Attorneys for Plaintiff
 
 

1. This is a securities class action on behalf of persons who purchased the publicly traded securities of Legato Systems, Inc. ("Legato" or the "Company") between October 21, 1999 and January 19, 2000, inclusive (the "Class Period"), against Legato and certain of its senior officers. Legato develops, markets, and supports network storage management software products for heterogeneous client/server computing environments and large scale enterprises. The Company's storage management solutions are designed to support a wide range of client, server and storage devices such as DOS, NetWare, NT, OS/2, UNIX, and Windows.

2. During the Class Period, Legato reported record results, and up until the end of the Class Period, the defendants maintained that its growth would continue through the fourth quarter 1999 and beyond. While defendants were publicly reporting profits of more than $16 million for Legato's third quarter of 1999, defendants used Legato common stock to fund its most important acquisition ever - the acquisition of Ontrack Data International, Inc. ("Ontrack").

3. During the Class Period, the Individual Defendants (Louis C. Cole, Kent D. Smith, Stephen C. Wise and Nora M. Denzel), who controlled and were senior officers of Legato, engaged in the scheme to conceal Legato's badly flagging growth to prevent the decline in the price of Legato stock in order to: (i) use Legato's artificially inflated stock as currency to fund the Company's acquisition of companies in stock-for-stock transactions; and (ii) reap $11.5 million in insider trading proceeds.

4. As Legato continued to report "record" profits and defendants created the fiction that they were achieving 150% growth in net income, the price of Legato stock reacted, rising to a Class Period high of $79-1/4 on December 23, 1999. Defendants sought to profit from Legato's fictional record profits and purported growth and sold over 178,000 shares in just six days for total ill-gotten proceeds of $11.5 million. In order to inflate the price of Legato's stock, defendants caused the Company to falsely report its results for the third quarter of 1999 and continued to attempt to improperly recognize revenue in the fourth quarter until Legato's auditors refused to signoff on the defendants' fourth quarter and year-end financial results.

5. By the end of December 1999, the Company had assured itself of acquiring Ontrack - its most important acquisition ever - and had sought to create the fiction of its "record" growth just long enough to fund the Ontrack acquisition in a stock-for-stock acquisition. However, the defendants were facing pressure knowing they would have to announce that Legato had improperly recorded revenue and earnings in the third quarter of 1999 (which accounted for more than 22% of its third quarter earnings) and sought to improperly record almost $40 million in revenue in its to-be-released fourth quarter results, as Legato was in its pre-audit stages and would be forced to come clean once accounting improprieties were revealed. On January 19, 2000, Legato dropped an atomic bomb on investors, revealing that it would restate its third quarter earnings and that it would fall desperately short of meeting its forecasted earnings for the fourth quarter 1999. This revelation caused Legato stock to be halted on NASDAQ and ultimately to plummet to $29 per share in after-hour trading, a decline of 63% from its Class Period high.

6. The claims asserted herein arise under and pursuant to§§10(b) and 20(a) of the Securities Exchange Act of 1934 (the "Exchange Act") [15 U.S.C. §§78j(b) and 78t(a)], and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission ("SEC") [17 C.F.R. §240.10b-5].

7. (a) Venue is proper in this District pursuant to §27 of the Exchange Act. Many of the acts and transactions giving rise to the violations of law complained of herein, including the preparation and dissemination to the investing public of false and misleading information, occurred in this District. Legato has its principal place of business at 3210 Porter Drive, Palo Alto, California.

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

8. In connection with the acts, conduct and other wrongs complained of, the defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, the United States mails, and the facilities of the national securities markets.

9. Plaintiff John C.J. Quong, Trustee, purchased Legato securities during the Class Period as detailed in the attached certification and was damaged thereby.

