
reason why they will not bring such a suit, for to do so would
subject themselves and their colleagues to a judgment of millions
that would be payable from their individual assets alone. On the
other hand, if the claims are brought derivatively and if such
insurance coverage exists, it will provide a basis for the Company
to effectuate a recovery.
TOUCHSTONE'S INTERNAL FORECASTS,
PLANS AND PROJECTIONS
28. A key management tool for top executives of modern public
companies is the use of annual budgets or forecasts, by which a
Company's Board of Directors, after input from its top executives,
set performance goals and then closely monitor the Company's actual
performance, i.e., results of operations compared to the budgeted
and/or forecasted results. TouchStone prepared its 1995 forecast
and budget by late 1994 and then updated it during 1995. Each of
the Individual Defendants was aware of TouchStone's 1995 forecast
and budget and of internal reports prepared by Maas and circulated
monthly, comparing TouchStone's actual results to those previously
budgeted and/or forecasted. TouchStone's top executives used its
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1995 budget and forecast as the basis for the statements they made
publicly about the Company's performance during 1995. Based on the
negative internal reports of the Company's actual performance
compared to that budgeted and forecasted, the Individual Defendants
each knew TouchStone's business was not performing as well as
publicly represented and that such poor performance was being
overcome only by falsifying TouchStone's financial results. Thus,
defendants knew that the public statements issued during the Class
Period about TouchStone's financial performance and business were
false and misleading when made.
STATUTORY SAFE HARBOR
29. The statutory safe harbor provided by the Exchange Act
for forward looking statements under certain circumstances does not
apply to any of the allegedly false forward looking statements
pleaded in this Complaint. None of the forward looking statements
pleaded at ¶¶49, 50, 52, 56, 69, 71 and 73 were identified as
"forward looking statements" when made. Nor was it stated that
actual results "could differ materially from those projected," nor
did meaningful cautionary statements identifying important factors
that could cause actual results to differ materially from that in
the forward looking statements accompany those forward looking
statements. Alternatively, to the extent that the statutory safe
harbor does apply to any forward looking statements pleaded in
¶¶49, 50, 52, 56, 69, 71 and 73, the defendants are liable for
those false forward looking statements because at the time each of
those forward looking statements was made the speaker knew the
forward looking statement was false and the forward looking
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statement was authorized and/or approved by an executive officer of
TouchStone who knew that those statements were false when made.
PLAINTIFF CLASS ALLEGATIONS
30. Plaintiff brings this action as a class action pursuant
to Federal Rules of Civil Procedure 23(a) and (b)(3) on behalf of
all persons who purchased the stock of the Company during the Class
Period, except defendants, members of their immediate families and
any entity in which a defendant has a controlling interest.
31. The members of the Class are so numerous that joinder of
all members is impractical. The Company has more than 7.2 million
shares of common stock outstanding, owned by over 3,500
shareholders of record throughout the country.
32. Plaintiff's claims are typical of the claims of the Class
because plaintiff and all the Class members sustained damages which
arose out of defendants' wrongful conduct.
33. Plaintiff will adequately protect the interests of the
Class. Plaintiff has retained counsel who are experienced and
competent in class action securities litigation. Plaintiff has no
interests which are in conflict with those of the Class.
34. A class action is superior to all other available methods
for the fair and efficient adjudication of this controversy.
Plaintiff knows of no difficulty to be encountered in the
management of this action that would preclude its maintenance as a
class action.
35. Questions of law and fact common to the members of the
Class predominate over any questions which may affect only
individual members in that defendants have acted on grounds
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generally applicable to the entire Class. Among the questions of
law and fact common to the Class are:
(a) Whether the federal securities laws and the Cal.
Corp. Code were violated by defendants' acts;
(b) Whether TouchStone's statements during the Class
Period misrepresented and/or omitted material facts;
(c) Whether defendants participated in and pursued the
fraudulent scheme and course of business complained of;
(d) Whether defendants acted intentionally or recklessly
in omitting and/or misrepresenting material facts;
(e) Whether the defendants artificially inflated the
Company's financial results;
(f) Whether the market price of TouchStone's stock was
artificially inflated due to the nondisclosures and/or
misrepresentations complained of; and
(g) The extent of damage sustained by the Class and the
appropriate measure of damages.
THE FRAUDULENT SCHEME AND COURSE OF BUSINESS
36. Each of the defendants is liable as a participant in a
fraudulent scheme and course of business that operated as a fraud
or deceit on purchasers of TouchStone stock. All of the defendants
made false and misleading statements and/or concealed material
adverse facts which operated as a fraud or deceit on purchasers of
TouchStone stock. The scheme was designed to and did: (i) deceive
the investing public regarding TouchStone's financial results and
business; (ii) artificially inflate the price of TouchStone stock;
(iii) cause plaintiff and other members of the Class to purchase
TouchStone stock at inflated prices; and (iv) permit TouchStone and
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the Individual Defendants to sell over 2.3 million shares of
TouchStone stock at $13.50 per share.
37. TouchStone was founded in 1982 by defendants Dingus,
Jenkins and Welch, and went public in August 1984. Subsequent to
that offering TouchStone stock sold between $.01 and $.02 per share
for several years.
38. Prior to 1988 TouchStone sold products known as
"connectables" but achieved little success. In 1989 TouchStone
began to sell software for diagnostic testing of PC computer
operating systems known as "utility software." However,
Touchstone's software products also achieved little success. Thus,
during 1990-1993 and the first half of 1994, TouchStone achieved
only minimal earnings per share and during this period TouchStone
stock never traded above $l.00 per share and traded as low as $.06
per share. As a result TouchStone was unable to sell any stock to
raise capital and TouchStone's insiders were unable to sell any of
their shares to pocket cash.
39. Finally, during the last half of 1994, a new product
introduced by TouchStone called WINCheckIt apparently achieved some
success, and in the third and fourth quarter of 1994 TouchStone was
able to report earnings per share of $.12 -- its most successful
two quarters ever. However, its stock continued to languish
between $.25 and $1.56 per share.
40. During 1995, stocks which appeared positioned to benefit
from the anticipated release of Microsoft's Windows '95 performed
very well as market interest in companies with such products
heightened with the impending introduction of Windows '95.
TouchStone's insiders recognized that this environment presented an
- 22 -
opportunity for them to exploit by pushing TouchStone stock up much
higher in price so that TouchStone and its insiders could sell
TouchStone stock to the public at inflated prices. However,
defendants were confronted with serious obstacles to reaching their
goal. TouchStone's WINCheckIt product was only compatible with
Microsoft's Windows 3.1 version which was shortly to be superseded
by Microsoft's Windows '95 version. Thus, WINCheckIt would not be
able to fuel revenue or earnings growth after the introduction of
Windows '95. Defendants also had no assurance that TouchStone's
new Windows '95 compatible product, WIN'95 Advisor, would be
successful. Finally, TouchStone's stock was listed only on the
NASDAQ "Small Cap" market which limited its appeal and restricted
defendants' ability to hype the stock up to higher levels.
41. In order to overcome these obstacles and capitalize on
this situation, defendants pursued a fraudulent scheme and course
of business that operated as a fraud or deceit on purchasers of
TouchStone stock by driving the stock to artificially inflated
levels by making false and misleading statements. Defendants
falsified TouchStone's financial results by reporting inflated
revenues and profits from "sales" of WINCheckIt and demand for
TouchStone's newest product, the WIN'95 Advisor, while
misrepresenting the current state of its business. Defendants'
scheme was extremely successful. TouchStone's false financial
reports and defendants' other false statements drove TouchStone
stock sharply higher from $3-3/4 per share on May 2, 1995, to a
Class Period high on August 24, 1995, of $17-5/8 per share.
42. Defendants capitalized on this artificial inflation in
TouchStone's stock price by quickly arranging a huge public
- 23 -
offering of TouchStone stock on August 25, 1995, in which
TouchStone sold 1.3 million shares and TouchStone's insiders sold
one million shares at $13.50 per share. TouchStone's top officers
and directors unloaded between 26% and 50% of their holdings in the
Company in this offering and in addition to getting the cash from
the sale of their own shares, they also benefitted by the cash
inflation TouchStone got from the sale of its shares, which boosted
the book value of their remaining holdings in the Company.
43. Just four months after the huge August 1995 stock
offering, TouchStone revealed it would suffer a large loss for the
1995 fourth quarter and likely for the 1995 year as a whole as
well, thus wiping out all the profits reported in 1995 before the
stock offering, due to massive returns of its WINCheckIt and WIN'95
Advisor products, and that of the 178,000 units previously recorded
as revenue the Company had truly sold only 70,000 WIN'95 Advisors
in 1995 -- suffering returns of over 100,000 units. TouchStone
stock fell as low as $2-3/4 per share, just about what it sold for
when defendants commenced their scheme to inflate the price of the
stock and just 20% of the price at which TouchStone and its
insiders unloaded 2.3 million shares on the investing public based
on false financial reports and false statements about TouchStone
and its most important products.
FALSE AND MISLEADING STATEMENTS
44. On February 28, 1995, TouchStone issued a press release
reporting its record year end 1994 results which stated:
President and Chief Executive Officer C. Shannon Jenkins
said, "The successful results can be credited to
continued success of our CheckIt product line, and
- 24 -
particularly the introduction of our new Windows utility,
WINCheckIt."
45. On April 5, 1995 TouchStone issued a press release
headlined "'WINCHECKIT' IS #1 PC UTILITY," which stated:
Ever since its release last August, "WINCheckIt,"
the All-In-One Windows Problem Solver, has been on a fast
track to success.
46. In mid-April 1995, TouchStone issued its 1994 Annual
Report to Shareholders which reported its 1994 financial results
and contained a letter signed by Jenkins and Dingus which stated:
The continued strength of the CheckIt family of PC
utilities . . . have already contributed to a record-
setting first quarter for 1995 (a 128% increase in
revenue compared with the same period in 1994).
Our strong brand-name identity and our solid sales
channel . . . have been the fuel behind our increasing
momentum. We are using those strengths in our
introduction of our new product WIN'95 Advisor, which we
announced in June 1995.