10. Defendant Legato is headquartered in Palo Alto, California, and represents itself as a company which develops, markets, and supports network storage management software products for heterogeneous client/server computing environments and large scale enterprises. The Company's storage management solutions are designed to support a wide range of client, server, and storage devices such as DOS, NetWare, NT, OS/2, UNIX, and Windows. Legato's stock is traded in an efficient market on NASDAQ.

11. (a) Defendant Louis C. Cole ("Cole") is Chairman of the Board, President and Chief Executive Officer of Legato. Because of Cole's positions, he knew the adverse non-public information about the business of Legato, as well as its finances, markets and present and future business prospects via access to internal corporate documents (including Legato'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 him in connection therewith. During the Class Period, Cole participated in the issuance and/or review of false and/or misleading statements, including the preparation of false and/or misleading press releases and SEC filings. During the Class Period, Cole sold 75,000 shares of Legato stock for proceeds of over $4.8 million.

(b) Defendant Kent D. Smith ("Smith") was Executive Vice President and Chief Operating Officer of Legato. Because of Smith's positions, he knew the adverse non-public information about the business of Legato, as well as its finances, markets and present and future business prospects via access to internal corporate documents (including Legato'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 via reports and other information provided to him in connection therewith. During the Class Period, Smith participated in the issuance of false and/or misleading statements, including the preparation and/or review of the false and/or misleading press releases and SEC filings. During the Class Period, Smith sold 29,500 shares of Legato stock for proceeds of over $1.9 million.

(c) Defendant Stephen C. Wise ("Wise") was Senior Vice President and Chief Financial Officer of Legato. Because of Wise's positions, he knew the adverse non-public information about the business of Legato, as well as its finances, markets and present and future business prospects via access to internal corporate documents (including Legato'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 via reports and other information provided to him in connection therewith. During the Class Period, Wise participated in the issuance of false and/or misleading statements, including the preparation and/or review of false and/or misleading press releases and SEC filings. During the Class Period, Wise sold 40,422 shares of Legato stock for proceeds of over $2.6 million.

(d) Defendant Nora M. Denzel ("Denzel") was the Senior Vice President of Legato. Because of Denzel's position, she knew the adverse non-public information about the business of Legato, as well as its finances, markets and present and future business prospects via access to internal corporate documents (including Legato'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 via reports and other information provided to her in connection therewith. During the Class Period, Denzel participated in the issuance of false and/or misleading statements, including the preparation and/or review of false and/or misleading press releases and SEC filings. During the Class Period, Denzel sold 34,000 shares of Legato stock for proceeds of over $2.2 million.

12. By reason of their positions, the officer and/or director defendants identified above, (collectively the "Individual Defendants") had access to material inside information about Legato and were able to control directly or indirectly the acts of Legato and the contents of the representations disseminated during the Class Period by or in the name of Legato.

13. The defendants are liable, jointly and severally, as direct participants in the wrongs complained of herein. Defendants had a duty promptly to disseminate accurate and truthful information with respect to Legato's products, operations, financial condition and future business prospects or to cause and direct that such information be disseminated so that the market price of Legato's shares would be based on truthful and accurate information.

14. The Individual Defendants, because of their positions of control and authority as officers and/or directors of the Company were able to and did control the contents of the various quarterly and annual financial reports, SEC filings, press releases, and presentations to securities analysts pertaining to Legato. Each Individual Defendant was provided with copies of Legato's press releases and SEC filings alleged herein to be misleading prior to or shortly after their issuance and had the ability and opportunity to prevent their issuance or to cause them to be corrected. Because of their board membership and/or executive and managerial positions with Legato, each Individual Defendant had access to the adverse non-public information about Legato's business, finances, products, markets and present and future business prospects particularized herein, via access to internal corporate documents, conversations or connections with corporate officers and employees, attendance at Legato's management and/or Board of Directors' meetings and committees thereof and via reports and other information provided to them in connection therewith. The Individual Defendants are liable for the false statements pleaded herein at ¶¶18, 21, 24, 27 as those statements were each "group published" information, the result of the collective action of the Individual Defendants.

15. During the Class Period, the Individual Defendants engaged in the scheme to conceal Legato's wrongful revenue recognition practices in order to prevent the decline in the price of Legato securities to: (i) use Legato's artificially inflated stock to fund the Company's acquisition of companies in stock-for-stock transactions; and (ii) reap $11.5 million in insider trading proceeds.

16. The defendants wanted to profit from their scheme and use the Company's stock as currency to funds its acquisitions. Defendants believed that the ability to report "record" results would cause Legato to be successful in future years and/or be an attractive acquisition target. To provide complete solutions, it was necessary for Legato to make acquisitions, as it otherwise would take years to develop the technology and infrastructure necessary to offer complete software solutions for data availability and data protection needs. Defendants knew it was essential that Legato's stock trade at high levels to cause shareholders of target companies to approve the acquisitions and to make such acquisitions non-dilutive by using as few shares as possible in exchange for other companies.

17. Each of the defendants either knew or was consciously reckless in disregarding the fact that the illegal acts and practices and misleading statements and omissions described herein would adversely affect the integrity of the market for Legato securities and would artificially inflate or maintain the prices of those securities. Each of the defendants, by acting as herein described, did so knowingly or in such a reckless manner as to constitute a fraud and deceit upon plaintiff and members of the Class plaintiff seeks to represent.

18. On October 20, 1999, Legato issued its results for the third quarter ended September 30, 1999, including record revenue of $71.7 million - a 67% increase over the comparable quarter - and net income of $16 million - a 150% increase over the comparable quarter. Commenting on Legato's "record" results, defendant Cole stated:

"I am very pleased with this quarter's performance.... Our third quarter results reflect the strong momentum we have seen in our business as customers continue to demand comprehensive software solutions for their data protection and data availability needs. The acquisition of Vinca, in combination with our FullTime data availability solutions, significantly extends Legato's leadership position in the rapidly growing data availability marketplace. We're also very excited with the broad industry support we have received in the quarter from our Celestra Consortium partners ...."

"Our recently completed third quarter was our strongest quarter in company history, and we're pleased with the contributions from our newly-acquired businesses.... Product license revenue was up sharply in the quarter to $54.0 million, increasing 65% over the third quarter of last year. Service and support revenues grew 71% to $17.7 million, reflecting continued strong demand for our consulting, education, maintenance, and support services. Our merger integration efforts over the past several quarters were very successful, and all operations have now been integrated into Legato consistent with our historic operating model ...."

Legato reported 3Q99 EPS of $0.18, beating the Street and our estimate of $0.16. EPS were 124% better than last year's $0.08. Revenues grew 67% to $72 million from $43 million last year, surpassing our $71 million forecast. Net income grew 143% to $16 million from $7 million, far exceeding our estimated 120% increase to $14.5 million. The company's exceptional performance was driven by a combination of strong top-line growth and increased efficiencies from the integration of the FullTime, Intelliguard and Vinca acquisitions.

21. On November 10, 1999, Legato filed with the SEC its report on Form 10-Q for the quarter ended September 30, 1999. The report on Form 10-Q included the false financial results previously reported on October 20, 1999.

22. The financial results reported by Legato for third quarter 1999 were false and misleading and prepared in violation of GAAP as detailed in ¶¶37-46.

23. On November 11, 1999, Warburg Dillon Read issued a report "initiating coverage with a $95 target price" on Legato by Jordan Klein. Because this was Warburg's first report on Legato, it was issued only after Klein had extensive discussions with Cole and Wise and was based on and repeated information provided by them. The report forecast 99 and 00 EPS as follows:

          EPS/1999     EPS/2000

QTR
1st:         $                   $0.19
2nd:        $                   $0.22
3rd:        $                   $0.25
4th:         $0.20            $0.28
Year:      $0.62            $0.95

The acquisition expands Legato's leadership in data availability and extends the company's information continuance strategy to include premier data recovery software and service solutions. The combination of Legato and Ontrack will allow Legato to offer enterprise customers a new level of data availability to enhance their overall information management plans. This acquisition also gives Legato the desktop tools to aggressively move into the expanding application service provider (ASP) market.