These statements were alive, uncorrected and part of the total mix
of information affecting TouchStone's stock price on May 2, 1995.
47. Throughout the Class Period, TouchStone distributed to
its shareholders, securities analysts, potential investors and the
securities markets, a "Company Backgrounder" which presented the
following "Company Profile":
TouchStone Software Corporation is an industry-
leading publisher of award-winning utility software
products for personal computers . . . .
- 25 -
TouchStone has concentrated on diagnostic utility
products since 1988 -- building upon the success of the
CheckIt line -- selling over half a million units and
establishing itself as a major force in the market.
48. On May 2, 1995, TouchStone issued a press release
reporting its first quarter 1995 financial results which stated
that revenues for the first quarter ended March 31, 1995
increased 128% to $2,878,000 . . . . Net income
increased 513% to $457,300 or $.07 per share for the
first quarter . . . .
* * *
C. Shannon Jenkins, President and Chief Executive
Officer stated, "We are very pleased with the way the
year has started. WINCheckIt continues to be our big
success story . . . . WINCheckIt is rich with features
but sells at a very competitive price point . . . . This
advantage was a key factor in overcoming the seasonal
effect that many software companies suffer in the first
quarter."
49. On May 10, 1995 TouchStone issued a press release
stating:
Spearheaded by the phenomenal success of WINCheckIt
. . . TouchStone Software Corp. looks forward to a bright
future.
* * *
"We have been rewarded as a leader in the industry . . ."
said C. Shannon Jenkins, President and CEO of TouchStone
Software.
- 26 -
50. On May 15, 1995, TouchStone issued its First Quarter
Report to Shareholders which repeated the previously reported first
quarter results and included a letter signed by Jenkins and Dingus
which stated, "[t]he record setting first quarter can be attributed
to the success of several products" including WINCheckIt. The
letter also said the "secret to TouchStone's exciting growth" was
its dedication to maintaining "its industry leadership" and that
the listing of TouchStone stock on the NASDAQ market "will
definitely increase its value to you, our Shareholders."
51. On May 15, 1995 TouchStone filed its report on Form 10-
QSB for the first quarter of 1995 with the SEC, which was signed by
Jenkins and Maas and repeated the earlier reported first quarter
results. It represented that those results, "include all
adjustments which are, in the opinion of management, necessary for
a fair presentation of the results of operations." The 10-QSB
Report attributed TouchStone's increased first quarter 1995 sales
"to the continued success of the Company's WINCheckIt Product."
The Form 10-QSB Report also stated: "Product returns have been
within management's expectations during 1993, 1994, and the first
quarter of 1995."
52. On May 17, 1995 TouchStone announced it had applied to
have its stock listed on the NASDAQ National Market System and
Jenkins stated that this listing "will definitely increase its
value to our shareholders."
53. On July 18, 1995 TouchStone announced it intended to
undertake a stock offering in a release that described TouchStone
as "a leading developer and publisher of utility software
products."
- 27 -
54. TouchStone's "Corporate Backgrounder," its May 2, 1995
press release, its First Quarter Report to Shareholders issued on
Form 10-QSB, and its May 10 and 17, 1995 and July 18, 1995 press
releases were false and misleading when issued and failed to
disclose the following then existing adverse facts which were known
to defendants:
(a) That TouchStone was not an industry-leading
manufacturer of utility software products or a major force in the
market but rather a fringe company with undistinguished products
that had never achieved substantial commercial success and could
not under any objective use of the terms be considered a "leading"
company or "major force" in the utility software industry;
(b) That TouchStone's "successful results" could not be
properly credited to the "continued success" of its WINCheckIt
product because that product's apparent success was exaggerated by
TouchStone through the artifice of:
(i) recording and reporting sales for shipment of
that product which were well beyond what TouchStone knew could be
resold by its distributors and resellers;
(ii) allowing distributors and resellers to return
unlimited unsold product; and
(iii) not providing adequate reserves for the
probable return of unsold product;
(c) That it was not true that the "success of the
CheckIt line" had established TouchStone "as a major force in the
marketplace" as the success of the CheckIt line of products was
greatly overstated and misrepresented by TouchStone for the reasons
stated above and TouchStone was not a major force in the market for
- 28 -
the same reason that it was not a leading manufacturer of utility
software for PCs;
(d) That it was not true that TouchStone's WINCheckIt
product was a "big success story" or a "phenomenal success" because
the success of that product was overstated and misrepresented by
TouchStone for the reasons set forth above;
(e) That defendants knew that WINCheckIt would not be
compatible with the new Windows '95 software to be issued by
Microsoft shortly after mid-year 1995 and as a result the life of
that product was coming to an end and the Company would have to
accept huge amounts of returns of WINCheckIt upon the introduction
of Windows '95 by Microsoft;
(f) That defendants were not in fact "very pleased with
the way the year has started because WINCheckIt continued to be our
big success story" as in fact defendants were concerned about the
WINCheckIt product because they knew that product would soon be
rendered obsolete by the introduction of Windows '95 and knew that
the apparent success of the product had been overstated and
misrepresented for the reasons set forth above;
(g) That it has not true that the success of the
WINCheckIt product combined with a very competitive price was an
advantage that had led to TouchStone achieving a strong first
quarter 1995 and which would overcome the negative seasonal effect
that software companies normally suffer in the first calendar
quarter as in fact TouchStone had artificially inflated its results
for that quarter by overshipping large amounts of WINCheckIt to
distributors while giving them an unlimited right to return that
product, without recording adequate reserves for those returns;
- 29 -
(h) That it was not true that the listing of TouchStone
stock on the NASDAQ market would "definitely increase its value" as
trading the stock on NASDAQ would per se have no impact on the
value and could in fact result in the stock falling much faster in
price upon the disclosure of adverse information, because of the
increased ability of institutions to trade in and quickly sell that
stock;
(i) That TouchStone's product returns in the last two
quarters of 1994 and first quarter of 1995 were well above
management's original expectations and required substantial
downward revision of TouchStone's financial results before they
were reported to the public;
(j) That TouchStone lacked sufficient and adequate
financial and accounting controls to permit the accurate or timely
recording of revenues and reports of profits in accordance with its
stated accounting policies and GAAP;
(k) That in order to conceal the deterioration of its
business, and to boost its profitability, TouchStone was secretly
engaging in a number of practices to artificially and improperly
boost its reported sales, net income and earnings per share,
including granting its distributors and resellers unqualified and
unlimited rights of return of products "purchased" while at the
same time providing lenient payment terms which resulted in its
distributors and resellers not having to pay for merchandise unless
and until they resold it;
(l) That contrary to the representations that
TouchStone's first quarter 1995 financial statements "fairly
presented" TouchStone's financial results, TouchStone's first
- 30 -
quarter 1995 financial statements were materially overstated and
not fairly presented or in accordance with GAAP, as TouchStone
overstated its revenues, net income and earnings per share for the
quarter;
(m) That the first quarter revenues and earnings of
TouchStone, as reported, were materially overstated through the
improper recognition of revenue, through, among other things, the
recognition as revenue on consignment shipments of merchandise to
distributors even though they had no obligation to pay for it
unless they resold it, on shipments of merchandise to distributors
who had the unlimited right to return unsold merchandise;
(n) That contrary to defendants' representations
regarding TouchStone's revenue recognition policy, TouchStone
permitted its customers unlimited and unqualified rights to return
product to it and had secretly agreed with its largest distributors
that as to material amounts of merchandise they had accepted from
TouchStone they did not have to pay for that merchandise unless and
until they resold it;
(o) That TouchStone had deliberately shipped excessive
amounts of product to key large customers, much more than there was
any reasonable hope of them reselling, which artificially inflated
TouchStone's revenues, net income and earnings in those quarters
and would adversely impact its revenues and earnings in future
quarters, as those customers returned that excessive product to
TouchStone;
(p) That TouchStone had failed to provide adequate
reserves for returns and rebates when market circumstances and
- 31 -
applicable industry practices indicated that such provisions were
required;
(q) That TouchStone was recording and reporting revenue
on "sale" of product where its customers had an unqualified right
of return of the product and where TouchStone had no way to
reasonably or in good faith estimate the amount of product that
ultimately would be returned; and
(r) That TouchStone's reported revenues, net income and
earnings per share for the first quarter of 1995 did not fairly or
accurately report TouchStone's actual results and were improperly
overstated as detailed in ¶¶81-116.
55. On August 2, 1995 TouchStone issued a press release
reporting its second quarter 1995 results, stating that
revenues for the second quarter ended June 30, 1995
increased to $3,320,000 . . . .
Net income increased to $403,400 or $.06 per share
for the second quarter . . . .
* * *
Touchstone Software Corp. is a leading developer and
publisher of utility software . . . .
56. On August 11, 1995, TouchStone issued its Second Quarter
Report to Shareholders which reported the previously announced
financial results and included a letter signed by Jenkins and
Dingus which stated:
Our newest product, WIN'95 Advisor, was released in
July 1995 with one of the largest orders in the Company's
history from Ingram Micro, totaling over $1.7 million.
- 32 -
We will have more exciting news about the product next
quarter.
57. On August 11, 1995, TouchStone filed its report on Form
10-QSB for the second quarter of 1995 with the SEC, which was
signed by Jenkins and Maas, repeated the previously released
financial results and stated that these results "include[d] all
adjustments which are, in the opinion of management, necessary for
a fair presentation of the results of operations." The Form 10-QSB
also stated that: "In July 1995, the Company received a single
order from Ingram Micro, totalling over $l.7 million, for its
WIN'95 Advisor, specially packaged for Sam's Club."
58. On August 22, 1995 an article about TouchStone's stock
offering appeared in the Los Angeles Times. With respect to the
shares that were to be sold by TouchStone's insiders in the
Offering, the article reported:
Dingus said officers haven't sold any stock since 1987
and simply want to diversify their accounts. . . .
"I don't believe anyone is looking at this as anything
but a nice way to put a little money in the bank."
59. TouchStone's "Corporate Backgrounder," its August 2, 1995
press release, its Second Quarter Reports to Shareholders and on
Form 10-QSB and its August 22, 1995 press releases were each false
and misleading when made and failed to disclose the following then
existing adverse facts which were known to or recklessly
disregarded by defendants:
(a) That TouchStone was not an industry-leading
manufacturer of utility software products or a major force in the
- 33 -
market but rather a fringe company with undistinguished products
that had never achieved substantial commercial success and could
not under any objective use of the terms be considered a "leading"
company or "major force" in the utility software industry;
(b) That TouchStone's $1.7 million order for WIN'95
Advisor was overstated as the order carried with it an unlimited
right to return, was contingent upon Sam's Club accepting the
product and was an excessive amount of that product, well beyond
what TouchStone knew could possibly be accepted by Sam's Club, and
this combined with the unlimited rights of return of that product
meant TouchStone had not established adequate reserves for those
future returns;
(c) That it was not true that TouchStone's insiders were
selling TouchStone stock in the offering simply to diversify their
accounts or just to put a little money in the bank, but rather as
an insider bail out at inflated prices before product returns wiped
out TouchStone's reported profits and caused its stock to collapse;
(d) That TouchStone lacked sufficient and adequate
financial and accounting controls to permit the accurate or timely
recording of revenues and reports of profits in accordance with its
stated accounting policies and GAAP;
(e) That in order to conceal the deterioration of its
business, and to boost its profitability, TouchStone was secretly
engaging in a number of practices to artificially and improperly
boost its reported sales, net income and earnings per share,
including granting its customers unqualified and unlimited rights
of return of products "purchased" and promising its customers that
- 34 -
they did not have to pay for merchandise unless and until they
resold it;
(f) That contrary to the representations that
TouchStone's second quarter 1995 financial statements "fairly
presented" TouchStone's financial results, TouchStone's second
quarter 1995 financial statements were materially overstated and
not fairly presented or in accordance with GAAP, as TouchStone
overstated its revenues, net income and earnings per share for each
quarter;
(g) That the second quarter revenues and earnings of
TouchStone, as reported, were materially overstated through the
improper recognition of revenue, through, among other things, the
recognition as revenue on consignment shipments of merchandise to
distributors even though they had no obligation to pay for it
unless they resold it, and on shipments of merchandise to
distributors who had the unlimited right to return unsold
merchandise;
(h) That contrary to defendants' representations
regarding TouchStone's revenue recognition policy, TouchStone
permitted its customers unlimited and unqualified rights to return
product to it and had secretly agreed with its largest distributors
that as to material amounts of merchandise they had accepted from
TouchStone they did not have to pay for that merchandise unless and
until they resold it;
(i) That TouchStone had deliberately shipped excessive
amounts of product to key large customers, much more than there was
any reasonable hope of them reselling, which artificially inflated
TouchStone's revenues, net income and earnings in those quarters
- 35 -
and would adversely impact its revenues and earnings in future
quarters, as those customers returned that excessive product to
TouchStone;
(j) That TouchStone had failed to provide adequate
reserves for returns and allowances when market circumstances and
applicable industry practices indicated that such provisions were
required;
(k) That TouchStone was recording and reporting revenue
on "sale" of product where its customers had an unqualified right
of return of the product and where TouchStone had no way to
reasonably or in good faith estimate the amount of product that
ultimately would be returned; and
(l) That TouchStone's reported revenues, net income and
earnings per share for the second quarter of 1995 did not fairly or
accurately report TouchStone's actual results and were improperly
overstated as detailed in ¶¶81-116
60. On August 24 and 25, 1995, Ray Norberte, TouchStone's
Investor Relations contact person, told inquiring investors that
"they were working around the clock. Faxed new orders far exceed
their wildest dreams," and that TouchStone had shipped 150,000
copies of WIN'95 Advisor and the field reported that "sales were
brisk," knowing that this information would be disseminated to the
market via the Internet. These statements were false and
misleading when made and failed to disclose -- as defendants knew
-- that orders for and sales of WIN'95 Advisor were not brisk, but
instead were overstated as such "sales" carried with them an
unlimited right of return.
- 36 -
61. On August 25, 1995, TouchStone completed a 2.3 million
share secondary public offering at $13.50 per share with TouchStone
selling 1.3 million shares and insiders selling one million shares.
The Prospectus reported TouchStone's apparently accelerating
profits:
Summary Financial Information
(in thousands, except per share)
Six months
Year ended December 31, ended June 30,
1992 1993 1994 1994 1995
Statement of Income Data:
Revenues $3,470 $4,925 $7,202 $2,617 $6,181
Net income 41 308 800 103 861
Net income per
common share $ .01 $ .06 $ .14 $ .02 $ .13
62. The Prospectus also reported TouchStone's apparently very
successful second half 1994 results:
Quarter Ended
Fiscal 1994
(in thousands, except per share amounts)
Mar. 31, June 30, Sept. 30, Dec. 31,
1994 1994 1994 1994
Product sales $1,174 $1,285 $1,581 $2,853
Royalty income 86 72 69 81
----- ----- ----- -----
Revenue 1,260 1,357 1,650 2,934
Net income $ 75 $ 29 $ 197 $ 499
Net income
per share $ .01 $ .01 $ .04 $ .08
63. The Prospectus indicated that TouchStone's enhanced
profitability had continued during 1995 by presenting TouchStone's
results for the first two quarters of 1995:
- 37 -
Fiscal 1995
Mar. 31, June 30,
1995 1995
(in thousands, except per share amounts)
Revenues: $2,861 $3,320
Net income $ 457 $ 404
Net income per share $ .07 $ .06
64. The Prospectus also represented that these 1994 and 1995
quarterly results "reflect all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of
such quarterly information."
65. The Prospectus again described TouchStone as "a leading
developer and publisher of utility software," and stated:
Following the August 1994 introduction of WINCheckIt
. . . the Company's revenues and profitability grew at an
accelerated rate during the last five months of 1994 and
the first quarter of 1995. . . . On July 24, 1995, the
Company began shipping WIN'95 Advisor, which will permit
Windows users to analyze their personal computer's
compatibility with Microsoft's new operating system,
Windows 95, which is scheduled for release in August
1995. In July 1995, the Company received a single order
from Ingram Micro, totaling over $l.7 million, for its
WIN'95 Advisor, specifically packaged for Sam's Club.
* * *
[T]he increases in revenue for the three months ended
March 31, 1995 and June 30, 1995 . . . were attributable
to sales of the Company's WINCheckIt product . . . .
66. With respect to the Company s accounting policies the
Prospectus stated:
- 38 -
Revenue Recognition
Product sales to distributors and retail customers
are recorded upon delivery of the related software in
accordance with Statement of Position 91-1, Software
Revenue Recognition. The Company records an accrual for
estimated returns at the time of product shipment based
on historical experience.
67. TouchStone's August 25, 1995 Prospectus was false and
misleading when issued and failed to disclose the following then
existing adverse facts which were known to defendants:
(a) That TouchStone was not an industry-leading
manufacturer of utility software products but rather a fringe
company with undistinguished products that had never achieved
substantial commercial success and could not under any objective
use of the terms be considered a "leading" company in the utility
software industry;
(b) That TouchStone's "successful results" could not be
properly credited to the "continued success" of its WINCheckIt
product because that product's apparent success was exaggerated by
TouchStone through the artifice of:
(i) recording and reporting sales for shipment of
that product which were well beyond what TouchStone knew could be
resold by its distributors and resellers;
(ii) allowing distributors and resellers to return
unlimited unsold product; and
(iii) not providing adequate reserves for the
probable return of unsold product;
- 39 -
(c) That TouchStone's $1.7 million order for WIN'95
Advisor was overstated as the order carried with it an unlimited
right of return, was contingent upon Sam's Club accepting the
product and was an excessive amount of that product, well beyond
what TouchStone knew could possibly be accepted by Sam's Club, and
this combined with the unlimited right of return of that product
meant TouchStone had not established adequate reserves for those
future returns;
(d) That defendants knew that the WINCheckIt product in
its distribution chain at the time of the offering was not
compatible with Windows '95 software to be issued by Microsoft
shortly after mid-year 1995 and as a result the life of that
product was coming to an end and it would have to accept huge
amounts of returns of the WINCheckIt product upon the introduction
of Windows '95 by Microsoft;
(e) That defendants were concerned about the success of
the WINCheckIt product because they know that product would soon be
rendered obsolete by the introduction of Windows '95 and knew that
the apparent success of the product had been overstated and
misrepresented for the reasons set forth above;
(f) That TouchStone's product returns in the last two
quarters of 1994 and first and second quarters of 1995 were well
above management's original expectations and this required
substantial downward revision of TouchStone's financial results
before they were represented to the public;
(g) That TouchStone lacked sufficient and adequate
financial and accounting controls to permit the accurate or timely
- 40 -
recording of revenues and reports of profits in accordance with its
stated accounting policies and GAAP;
(h) That in order to conceal the deterioration of its
business, and to boost its profitability, TouchStone was secretly
engaging in a number of practices to artificially and improperly
boost its reported sales, net income and earnings per share,
including granting its customers unqualified and unlimited rights
of return of products "purchased" and promising its customers that
they did not have to pay for merchandise unless and until they
resold it;
(i) That contrary to the representations that
TouchStone's interim 1995 financial statements "fairly presented"
TouchStone's financial results, TouchStone's interim 1995 financial
statements were materially overstated and not fairly presented or
in accordance with GAAP as TouchStone overstated its revenues, net
income and earnings per share for each quarter;
(j) That the 1995 interim quarterly revenues and
earnings of TouchStone, as reported, were materially overstated
through the improper recognition of revenue, through, among other
things, the recognition as revenue on consignment shipments of
merchandise to distributors even though they had no obligation to
pay for it unless they resold it, and on shipments of merchandise
to distributors who had the unlimited right to return unsold
merchandise;
(k) That contrary to defendants' representations
regarding TouchStone's revenue recognition policy, TouchStone
permitted its customers unlimited and unqualified rights to return
product to it and had secretly agreed with its largest distributors
- 41 -
that as to material amounts of merchandise they had accepted from
TouchStone they did not have to pay for that merchandise unless and
until they resold it;
(l) That TouchStone had deliberately shipped excessive
amounts of product to key large customers, much more than there was
any reasonable hope of them reselling, which artificially inflated
TouchStone's revenues, net income and earnings in those quarters
and would adversely impact its revenues and earnings in future
quarters, as those customers returned that excessive product to
TouchStone;
(m) That TouchStone had failed to provide adequate
reserves for returns and allowances when market circumstances and
applicable industry practices indicated that such provisions were
required;
(n) That TouchStone was recording and reporting revenue
on "sale" of product where its customers had an unqualified right
of return of the product and where TouchStone had no way to
reasonably or in good faith estimate the amount of product that
ultimately would be returned;
(o) That TouchStone's reported revenues, net income and
earnings per share for the quarters of 1994 and the first and
second quarters of 1995 did not fairly or accurately report
TouchStone's actual results and were improperly overstated as
detailed in ¶¶81-116.