The transaction will be accounted for under purchase accounting, and is expected to close in late January 2000, subject to customary regulatory and shareholder approvals. Legato will issue a combination of approximately 1.485 million shares of Legato stock (or 0.1491 shares for each issued and outstanding share of Ontrack's common stock) and approximately $20 million in cash for all of the outstanding stock of Ontrack Corporation, and will assume its employee options. The value of the transaction, based on Legato's closing price as of November 17, is approximately $134 million. Legato expects that the acquisition of Ontrack Corporation will be accretive to its 2000 earnings, excluding non-recurring merger-related costs and the ongoing amortization associated with the acquisition.

"The combination of Legato and Ontrack will give customers a more complete and more comprehensive set of data and application availability solutions provided by a single, industry-leading company," stated Louis Cole, president and CEO of Legato Systems. "Legato has a long history of providing our customers with leading data recovery solutions. The acquisition of Ontrack greatly extends our reach into the growing market for recovering data that has been previously unrecoverable using conventional methods," concluded Cole.

* * *

The acquisition of Ontrack is a natural extension to Legato's leadership in protecting, managing and moving data in heterogeneous environments. Legato is delivering information continuance through solutions that enable data and application availability. This acquisition enables Legato to provide the highest level of service in advanced storage management.

Key Points From Ontrack Acquisition

* Accretive In 2000 and Beyond, according to our forecast, as it should:

1. Add $50 million to revenues (new estimate $506 mil) and $0.05 to EPS in
2000;and

2. Add $80 million to revenues (new estimate $780 mil) and $0.10 to EPS (new
estimate $1.45) in 2001.

3. Ontrack business should be quickly leveraged through Legato's distribution
channels.

4. Operating margins are currently 18%. A minimum of integration should move
margins into the mid-20s

27. On December 15, 1999, Legato issued a press release stating that it had been added to the NASDAQ 100 Index. Commenting on the reasons for the addition the release stated:

Legato has demonstrated extraordinary financial performance over an extended period of time. For the first nine months of 1999, Legato achieved record revenue of $185.6 million, registering an increase of 64% over the same period last year of $113.3 million. Diluted earnings of $0.42 per share, excluding merger-related costs, increased 163% over the $0.16 earned during the first nine months of 1998.

"Our strong financial and business performance is reflective of Legato's broad vision of the storage management software market, and our ability to execute," said Stephen C. Wise, chief financial officer, Legato Systems, Inc. "Legato is positioned to sustain this growth as we continue to acquire and develop leading technologies that meet the expanding information continuance needs of customers and strategic partners."

Earnings Preview

We expect Legato to at least meet our $0.21 estimate, beating the Street's 4Q99 estimate of $0.20, which compares favorably with $0.08 in 3Q98. Revenues are forecast to grow 86% to $90.9 million versus 4Q98's $48.5 million.

We expect Legato's license-services revenue mix to be 78%-22% with license revenues of $70.6 million, which implies a 95% growth over last year's $36.2 million. We expect NetWorker to do the heavy lifting and grow 70% to $57.1 million and account for 81% of license revenues. In services, we forecast revenue growth of 57% to $16.8 million.

            EPS/1999    EPS/2000

QTR
1st:         $                  $0.19
2nd:        $                  $0.22
3rd:        $                  $0.25
4th:         $0.20           $0.28
Year:      $0.62           $0.95

31. On January 12, 2000, CIBC World Markets issued a report on Legato by M. Eisenstat, written after discussions with Wise, Cole and Denzel, which was based on and repeated information provided by them concerning the negative rumors which were beginning to devastate Legato shares and the prospects for consummating the Ontrack merger. The report also stated in part:

Investment Conclusion

During Legato Systems' precipitous drop from 68 7/16 to 57 3/4 this afternoon January 11, we checked in with management, who indicated no changes in guidance and that earnings are Ontrack for the quarter and for the coming fiscal year. We attribute the drop in the stock to comments by one of our competitors concerning revenue estimates which were misconstrued as negative, though this was not accompanied by any numbers revisions. Management indicated comfort with 4Q99 guidance for both the top and bottom lines, and we remain confident with our earnings model. We would use this pullback as a buying opportunity prior to earnings announcement.

From our discussion with management, 4Q99 revenue estimates run a tight range from $85-90 million with our estimate coming in at $90 million. This represents a significant acceleration of growth between 75% at the low end and 86% at the high end compared with 2Q99 and 3Q99 growth rates of 65% and 67% respectively. While our estimate is at the high end of the range, we expect to the company's revenues will come in closer to $87-88 million.

33. The acquisition of Ontrack was subject to the Ontrack shareholder vote on January 31, 2000. Defendants needed to delay their announcement of their accounting improprieties until after the merger with Ontrack and been voted on by Ontrack's shareholders. Just days before the shareholder vote, defendants were forced to reveal the truth concerning its third and fourth quarter financial results.

34. By the end of December 1999, the Company had virtually assured itself of acquiring Ontrack - its most important acquisition ever - and had created the fiction of Legato's purported ability to achieve "record" results and continued growth which would allow them to save millions in the cost of its stock-for-stock acquisition. However, the Company was facing pressure to reveal that it had achieved purported "record" growth through improper revenue recognition and that its fourth quarter 1999 results would be only a fraction of what defendants had represented, as Legato was in its pre-audit stages and would be forced to come clean concerning its accounting improprieties.

35. On January 19, 2000, the defendants' attempt to conceal the Company's accounting improprieties until after the Ontrack shareholders voted on the merger had failed. With the threat of Legato's auditors withdrawing/resigning prior to the filing of Legato's Form 10-K if defendants would not come clean on their accounting improprieties, restate the third quarter 1999 results, and "back out" revenue out of the "to-be-released" fourth quarter and disclose the same to the public, defendants were forced to admit their fraud.

36. Legato's actual financial results and the true status of its operations were concealed by defendants, which operated to artificially inflate or maintain the market price of Legato securities during the Class Period. Each of the releases, SEC filings (including the proxy statement/prospectus) and statements particularized herein was false and misleading and misrepresented and/or failed to disclose the following material adverse information:

(a) Legato's financial results were the result of accounting trickery as detailed in ¶¶37-46;

(b) Defendants knowingly tolerated Legato's inadequate internal accounting controls and consequently lacked any reasonable basis for the financial results reported by them;

(c) Legato's reported third quarter 1999 income was materially overstated;

(d) Only through Legato's accounting fraud had Legato achieved the earnings for 1999 reported by defendants;

(e) Legato was not successful in achieving its purported "record" growth and its fundamentals and prospects were deteriorating; and

(f) As a result of the foregoing, there was no reasonable basis in fact for defendants' statements that Legato actually earned $16.0 million in the third quarter of 1999, as the adverse facts set forth above were inconsistent with and seriously undermined those statements such that defendants had no reasonable basis to believe them and did not, in fact, believe them.

37. In order to inflate the price of Legato's securities, defendants caused the Company to falsely report its results for the third quarter of 1999 through the use of improper revenue recognition, thereby materially overstating its net income and EPS in the third quarter of 1999. Ultimately, Legato revealed that its results for the fourth quarter 1999 would be adversely affected due to Legato's attempt to recognize revenue improperly and that Legato's auditors would not sign off on the Company's 10-K if defendants insisted on violating GAAP.

38. Legato reported the following amounts during the Class Period:

                                 9/30/99

Total Revenue           $71.7 million
Net Income               $16.0 million
EPS                          $0.18

40. These results and the representations concerning them were false and misleading when made, as Legato's financial statements for the third quarter of 1999 were not fair presentations of Legato's results and were presented in violation of GAAP and SEC rules.