68. On August 29, 1995 an article appeared in The Wall Street
Journal that stated: "Touchstone Software Corp. . . . says it has
enjoyed brisk demand for its first Windows product, WINCheckIt."
The source of this statement was Dingus or Jenkins.
- 42 -
69. On September 20, 1995 a research report was issued on
TouchStone by Punk Ziegel, the co-lead underwriter of TouchStone's
August 1995 Offering which reported that TouchStone was
"maintaining leadership" in utility software, was enjoying good
demand for its WINCheckIt and WIN'95 Advisor products, both of
which were then selling well, and forecast 1995 and 1996 earnings
per share of $.29 and $.43, respectively. The source of this
information was Jenkins and Dingus who provided this information to
Charlynn Blatter of Punk Ziegel for inclusion in her report and who
reviewed and approved the research report before it was issued.
70. TouchStone's August 29, 1995 press release and the
statements in the September 20, 1995 research report were each
false and misleading when made and failed to disclose the following
then existing adverse facts which were known to defendants:
(a) That TouchStone was not retaining leadership in
utility software because it was not an industry-leading
manufacturer of utility software products and did not have a
leadership position in the industry because it was nothing more
than a fringe company which products had never achieved substantial
commercial success and could not under any effective use of the
term, be considered to be in a position of industry leadership;
(b) That TouchStone was not enjoying good demand for its
WINCheckIt and WIN'95 Advisor products and in fact was encountering
sharply decreasing demand for the WINCheckIt product and very weak
demand for the WIN'95 Advisor product and indications from its
distributors that it would be receiving large amounts of returns
during the third and fourth quarters of 1995;
- 43 -
(c) That the forecasts of earnings per share of $.29 and
$.43, respectively, in 1995 and 1996 for TouchStone were known by
defendants to be false as (i) such projections were dependent to a
large extent on projections of increased sales of WINCheckIt which
were completely unrealistic; (ii) demand for TouchStone's
WINCheckIt had softened indicating that future sales growth would
be slower which would hurt TouchStone's profitability; and
(iii) WIN'95 Advisor sales were very poor and would hurt
TouchStone's results; and
(d) That TouchStone's earnings reported in 1995 were
false and as a result of the foregoing factors the forecasts of
increased earnings for TouchStone in 1995 and 1996 by defendants
were false as they had no reasonable basis in fact, were seriously
undermined by the adverse facts set forth above and were not
genuinely believed by defendants.
71. On September 29, 1995, rumors circulated that sales of
WIN'95 Advisor were soft and that its sell-through was weak. When
TouchStone's stock fell, TouchStone, through Punk Ziegel, denied
these rumors and insisted it would sell 220,000 to 225,000 WIN'95
Advisor units in 1995, that the sell-through was "as expected" and
that sales unaccompanied by a purchase of Windows '95 have been
"higher than expected." The source of this information was Jenkins
and Dingus who provided this information to Charlynn Blatter of
Punk Ziegel for public release and who approved the release of this
information. As a result, TouchStone stock continued to sell at
artificially inflated prices through the balance of the Class
Period.
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72. The statements of September 29, 1995 were each false and
misleading when made and failed to disclose the following then
existing adverse facts which were known to defendants:
(a) That sales of TouchStone's WIN'95 Advisor product
were very poor and much lower than expected and much lower than the
levels necessary to avoid massive product returns which would
result in TouchStone suffering much lower earnings, if not losses,
in the last part of 1994;
(b) That sales of WIN'95 Advisor units unaccompanied by
a purchase of Windows '95 were poor and not as high as expected nor
represented; and
(c) That as of the end of September 1995 TouchStone had
shipped and recorded revenue on approximately 170,000 WIN'95
Advisor units but in reality had only sold approximately 70,000 of
those units at retail and thus there was absolutely no basis to
believe or represent that TouchStone could sell 220,000 to 225,000
WIN'95 Advisor units in 1995, which statement was known by
defendants to be false.
73. On October 17, 1995 TouchStone finally admitted that
sales of its WIN'95 Advisor product were weak and below
expectations and it had cut the price of the product. While
TouchStone stock fell, the stock continued to trade at artificially
inflated levels throughout the balance of the Class Period as
defendants misrepresented that TouchStone would still make money in
the fourth quarter of 1995, and would earn about $.08 per share,
and that TouchStone expected demand for WIN'95 Advisor to pick up
during the holiday season.
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74. On October 19, 1995, TouchStone issued a press release
reporting its third quarter 1995 results, which
reported today that revenues for the third quarter ended
September 30, 1995 increased 113% to $3,517,000 . . . .
Net income increased 143% to $479,000 or $.07 per share
for the third quarter . . .
* * *
C. Shannon Jenkins, President and Chief Executive
Officer stated, "We are very pleased to report another
record-setting quarter."
75. On November 6, 1995, TouchStone filed its report on Form
10-QSB for the third quarter with the SEC, which was signed by
Jenkins and Maas and repeated the previously announced financial
results. The 10-QSB also stated that the third quarter results,
"include all adjustments which are . . . necessary for a fair
presentation of the results of operations."
76. TouchStone's October 17, 1995 statements, its October 19,
1995 press release and its third quarter report on Form 10-QSB were
false and misleading when made and failed to disclose the following
then existing adverse facts which were known to defendants:
(a) That defendants knew as of October 17, 1995 that the
returns of WINCheckIt and WIN'95 Advisor products would be so large
that TouchStone would suffer a substantial loss in the fourth
quarter of 1995;
(b) That defendants knew that demand for the WIN'95
Advisor product which had never been strong had fallen sharply and
that due to that demand and the lackluster sales of the Windows '95
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conversion, demand for WIN'95 Advisor would not pick up at all
during the balance of 1995;
(c) That TouchStone's purported revenues, net income and
earnings per share for the third quarter of 1995 did not fairly or
accurately report TouchStone's actual results and were improperly
overstated as detailed in ¶¶81-116; and
(d) That TouchStone was not pleased to report another
record setting quarter in the third quarter of 1995 as in fact
TouchStone's insiders were disappointed with the Company's
performance during the third quarter during which it had received
massive returns of WINCheckIt and WIN'95 Advisor products and had
actually in fact suffered large losses in the third quarter of
1995.
77. On December 21, 1995, contrary to all previous repre-
sentations and indications, TouchStone revealed that it would
report a huge loss for the fourth quarter due to massive returns of
WIN'95 Advisor and WINCheckIt products, which loss was so large
that it would likely result in a loss for the full 1995 year as
well. TouchStone admitted that TouchStone's WIN'95 Advisor product
had been a complete failure and had actually sold only 70,000 out
of 178,000 units it had previously shipped and recorded revenue,
and thus over 100,000 of those units would be returned. After
these revelations, TouchStone stock fell to as low as $2-3/4 per
share.
78. All the positive statements about TouchStone's business
and financial performance quoted in ¶¶44-75 hereof were each
materially false and misleading when issued. The Company's
financial statements for the quarters ended March 31, 1995, June
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30, 1995 and September 30, 1995 were falsely reporting net income
and earnings per share when, in fact, TouchStone had achieved much
lower profits or actually suffered losses. Defendants also
concealed and failed to disclose, inter alia, the following adverse
information concerning the Company and its business, disclosure of
which was necessary to make the statements made not false and
misleading, and which facts were then known only to defendants due
to their access to internal TouchStone corporate data:
(a) That TouchStone's quarterly financial statements for
the periods ended March 31, 1995, June 30, 1995 and September 30,
1995, did not accurately or fairly present the Company's financial
condition or operating results, but rather materially overstated
net income and earnings per share;
(b) That TouchStone's new WIN'95 Advisor product was not
being well received at retail and, in fact, the initial response of
customers was so modest that defendants knew at the outset of the
Class Period that sales from this new product would not be
sufficient to sustain TouchStone's profitability;
(c) That TouchStone was not excited about or very
pleased with initial customer reaction to its new WIN'95 Advisor
and that, in fact, TouchStone's insiders were disappointed with
initial reaction to this new product and they knew that sales of
this product were insufficiently strong to permit TouchStone to
achieve the level of profitability it forecast;
(d) That market acceptance of and consumer demand for
TouchStone's WINCheckIt and WIN'95 Advisor products was so weak
that TouchStone knew it would be necessary for TouchStone to accept
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huge returns and take a major write-off, which would result in a
1995 loss;
(e) That TouchStone lacked sufficient and adequate
financial and accounting controls to permit the accurate or timely
recording of revenues and reports of profits in accordance with its
stated accounting policies and GAAP;
(f) That in order to conceal the deterioration of its
business, and to boost its profitability so it could conclude a
large stock offering, TouchStone was secretly engaging in a number
of practices to artificially and improperly boost its reported
sales, net income and earnings per share, including granting its
customers unqualified and unlimited rights of return of products
"purchased" and promising its customers that they did not have to
pay for merchandise unless and until they resold it;
(g) That contrary to the representations that
TouchStone's interim 1995 financial statements "fairly presented"
TouchStone's financial results, TouchStone's interim 1995 financial
statements were materially overstated and not fairly presented or
in accordance with GAAP, as set forth in ¶¶81-116, as TouchStone
overstated its revenues, net income and earnings per share for each
quarter;
(h) That the 1995 interim quarterly revenues and
earnings of TouchStone, as reported, were materially overstated
through the improper recognition of revenue, through, among other
things, the recognition as revenue on consignment shipments of
merchandise to distributors even though they had no obligation to
pay for it unless they resold it, and on shipments of merchandise
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to distributors who had the unlimited right to return unsold
merchandise;
(i) That contrary to defendants' representations
regarding TouchStone's revenue recognition policy, TouchStone
permitted its customers unlimited and unqualified rights of return
and had secretly agreed with its largest distributors that as to
material amounts of merchandise they had accepted from TouchStone
they did not have to pay for that merchandise unless and until they
resold it;
(j) That TouchStone had deliberately shipped excessive
amounts of the product to key large customers, much more than there was
any reasonable hope of them selling, which artificially inflated
TouchStone's revenues, net income and earnings in those quarters
and would adversely impact its revenues and earnings in future
quarters, as those customers returned that excessive product to
TouchStone;
(k) That TouchStone had failed to provide adequate
reserves for returns and allowances when market circumstances and
applicable industry practices indicated that such provisions were
required;
(l) That TouchStone was recording and reporting revenue
on "sale" of product where its customers had an unqualified right
of return of the product and where TouchStone had no way to
reasonably or in good faith estimate the amount of product that
ultimately would be returned;
(m) That defendants had no adequate or reasonable basis
in fact for their positive forecasts and projections regarding
TouchStone's revenue or earnings growth which statements were, in
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fact, false as they were inconsistent with the above negative
facts;
(n) That defendants' forecasts of TouchStone's increased
earnings per share for 1995 and 1996 were known by defendants to be
false as (i) such forecasts were dependent to a large extent on
projections of increased sales of WINCheckIt which were completely
unrealistic; (ii) demand for TouchStone's WINCheckIt had decreased,
indicating that future sales would decline which would hurt
TouchStone's profitability; and (iii) WIN'95 Advisor sales were
very poor from the outset which would hurt TouchStone's results;
and
(o) That the forecasts of increased earnings for
TouchStone in 1995 and 1996 of $29 and $.43, respectively, and of
earnings per share of $.08 the fourth quarter of 1995, were
false as they were undermined by the adverse facts set forth above
and were not genuinely believed by defendants.