41. GAAP are those principles recognized by the accounting profession as the conventions, rules and procedures necessary to define accepted accounting practice at a particular time. SEC Regulation S-X (17 C.F.R. §210.4-01(a)(1)) states that financial statements filed with the SEC which are not prepared in compliance with GAAP are presumed to be misleading and inaccurate, despite footnote or other disclosure. Regulation S-X requires that interim financial statements must also comply with GAAP, with the exception that interim financial statements need not include disclosure which would be duplicative of disclosures accompanying annual financial statements. 17 C.F.R. §210.10-01(a).

42. The Individual Defendants caused Legato to falsify its reported financial results through its improper recognition of revenue of its software contracts with several of its largest customers including Storage Networks, Inc.

43. Unfortunately for investors, these results, and the representations concerning them, were false. Absent the Company's improper accounting for its software contracts, Legato would have reported materially lower EPS.

44. On January 19, 2000, the defendants' attempt to conceal the Company's accounting improprieties until after the Ontrack shareholders voted on the merger had failed. With the threat of Legato's auditors withdrawing/resigning prior to the filing of Legato's Form 10-K if defendants would not come clean on their accounting improprieties, restate the third quarter 1999 results, and "back out" revenue out of the "to-be-released" fourth quarter and disclose the same to the public, defendants were forced to admit their fraud.

45. Due to these accounting improprieties, the Company presented its financial results and statements in a manner which violated GAAP, including the following fundamental accounting principles:

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

(b) The principle that financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit and similar decisions was violated (FASB Statement of Concepts No. 1, ¶34);

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

(d) The principle that financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it was violated. To the extent that management offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospective investors and to the public in general (FASB Statement of Concepts No. 1, ¶50);

(e) The principle that financial reporting should provide information about an enterprise's financial performance during a period was violated. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance (FASB Statement of Concepts No. 1, ¶42);

(f) The principle that financial reporting should be reliable in that it represents what it purports to represent was violated. That information should be reliable as well as relevant is a notion that is central to accounting (FASB Statement of Concepts No. 2, ¶¶58-59);

(g) The principle of completeness, which means that nothing is left out of the information that may be necessary to insure that it validly represents underlying events and conditions was violated (FASB Statement of Concepts No. 2, ¶79); and

(h) The principle that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered was violated. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent (FASB Statement of Concepts No. 2, ¶¶95, 97).

46. Further, 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.

47. Legato had a responsibility to maintain sufficient accounting controls to accurately report its financial results. It is well settled that the representations made by a company in its financial statements and in other financial disclosures to the public are the representations of that company's management. Indeed, even when a company issues audited financial statements together with the report of that company's independent auditors, that report always expressly provides that "the financial statements are the responsibility of [the company's] management."

48. According to SEC rules, to accomplish the objectives of accurately recording, processing, summarizing and reporting financial data, a company must establish an internal control structure. Pursuant to §13(b)(2) of the Exchange Act, Legato was required to:

(A) make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; and

(B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that -

(i) transactions are executed in accordance with management's general or specific authorization;

(ii) transactions are recorded as necessary ... to permit preparation of financial statements in conformity with generally accepted accounting principles ....

50. As described in SAS 55, the applicability and importance of specific control environment factors, accounting system methods and records, and control procedures that an entity should establish should be considered within the context of such criteria as an entity's size, its organization and ownership characteristics, the nature of its business, the diversity and complexity of its operations, the entity's method of processing data, and its applicable legal and regulatory requirements. In short, the larger the entity, the more the nature of the entity's business is complex, diverse and sophisticated, and the public ownership of the entity customarily requires a sophisticated internal control structure to ensure that transactions are accurately recorded and that, prior to the public disclosure of any financial information, such transactions are compared to the existing assets (e.g., comparing inventory as recorded on a company's books to those amounts actually "on hand") to eliminate any discrepancies between the recorded and actual amounts.