79. Throughout the Class Period in TouchStone's periodic and
other filings with the SEC, defendants included a "boilerplate"
statement regarding product returns which stated in substance as
follows:
The Company sells its products domestically primarily
through distributors for resale to the retail channel.
In 1994, three distributors accounted for approximately
75% of the Company's product sales. These customers
typically order on an as-needed basis, and the Company
operates with relatively little backlog. Sales are
recorded at the time products are shipped. However, as
is the case with other consumer product manufacturers,
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the Company's operations in subsequent periods are
subject to the risk of product returns through the
exercise by customers of contractual return rights or as
a result of the Company's strategic interest in assisting
customers in balancing and updating inventories.
Although the Company attempts to monitor and manage the
volume of its sales to its customers, large shipments in
anticipation of demand which is subsequently unrealized
can lead to overstocking by the distributors and
substantial product returns. Furthermore, the risk of
product returns or price rebates may increase if the
demand for the Company's products declines. Although the
Company maintains allowances for projected returns and
price rebates, there can be no assurance that actual
levels of returns will not significantly exceed amounts
anticipated by the Company.
This statement was boilerplate because it did not change in any
substantial way over a 10 month period even though TouchStone's
business and the forces impacting its business and products changed
drastically during that period and even though TouchStone was
experiencing serious and worsening problems with product returns
during the first three quarters of 1995. It also provided no
meaningful cautionary warnings to investors that TouchStone would
suffer losses during 1995 because the boilerplate statement was
itself false and misleading in several respects. First, it failed
to disclose that TouchStone had granted its major distributors
unlimited rights of return and that their obligation to pay was
contingent upon resale of the product. Second, it failed to
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disclose that defendants knew TouchStone would encounter huge
returns of WINCheckIt after the introduction of Windows '95, but
had not adequately reserved for those returns. Third, it failed to
disclose that TouchStone's product returns in the fourth quarter of
1994 and the first three quarters of 1995 were much higher than
management's original expectations based on historical exposure and
required large downward revisions of TouchStone's financial results
before they could be reported publicly. Fourth, it failed to
disclose that TouchStone had no valid historical basis to estimate
future returns of its WIN'95 Advisor product and that since its
distributors had unlimited rights of return of the product and had
accepted shipments of far more of such product than they could
reasonably expect to sell to help TouchStone boost its reported
earnings, massive returns of this product were inevitable. Thus,
defendants knew that the actual levels of returns as in the past,
would significantly exceed the amounts "anticipated" (i.e.,
reserved for) by the Company.
DEFENDANTS' INSIDER SELLING
80. While TouchStone's officials were issuing favorable
statements about TouchStone's business, the defendants sold 2.3
million shares of the stock they owned for proceeds of about $30
million to profit from the artificial inflation in the TouchStone
stock price which their fraud had created. Notwithstanding their
access to confidential information as a result of their status as
directors and/or officers of the Company with a corresponding duty
to disclose the adverse material facts set forth herein, the
Individual Defendants sold and caused TouchStone to sell
significant amounts of TouchStone shares at artificially inflated
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prices throughout the Class Period while in possession of material
non-public information:
DATE SHARES PRICE PROCEEDS
NAME SOLD SOLD PER SHARE FROM SALE
TouchStone 8/25 1,300,000 $13.50 $16.3 million
Dingus 8/25 443,000 13.50 5.9 million
Jenkins 8/25 243,000 13.50 3.2 million
Maas 8/25 121,000 13.50 1.6 million
Welch 8/25 82,000 13.50 1.1 million
Watters 8/25 70,000 13.50 $ 945,000
Fidyke 8/25 41,000 13.50 $ 553,000
TOUCHSTONE'S FALSE FINANCIAL STATEMENTS
81. The Company's Form 10-QSB's filed with the SEC for the
periods ended March 31, June 30, and September 30, 1994 and
March 31, June 30, and September 30, 1995 each stated that they
"reflect all adjustments which are, in the opinion of management,
necessary for a fair presentation of the results." This statement,
which was included in all six of the aforementioned Form 10-QSB's
was false and misleading when made, as the financial statements
included in the Form 10-QSB's did not include all adjustments
necessary for a "fair presentation of the results." TouchStone
overstated its revenues, net income and earnings per share, by
deliberately violating GAAP for the first, second and third
quarters of 1994 and 1995.
82. In order to inflate quarterly earnings in 1994 and 1995,
TouchStone improperly recognized revenue and understated reseller
rebates and product return reserves in violation of GAAP.
TouchStone engaged in a pattern of recording insufficient reserves
during the first three quarters of 1994 and 1995, followed by
dramatic increases to reserves in each of the fourth quarters --
the periods subject to independent audits. In essence, by waiting
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to record product return reserves until later in the year, i.e.,
during the fourth quarter, TouchStone was inflating its reported
revenues, net income and earnings per share in the earlier
quarters. TouchStone's financial reporting controls were
inadequate during quarterly financial reporting periods and could
not be relied upon to provide accurate financial results in
accordance with GAAP because, among other things, its financial
statements, under SEC regulation S-B, were not subject to quarterly
reviews by the auditors and TouchStone's Chief Financial Officer,
defendant Maas, was not a CPA.
83. TouchStone's improper accounting practices enabled
defendants to reap about $30 million in the August 1995 public
offering, as the shares were sold based upon inflated earnings
reported in the unaudited March 31 and June 30, 1995 and 1994
quarterly financial statements filed on Form 10-QSB and the August
25, 1995 Prospectus.
84. The vast majority of TouchStone's revenue during 1994 and
1995 stemmed from two software products, WINCheckIt and WIN'95
Advisor. WINCheckIt, introduced in August of 1994, was a
diagnostic utility program written for and compatible with
Microsoft's Windows 3.1. WINCheckIt was not compatible with
Microsoft's new Windows '95 version and therefore was approaching
the end of its life cycle by June 30, 1995. WIN '95 Advisor
introduced in July 1995, was essentially a one-time diagnostic
product strictly designed to test and prepare a personal computer
system for upgrade to Microsoft Windows '95 which was introduced in
August 1995.
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First Quarter Ended March 31, 1995
85. In the first quarter of 1995, TouchStone's reserves for
reseller rebates and product returns were inadequate. As a result
of improperly and prematurely recognizing revenue and understating
reserves, defendants inflated TouchStone's earnings by
approximately $68,000 or $.01 per share.
86. This misstatement was material to the users of the
financial statements as the $.01 per share inflation during the
first quarter represented a 14% reduction in earnings from the
originally reported false earnings per share of $.07. Moreover,
because TouchStone reported successively improving earnings in the
four quarters immediately preceding the quarter ended March 31,
1995, the downturn in earnings to $.06 instead of the reported $.07
represented a significant 33% downturn in earnings as compared to
a falsely reported 22% downturn during the first quarter of 1995.
87. In accordance with GAAP, materiality is defined as:
The magnitude of an omission or misstatement of
accounting information that, in the light of surrounding
circumstances, makes it probable that the judgment of a
reasonable person relying on the information would have
been changed or influenced by the omission or
misstatement.
FASB Statement of Concepts No. 2.
88. Additionally, the Financial Accounting Standards Board
(FASB) has acknowledged that case law has helped define materiality
by stating that:
The courts have stepped in to fill the gap. It is
the impact of information on an investor's judgment that
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is at the heart of the distinction. To quote the Tenth
Circuit Court of Appeals, information is material if
". . . the trading judgment of reasonable investors would
not have been left untouched upon receipt of such
information." Mitchell v. Texas Gulf Sulphur Co., 446
F.2d 90 at 99-100 (10th Cir. 1971).
FASB Statement of Concepts No. 2 (emphasis added).
89. In this case, the "trading judgment" of reasonable
investors would clearly have been influenced by a 14% reduction in
reported earnings, and a 33% downturn in earnings from the previous
quarter.