51. According to SAS 55.13:

Establishing and maintaining an internal control structure is an important management responsibility. To provide reasonable assurance that an entity's objectives will be achieved, the internal control structure should be under ongoing supervision by management to determine that it is operating as intended and that it is modified as appropriate for changes in conditions.

53. On January 19, 2000, Legato revealed that it would need to restate its third quarter 1999 results. The release also stated that, despite its forecasts of $85 to $95 million in fourth quarter revenue and $0.19 to $0.21 EPS, Legato's results would actually be almost half of what defendants had represented. Legato reported fourth quarter revenue of $48.5 million and EPS of just $0.08. In response, Legato's shares plummeted $24 per share to $29 in after hours trading.

54. As Legato's stock increased in price due to these very positive statements about Legato's business detailed in ¶¶18-20, 23-25, 27-29, 31, Legato's insiders Cole, Denzel, Smith and Wise took advantage of this artificial inflation of Legato's stock by selling off 75,000, 34,000, 29,500 and 40,422 shares, respectively, of their stock at as high as $67.75 per share, pocketing $4.8 million, $2.2 million, $1.9 million and $2.6 million, respectively, in illegal insider trading proceeds. In total, between November 23, 1999 and November 30, 1999 - a period of seven days and after defendants issued false financial results for Legato's third quarter 1999 and filed those results with the SEC in its 10-Q - the Individual Defendants unloaded over 178,000 shares of their Legato stock for $11.5 million in illegal insider trading proceeds.

55. Plaintiff brings this lawsuit pursuant to Rule 23(a) and (b)(3) of the Federal Rules of Civil Procedure, on behalf of himself and on behalf of a class of persons who purchased Legato publicly traded securities from October 21, 1999 through January 19, 2000, inclusive (the "Class"). Excluded from the Class are defendants herein, members of the immediate families of each of the defendants, any person, firm, trust, corporation, officer, director or other individual or entity in which any defendant has a controlling interest or which is related to or affiliated with any of the defendants, and the legal representatives, agents, affiliates, heirs, successors-in-interest or assigns of any such excluded party.

56. This action is properly maintainable as a class action for the following reasons:

(a) The Class is so numerous that joinder of all Class members is impracticable. As of September 30, 1999, Legato had approximately 84 million shares outstanding. Members of the Class are scattered throughout the United States.

(b) There are questions of law and fact which are common to members of the Class and which predominate over any questions affecting only individual members. The common questions include, inter alia, the following:

(i) Whether the defendants' acts as alleged herein violated the federal securities laws;

(ii) Whether defendants participated in and pursued the common course of conduct complained of herein;

(iii) Whether documents, SEC filings, press releases and other statements disseminated to the investing public and Legato's securities stockholders during the Class Period misrepresented material facts about the operations, financial condition and earnings of Legato;

(iv) Whether the market prices of Legato securities during the Class Period were artificially inflated due to material misrepresentations and the failure to correct the material misrepresentations complained of herein; and

(v) To what extent the members of the Class have sustained damages and the proper measure of damages.

(c) Plaintiff's claim is typical of the claims of other members of the Class and plaintiff has no interests that are adverse or antagonistic to the interests of the Class.

(d) Plaintiff is committed to the vigorous prosecution of this action and has retained competent counsel experienced in litigation of this nature. Accordingly, plaintiff is an adequate representative of the Class and will fairly and adequately protect the interests of the Class.

(e) Plaintiff anticipates that there will not be any difficulty in the management of this litigation as a class action.

57. For the reasons stated herein, a class action is superior to other available methods for the fair and efficient adjudication of this action and the claims asserted herein. Because of the size of the individual Class members' claims, few, if any, Class members could afford to seek legal redress individually for the wrongs complained of herein.