Second Quarter Ended June 30, 1995
90. TouchStone improperly and materially overstated revenues
and net income by improperly recognizing revenue and understating
product return reserves associated with WINCheckIt, a product that
was nearing the end of its life cycle in the second quarter ended
June 30, 1995.
Improper Revenue Recognition
91. During the second quarter of 1995, TouchStone recorded
approximately $2 million in sales relating to WINCheckIt. These
sales were improperly recognized because the customer (distributor
/reseller) had the unconditional right to return unsold software
and payment was contingent upon resale to the retailer. In
accordance with GAAP, when a company's distributor has the right to
return software, either contractually or by practice, revenue
cannot be recognized if payment is contingent upon the resale of
the product. (FASB 48, Revenue Recognition When the right of
Return Exists, ¶6b,f and 8, and AICPA SOP 91-1, ¶54, 55.)
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92. For TouchStone's large distributors such as Ingram Micro,
Merisel and others, payment was contingent upon product sell-
through. By practice or contract, its distributors were not
required to pay TouchStone until the product was sold through.
Additionally, distributors were awarded such lenient and extended
payment terms that sales were, in effect, contingent because the
product was usually returned or sold through by the time payment
was finally due.
93. This improper accounting practice necessarily results in
a growth in accounts receivables which are not being paid. This is
demonstrated by the unfavorable climb in TouchStone's "Days Sales
in Gross Receivables" ratio. For example, the average number of
days it took the Company to collect gross accounts receivables
increased from 64 days at December 31, 1994, to 86 days at June 30,
1995. This deterioration in receivable collection is the result of
TouchStone recording revenue for conditional sales and distributors
not having to pay for inventory that they were unable to resell
(i.e., payment was contingent upon resale).
Inadequate Reserves
94. In accordance with GAAP, losses from uncollectible
receivables must be accrued when information available prior to the
issuance of the financial statements indicates that it is probable
that the receivable had been impaired or a liability had been
incurred at the date of the financial statements, and the amount of
the loss can be reasonably estimated. (SFAS No. 5, ¶8.)
TouchStone violated this pronouncement by failing to adequately
reserve for accounts receivable which were uncollectible due to
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return privileges or other causes for the quarter ended June 30,
1995.
95. Originally introduced in August 1994, WINCheckIt was
designed for earlier versions of Windows and was not compatible
with Windows '95 which was introduced on August 24, 1995.
Accordingly, the product was nearing the end of its life cycle by
the second quarter ended June 30, 1995.
96. During the first half of 1995, WINCheckIt accounted for
64% of product revenues. However, during the third quarter of
1995, revenue for WINCheckIt decreased dramatically, and
constituted no more than 15% of TouchStone's third quarter sales.
Therefore WINCheckIt sales totaled approximately $510,000 in the
third quarter, compared to the previous quarter's sales of
approximately $2 million -- a 75% decrease. Thus, as the demand
for the product dropped drastically with the impending introduction
of Windows '95 in August 1995, TouchStone knew that unsold
WINCheckIt in distributors' inventory would remain unsold and
consequently be returned.
97. In addition to the above, TouchStone also introduced a
new version of the product, WINCheckIt 4.0 at the beginning of the
fourth quarter of 1995 which was compatible with both Windows '95
and the earlier Windows 3.1. The introduction of WINCheckIt 4.0
made WINCheckIt obsolete. In light of the 75% drop in sales and
the impending obsolescence of WINCheckIt at the end of the second
quarter of 1995, TouchStone was required under GAAP to provide
adequate reserves for any unsold product remaining in the
distributors inventory at June 30, 1995, but did not.
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98. Ultimately, in the third quarter of 1995, Touchstone
increased their product return reserve by approximately $1 million
or 181%. This increase in product return reserves, albeit
inadequate, was primarily attributable to anticipated returns of
WINCheckIt which should have been reserved for at June 30, 1995.
June 30, 1995 Financial Statement Impact
99. In spite of the requirements of GAAP, TouchStone
deliberately understated product return reserves associated with
WINCheckIt by at least $1 million in the second quarter ended June
30, 1995. Had TouchStone followed GAAP and appropriately reserved
for product returns in accordance with SFAS No. 5 and SFAS No. 48,
the Company would have reported a net loss of approximately
$215,000 and loss per share of $.03 instead of net income of
$403,373 and earnings per share of $.06 for the second quarter
ended June 30, 1995.
August 25, 1995 Prospectus
100. In order to inflate earnings and give a false impression
of historical earnings, TouchStone, in violation of GAAP,
understated reserves for product returns and reseller rebates
during the first three quarters of 1994. On page 19 of the
Prospectus, TouchStone presented quarterly financial data for each
of the four quarters in 1993 and 1994 and the first two quarters of
1995.
101. TouchStone's reserves increased from $202,322 at
September 30, 1994, to $831,000 at December 31, 1994. This
represented an increase of approximately $628,000 or 300%. This
dramatic increase during the fourth quarter of 1994 was the result
of TouchStone recording, for the first time, reserves for reseller
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rebates (price protection) and product returns of $461,000 and
$257,000, respectively.
102. The sudden increase in reserves during the fourth quarter
of 1994 was the result of heightened scrutiny during the year-end
audit by Deloitte & Touche. These significant additions to
reserves, or the reasons thereto, are not explained anywhere in
TouchStone's December 31, 1994 Form 10-KSB even though the SEC
requires significant fourth quarter adjustments to be disclosed and
explained in the financial statements. TouchStone was providing
resellers and distributors rights of return and price protection
throughout 1994 and the $628,000 increase in reserves recorded in
the fourth quarter of 1994 did not relate entirely to the fourth
quarter of 1994. Therefore, TouchStone inflated their net income
in the 1994 quarterly financial statements filed on Forms 10-QSB by
understating their reserves for reseller rebates and product return
reserves. More importantly, TouchStone re-issued these misstated
1994 financials in their August 25, 1995 Prospectus.
103. Ultimately by September 30, 1995 TouchStone's reserves
for rebates, returns and doubtful accounts had grown to $2.7
million and represented 68% of gross accounts receivables! By
comparison, during the first three quarters of fiscal 1994 the
reserves never exceeded 13% of gross receivables. The reserves
also increased at a much higher rate than sales. TouchStone's 1994
first, second and third quarter reserves represented 9%, 9% and 13%
of sales, respectively. By the third quarter of fiscal 1995,
reserves represented 82% of sales. By failing to adequately
reserve for receivables, TouchStone overstated its first, second
and third 1994 quarterly net income. Additionally, at the
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effective date of the Prospectus, August 25, 1995, TouchStone's
management knew that reserves for the first and second quarters of
1995 had by now grown to 50% and 52% of receivables, respectively.
The dramatic increase in reserves as compared to prior years was
the result of the inadequate 1994 quarterly reserve levels.
TouchStone's management had ample opportunity to adjust the
misstated 1994 quarterly data in the August 25, 1995 Prospectus but
deliberately did not do so.
104. By understating quarterly reserves during 1994, Touch-
Stone overstated its net income during the first, second and third
quarters of 1994 by approximately $108,000, $121,000 and $148,500,
respectively.
105. To further enhance the falsity of TouchStone's
Prospectus, the Company represented that it had obtained a third
quarter $l.7 million order for WIN'95 Advisor. This statement was
misleading when made as TouchStone indicated that the order was
earmarked for Sam's Club but failed to disclose that the
distributor, Ingram Micro, had the unconditional right to return
the product if Sam's Club did not accept the product.
Third Quarter Ended September 30, 1995
106. TouchStone also improperly and materially overstated
revenues and net income during the third quarter ended September
30, 1995 by improperly recognizing revenue and understating product
return reserves associated with the WIN'95 Advisor, a new product
introduced in July of the same quarter.
Improper Revenue Recognition
107. During the quarter, the Company recorded revenues of
approximately $3.9 million associated with the WIN'95 Advisor of
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which an estimated $1.7 million was sold to Ingram Micro
purportedly to fill one Sam's Club order. A substantial portion of
these sales were improperly recognized because the customer had the
unconditional right to return unsold product, payment was
contingent upon distributor resale, and the Company could not
reasonably estimate the level of expected product returns.
108. This sale represented approximately 87,000 units of
WIN'95 Advisor which were designated for a third party purchaser,
Sam's Club. This sale was recorded in violation of GAAP and SOP
91-1 because Ingram Micro had the right to return the product,
TouchStone did not have the ability to reasonably estimate the
amount of returns, and the sale was contingent upon Sam's Club
accepting the units. Ultimately, in the fourth quarter, TouchStone
admitted that it would be taking back 108,000 of the 178,000 units
of WIN'95 Advisor resulting in a $2 million addition to the
Company's reserves. The units initially "sold" to Ingram Micro in
the third quarter of 1995, were included in the 108,000 units being
returned. Undoubtedly a substantial portion of these units are
being returned and, in accordance with GAAP, should not have been
recorded as revenue in the first place.
109. In accordance with GAAP, when an enterprise's
distributors have the right to return product, either contractually
or by practice, revenue cannot be recognized if payment is
contingent upon the distributors' resale of the product, or if the
amount of future product returns cannot be reasonably estimated.
(FASB 48, Revenue Recognition When the right of Return Exists,
¶6b,f and 8, and AICPA SOP 91-1, ¶54, 55.)
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Returns Not Estimable
110. TouchStone could not reasonably estimate the level of
future product returns from distributors and resellers. TouchStone
admitted as much in its "boilerplate" statement included in the
Company's Prospectus and other SEC filing during the Class Period
which stated:
Although the Company maintains allowances for projected
returns, there can be no assurance that actual levels of
returns will not significantly exceed amounts anticipated
by the Company.
Because TouchStone could not provide assurance that product return
reserves were not significantly understated, then necessarily they
could not reasonably estimate returns. Therefore, TouchStone
should not have recognized revenue upon shipment, but rather upon
expiration of the return privilege or collection of the receivable
(installment method) as required by SOP 91-1 and SFAS No. 48.
AICPA Statement of Position (SOP) 91-1, "Software Revenue
Recognition" states in part:
Absence of a Reasonable Basis for Estimating the Degree
of Collectibility of Receivables
.37 Revenues associated with software transactions
for which there is no reasonable basis of estimating the
degree of collectibility of related receivables should be
accounted for using either the installment method or the
cost recovery method of accounting.
111. Additionally, TouchStone should have considered other
significant factors which indicated that the Company could not
reasonably estimate its WIN'95 Advisor product returns and should
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not have recognized revenue. First, WIN'95 Advisor was a new
product, with no return history. This severely impaired
TouchStone's ability to reasonably estimate future returns.
Second, WIN'95 Advisor sales were highly dependent upon the level
of sales of Microsoft Windows '95 and a continuing perception that
installation of Windows '95 would be difficult.1
Inadequate Reserves
112. By the time TouchStone issued its September 30, 1995
financial statements, it knew, or was reckless in not knowing that
the product return reserve for WIN'95 Advisor was inadequate.
Furthermore, sales of WIN'95 Advisor had dropped 30% by the end of
the first week of October 1995, and the Company reduced the
product's price in early October 1995 by approximately 36%, from
$30 to $19 per copy. Given the large amount of product remaining
unsold at distributors, the lagging September sales and the
substantial early October price reductions, TouchStone knew that
distributors would return large quantities of the unsold product
and that additionally, distributors and resellers would demand
____________________
1 In addition, for reseller arrangements, GAAP required that the
following factors should be considered:
Business practices, the reseller's operating history,
competitive pressures, formal or informal communication,
or factors that indicate that payment is contingent on
the reseller's success in distributing individual units
of the product may lead to a decision not to recognize
revenue.
Uncertainties about the potential number of copies to be
sold by the reseller because of such factors as the
newness of the product or marketing channel, competitive
products, or dependence on the market potential of
another product offered by the reseller, may indicate
that profit cannot be reasonably estimated on delivery.
SOP 91-1 ¶58 (emphasis added).
- 65 -
price protection credits for any remaining product not returned.
Even though TouchStone was aware of the above, it did not establish
sufficient reserves by the end of the third quarter.
113. Ultimately, of the original 178,000 copies of WIN'95
Advisor shipped to distributors and resellers during the third
quarter of 1995, only 70,000 were sold through as of December 22,
1995. The Company has admitted that the remaining 108,000 copies
will be returned. Accordingly, the Company will be forced to take
a fourth quarter charge of $2 million for sales improperly recorded
in the third quarter.
September 30, 1995 Financial Statement Impact
114. In violation of GAAP, TouchStone overstated revenues and
understated reserves by at least $2 million. Had TouchStone
recognized revenue and provided adequate reserves in accordance
with GAAP, it would have reported a net loss of $776,571 instead of
net income of $478,967, and a loss per share of $.11 instead of
earnings per share of $.07 for the third quarter ended September
30, 1995.
SUMMARY OF ACCOUNTING IMPROPRIETIES
115. In violation of GAAP (SFAS No. 48, SFAS No. 5 and SOP 91-
1), TouchStone deliberately inflated its earnings by improperly
recording revenue and understating reseller rebate and product
return reserves during 1994 and 1995. As a result, TouchStone's
1994 and 1995 quarterly financial statements, filed in Forms 10-QSB
and in the August 25, 1995 Prospectus were materially misstated
with respect to assets, revenues and earnings per share. The chart
below summarizes these misstatements for 1995.
- 66 -
TouchStone Software Corporation
Effect Of Accounting Improprieties
03/30/95 06/30/95 09/30/95
Improper revenue recognition
& inadequate reserves $110,000 $1,000,000 $2,000,000
-------- ---------- ----------
Operating income over-
statement $110,000 $1,000,000 $2,000,000
Tax effect $ 41,802 $ 380,734 $ 744,462
-------- ---------- ----------
Net overstatement $ 68,198 $ 619,266 $1,255,538
Net income, as reported $457,300 $ 403,373 $ 478,967
-------- ---------- ----------
Actual net income $389,102 $ (215,893) $ (776,571)
Earnings per share, as
reported $ 0.07 $ 0.06 $ 0.07
Actual earnings (loss)
per share $ 0.06 $ (0.03) $ (0.11)
116. Due to these accounting improprieties, the Company
presented its results in a manner which violated the following
generally accepted accounting principles, among others:
(a) 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);
(b) The principle that financial reporting should
provide information about the economic resources of an enterprise,
the claims to those resources, and the effects of transactions,
events and circumstances that change resources and claims to those
resources was violated (FASB Statement of Concepts No. 1, ¶40);
(c) 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.
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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);
(d) 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);
(e) 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);
(f) The principle of completeness, which means that
nothing is left out of the information that may be necessary to
ensure that it validly represents underlying events and conditions,
was violated (FASB Statement of Concepts No. 2, ¶79); and
(g) 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).
- 68 -
117. 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. For example:
(a) Under Item 303 of Regulation S-K, promulgated by the
SEC under the Exchange Act, there is a duty to disclose in periodic
reports filed with the SEC "known trends or any known demands,
commitments, events or uncertainties" that are reasonably likely to
have a material impact on a company's sales revenues, income or
liquidity, or cause previously reported financial information not
to be indicative of future operating results. 17 C.F.R.
§229.303(a)(1)-(3) and Instruction 3. In addition to the periodic
reports required under the Exchange Act, management of a public
Company has a duty promptly "to make full and prompt announcements
of material facts regarding the company's financial condition."
SEC Release No. 34-8995, 3 Fed. Sec. L. Rep. (CCH) ¶23,120A, at
17,095, 17 C.F.R. §241.8995 (October 15, 1970). The SEC has
repeatedly stated that the anti-fraud provisions of the federal
securities laws, which are intended to ensure that the investing
public is provided with "complete and accurate information about
companies whose securities are publicly traded," apply to all
public statements by persons speaking on behalf of publicly traded
companies "that can reasonably be expected to reach investors and
the trading markets, whoever the intended primary audience." SEC
- 69 -
Release No. 33-6504, 3 Fed. Sec. L. Rep. (CCH) ¶23,120, at
17,095-3, 17 C.F.R. §241.20560 (January 13, 1984). The SEC has
emphasized that "[i]nvestors have legitimate expectations that
public companies are making, and will continue to make, prompt
disclosure of significant corporate developments." SEC Release No.
18271, [1981-1982 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶83,049,
at 84,618 (November 19, 1981); and
(b) Schedule D of the National Association of Securities
Dealers ("NASD") Manual, which governs companies whose securities
are included in the NASDAQ market requires a NASDAQ company to
"make prompt disclosure to the public through the press of any
material information that may affect the value of its securities or
influence investors' decisions." NASD Manual, Schedule D, Part II,
§1(c)(13) [§1803(c)(13)].
CLASS CLAIM FOR RELIEF I
Section 10(b) Of The
Exchange Act and Rule 10b-5
118. Plaintiff incorporates by reference ¶¶1-117.
119. The defendants knew, or were reckless in failing to know,
of the material omissions from and misrepresentations contained in
the statements as set forth above. Each of the defendants: (a)
knew or had access to the material adverse non-public information
about TouchStone's financial results and then existing business
conditions, which was not disclosed; and (b) participated in
drafting, reviewing and/or approving the misleading statements,
releases, reports and other public representations of and about
TouchStone.
- 70 -
120. Throughout the Class Period, defendants, with knowledge
of or reckless disregard for the truth, disseminated or approved
releases, statements and reports, referred to above, which were
misleading in that they contained misrepresentations and failed to
disclose material facts necessary in order to make the statements
made, in light of the circumstances under which they were made, not
misleading.
121. During the Class Period, defendants, individually and via
a scheme, directly or indirectly, participated in a common course
of business to conceal material adverse information regarding the
financial performance of the Company and the then existing business
conditions as specified herein. Defendants employed devices,
schemes and artifices to defraud and engaged in acts, practices and
a course of business as herein alleged to commit a fraud on the
integrity of the market for the Company's stock and to maintain
artificially high market prices for the common stock of TouchStone.
This included the formulation, making of and/or participation in
the making of, untrue statements of material facts and the omission
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 engaging in acts, practices and a course of
business which operated as a fraud and deceit upon plaintiff and
the Class, all of the above in connection with the purchase of
TouchStone common stock by plaintiff and members of the Class.
122. By reason of the conduct alleged herein, defendants know-
ingly or recklessly, directly and indirectly, have violated §10(b)
of the Exchange Act and Rule 10b-5 promulgated thereunder in that
they (a) employed devices, schemes and artifices to defraud; (b)
- 71 -
made untrue statements of material facts or omitted to state
material facts necessary in order to make statements made, in light
of the circumstances under which they were made, not misleading; or
(c) engaged in acts, practices and a course of business that
operated as a fraud or deceit upon plaintiff and others similarly
situated in connection with their purchases of TouchStone common
stock during the Class Period.
123. Plaintiff and the Class have suffered substantial damages
in that, in reliance of the integrity of the market, they paid
artificially inflated prices for TouchStone common stock as a
result of defendants' violations of §10(b) of the Exchange Act and
SEC Rule 10b-5. Plaintiff and the Class would not have purchased
TouchStone stock at the prices they paid, or at all, if they had
been aware that the market prices had been artificially and falsely
inflated by defendants' misleading statements and concealment. At
the time of the purchases by Plaintiff and the Class of TouchStone
common stock, the fair and true market value of said common stock
was substantially less than the prices paid by them.
CLASS CLAIM FOR RELIEF II
Section 20(a) Of The Exchange Act
124. Plaintiff incorporates by reference ¶¶1-123.
125. The Individual Defendants other than Fidyke and Watters
acted as controlling persons of the Company within the meaning of
§20 of the Exchange Act. By reason of their positions as senior
officers and directors and their shareholdings of TouchStone stock,
as alleged above, the Individual Defendants other than Fidyke and
Watters had the power and authority to cause the Company to engage
- 72 -
in the wrongful conduct complained of herein. TouchStone, in turn,
controlled each of the Individual Defendants.
126. By reason of such wrongful conduct, TouchStone and the
Individual Defendants other than Fidyke and Watters are liable
pursuant to §20(a) of the Exchange Act. As a direct and proximate
result of their wrongful conduct, plaintiff and the other members
of the Class suffered damages in connection with their purchases of
the Company's securities during the Class Period.
CLASS CLAIM FOR RELIEF III
Cal. Corp. Code §§25400(c)(d), 25401, 25402
127. Plaintiff incorporates by reference ¶¶1-117.
128. The foregoing conduct by defendants constitutes
violations of Cal. Corp. Code §§25400(c)(d), 25401, 25402 entitling
the class to the remedies and damages provided by Cal. Corp. Code
§§25500-502 against each of the defendants.
DERIVATIVE CLAIM FOR RELIEF IV
Intentional Breach of Fiduciary Duties
129. Plaintiff incorporates by reference ¶¶1-117.
130. The Individual Defendants are fiduciaries of TouchStone
and owed it the duty to conduct the business of the Company
loyally, carefully, diligently and prudently.
131. The Individual Defendants, in their roles as officers and
directors of the Company, participated in the acts of mismanagement
alleged herein, or acted in reckless disregard of the facts known
to them, and caused TouchStone to violate the federal and state
securities laws whereby they misused proprietary corporate
information for their personal profit. These defendants became
aware, or should have become aware through reasonable inquiry, of
- 73 -
the adverse facts alleged herein, but did nothing to correct them
and thereby breached their duty of care, loyalty, accountability
and disclosure to the shareholders of the Company.
132. The Individual Defendants abdicated their corporate
responsibilities by mismanaging the Company in at least the
following ways:
(a) They caused TouchStone to violate the federal and
state securities laws;
(b) They concealed from the Company's shareholders and
the investing public the true nature and extent of the problems
that the Company was suffering while falsifying its financial
statements; and
(c) They misused TouchStone's internal proprietary
corporate information in violation of federal and state laws and
corporate rules and policies, to their personal profit.
133. As a result of defendants' wrongful conduct and wrongful
action, TouchStone has suffered considerable damage.
134. The Individual Defendants engaged in the aforesaid
conduct in intentional breach and/or reckless disregard of their
fiduciary duties to the Company and conspired to, and did, abuse
the control vested in them by virtue of their high-level positions
in the Company.
135. Each of the Individual Defendants is responsible to
indemnify TouchStone for the damages caused to purchasers
throughout the entire Class Period pleaded. The Individual
Defendants were aware of the false and misleading nature of the
statements issued throughout the Class Period, and that those
statements were issued with reckless disregard for their truth or
- 74 -
falsity. Thus, each of the Individual Defendants is liable to
TouchStone for any liability it incurs to purchasers of TouchStone
stock during the Class Period.
136. The actions of the Individual Defendants, as officers and
directors of TouchStone, caused TouchStone to violate the federal
and state securities laws. TouchStone, therefore, will have to
spend millions in defending cases alleging such liability and will
likely be held liable for that violation. The Individual
Defendants were able to, and did, control, directly or indirectly,
the content of the public statements and financial statements
disseminated by TouchStone. With knowledge of the falsity of the
statements contained therein and in reckless disregard of the true
financial and operation condition of TouchStone, these officers and
directors caused the complained of omission of material facts as
alleged herein from such public and financial statements. By
virtue of the foregoing, defendants have caused TouchStone to
violate the federal and state securities laws as alleged in the
class action.
137. Each of the Individual Defendants failed to exercise
reasonable diligence and due care, was reckless and committed one
or more of the following actions or omissions constituting waste,
fraud, self-dealing, mismanagement and breaches of fiduciary duty:
(a) The Individual Defendants misused proprietary non-
public corporate information to profit by insider selling of the
Company's stock in violation of the Company's policies and rules
against such misuse of information or sales and in violation of
federal and state law;
- 75 -
(b) The Individual Defendants made stock sales, failing
to comply with the Company's policies and rules against such sales,
as well as federal and state laws precluding such sales;
(c) The Individual Defendants authorized, caused or
permitted TouchStone to conduct its business in an unsafe,
imprudent and dangerous manner by pursuing unsound practices,
including concealing the true nature of their reckless, unsafe,
unsound practices and the serious adverse impact of these practices
on TouchStone's financial condition and prospects. In addition,
they permitted TouchStone to falsify its statements to the public
to try to conceal the true adverse impact of its problems; and
(d) The Individual Defendants authorized, caused or
permitted TouchStone to operate and report information in a manner
which was contrary to federal and state law, thus exposing it to
liability for violation of the federal securities laws for which
the Company has been sued in this class action.
138. The Individual Defendants' conduct has also damaged
TouchStone by exposing it to the cost of the defense of, and
possible cost of liability for, a violation of the federal and
state securities laws as a result of the class action claims now
pending against it.
DERIVATIVE CLAIM FOR RELIEF V
Negligent Breach Of Fiduciary Duties
139. Plaintiff incorporates by reference ¶¶1-117.
140. The defendants engaged in the aforesaid conduct without
exercising the reasonable and ordinary care owed to the Company by
directors and officers of a company.
- 76 -
141. TouchStone has been injured by reason of the defendants'
negligent breaches of their fiduciary duties.
DERIVATIVE CLAIM FOR RELIEF VI
Cal. Corp. Code §25502.5
142. Plaintiff incorporates by reference ¶¶1-117.
143. The Individual Defendants who were officers and directors
of TouchStone collectively sold one million shares of TouchStone
stock while knowing material information about TouchStone by virtue
of being officers and directors which was not available to the
public nor intended to be available to the public and which would
have significantly affected the market price of TouchStone stock,
violating Cal. Corp. Code §25402, and was not known or in the
possession of the sub-class who purchased their TouchStone common
stock contemporaneously with the Individual Defendants' stock
sales, relying on the integrity of the market.
144. TouchStone has total assets in excess of $1 million. Its
common stock is held by more than 3,500 persons of record.
145. The Individual Defendants are liable to TouchStone for up
to three times the difference between the price at which they sold
their common stock and the market value which this stock would have
had at the time of the sale if the information known to the
Individual Defendants had been publicly disseminated prior to that
time and a reasonable time had elapsed for the market to absorb the
information, and are liable for reasonable costs and attorneys'
fees in conjunction with bringing this action.
BASIS FOR ALLEGATIONS
Based upon the investigation of his counsel which included a
review of TouchStone Software Corporation's SEC filings, securities
- 77 -
analysts reports and media reports issued by the Company, and a
review by accounting and financial consultants, plaintiff has
alleged the foregoing and believes that as to ¶¶1, 4, 5, 8-10, 12,
28, 36, 40-43, 54, 59, 67, 70-73, 76 and 78, substantial
evidentiary support will exist for those allegations after a
reasonable opportunity for discovery.
WHEREFORE, plaintiff prays for judgment as follows:
1. Declaring this action to be a proper class action
pursuant to Rules 23(a) and 23(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, pursuant to Rules 64, 65 and any
appropriate state law remedies;
5. Awarding plaintiff extraordinary equitable and/or
injunctive relief as permitted by law, equity and any statutory
provision sued hereunder, including attaching, impounding and
imposing a constructive trust upon or otherwise restricting the
proceeds of defendants' trading activities or their other assets so
as to assure that TouchStone has an effective remedy;
6. Awarding plaintiff, on behalf of Nominal Defendant
TouchStone, damages, including punitive damages under Claims For
- 78 -
Relief IV and V and treble damages under Claim For Relief VI and
reasonable costs and attorneys' fees; and
7. Awarding such other relief as this Court may deem just
and proper.
JURY DEMAND
Plaintiff Demands a trial by jury.
DATED: January 26, 1996
MILBERG WEISS BERSHAD
HYNES & LERACH
WILLIAM S. LERACH
ALAN SCHULMAN
DARREN J. ROBBINS
________________________________
WILLIAM S. LERACH
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058
MILBERG WEISS BERSHAD
HYNES & LERACH
JEFF S. WESTERMAN
355 South Grand Avenue
Suite 4170
Los Angeles, CA 90071
Telephone: 213/617-9007
DYER DONNELLY & LILLEY
ROBERT J. DYER III
825 Logan Street
Denver, CO 80203-3114
Telephone: 303/861-3003
Attorneys for Plaintiff
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VERIFICATION
I, WILLIAM S. LERACH, hereby declare as follows:
I am one of the attorneys for the plaintiff in the above-
entitled action. I have read the Complaint and verify the matters
stated therein based on: (i) public SEC filings by the Company;
(ii) reports covering the Company by securities analysts; (iii)
information in the media reports concerning the activities of the
defendants; and (iv) advice from financial and other consultants
and, on that ground, state that the matters herein are true.
I make this verification because the plaintiff is absent from
San Diego County, where I maintain my office. Executed this 26th
day of January, 1996, at San Diego, California.
________________________________
WILLIAM S. LERACH
- 80 -
CERTIFICATION OF NAMED PLAINTIFF
PURSUANT TO FEDERAL SECURITIES LAWS
Darrin J. Caramonta ("Plaintiff"), declares, as to the claims
asserted under the federal securities laws, that:
1. Plaintiff has reviewed the Complaint and authorized its
filing.
2. Plaintiff did not purchase the security that is the
subject of this action at the direction of plaintiff's counsel or
in order to participate in this private action.
3. Plaintiff is willing to serve as a representative party
on behalf of the class, including providing testimony at deposition
and trial, if necessary.
4. Plaintiff's transaction(s) in the security that is the
subject of this action during the Class Period is/are as follows:
Security Transaction Date
Common Stock Purchased 200 shares 08/28/95
5. During the three years prior to the date of this
Certificate, plaintiff has sought to serve or served as a repres-
entative party for a class in the following actions filed under the
federal securities laws: None. Plaintiff has sought to serve or
served as a representative party for a class in the following
actions filed in the three years prior to January 26, 1996: None.
6. The Plaintiff will not accept any payment for serving as
a representative party on behalf of the class beyond the
Plaintiff's pro rata share of any recovery, except such reasonable
costs and expenses (including lost wages) directly relating to the
representation of the class as ordered or approved by the court.
- 81 -
I declare under penalty of perjury that the foregoing is true
and correct. Executed this 24 day of January, 1996, at
Dallas, Texas.
________________________________
DARRIN J. CARAMONTA
- 82 -
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