58. The statutory safe harbor provided for forward-looking statements under certain circumstances does not apply to the allegedly false statements pleaded in this Complaint, as the statutory safe harbor does not apply to the defendants' misrepresentations of currently existing or historical facts, including defendants' dissemination of false financial statements.

59. Plaintiff repeats and realleges the allegations set forth above as though fully set forth herein.

60. This Count is brought by plaintiff pursuant to §10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder by the SEC against Legato and the Individual Defendants.

61. The defendants: (a) employed devices, schemes, and artifices to defraud; (b) made untrue statements of material fact and/or omitted to state material facts necessary in order to make the statements made not misleading; and (c) engaged in acts, practices, and a course of business which operated as a fraud and deceit upon the purchasers of Legato securities in an effort to maintain artificially high market prices for Legato's securities in violation of §10(b) of the Exchange Act and Rule 10b-5. Legato and the Individual Defendants are sued either as primary participants in the wrongful and illegal conduct charged herein or as controlling persons as alleged below.

62. In addition to the duties of full disclosure imposed on the Individual Defendants by their status as controlling persons of Legato, as a result of their affirmative statements and reports, or participation in the making of affirmative statements and reports to the investing public, defendants had a duty to promptly disseminate truthful information that would be material to investors in compliance with the integrated disclosure provisions of the SEC as embodied in SEC Regulations S-X (17 C.F.R. §§210.01, et seq.) and S-K (17 C.F.R. §§229.10, et seq.) and other SEC regulations, including accurate and truthful information with respect to Legato's securities, operations, financial condition and earnings so that the market price of Legato's securities would be based on truthful, complete and accurate information.

63. Legato and the Individual Defendants, individually and in concert, directly and indirectly, by using the means and instrumentalities of interstate commerce and/or of the mails, engaged and participated in a continuous course of conduct to conceal adverse material information about the business, operations and future prospects of Legato as specified herein. The defendants employed devices, schemes and artifices to defraud, while in possession of material adverse non-public information and engaged in acts, practices, and a course of conduct as alleged herein in an effort to assure investors of Legato's value and performance and continued substantial growth, which included the making of, or the participation in the making of, untrue statements of material facts and omitting to state material facts necessary in order to make the statements made about Legato and its business operations and future prospects, in the light of the circumstances under which they were made, not misleading, as set forth more particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon the purchasers of Legato securities during the Class Period.

64. The primary liability and controlling person liability of the defendants named in this Count arises from the following facts: during the Class Period, the Individual Defendants (Cole, Smith, Wise and Denzel), who controlled and were senior officers of Legato, engaged in the scheme to conceal Legato's badly flagging growth to prevent the decline in the price of Legato stock in order to: (i) use Legato's artificially inflated stock as currency to fund the Company's acquisition of companies in stock-for-stock transactions; and (ii) reap $11.5 million in insider trading proceeds.

65. The Individual Defendants had actual knowledge of the misrepresentations and omissions of material facts set forth herein. Such defendants' material misrepresentations or omissions were done knowingly and for the purpose and effect of concealing Legato's operating condition and future business prospects from the investing public and supporting the artificially inflated price of their securities, as demonstrated by said defendants' overstatements and misstatements of Legato's business, operations and future earnings prospects throughout the Class Period. Defendants knew that Legato's financial statements were materially misstated throughout the Class Period.

66. As a result of the dissemination of the materially false and misleading information and failure to disclose material facts by all defendants, as set forth above, the market price of Legato securities were artificially inflated during the Class Period. In ignorance of the fact that market prices of Legato securities were artificially inflated, and relying directly or indirectly on the false and misleading statements made by defendants, or upon the integrity of the market in which the securities trade, and the truth of any representations made to appropriate agencies as to the investing public, at the times at which any statements were made, and/or on the absence of material adverse information that was known by defendants but not disclosed in public statements by defendants during the Class Period, plaintiff and the other members of the Class acquired Legato's securities during the Class Period at artificially high prices and were damaged thereby.

67. At the time of said misrepresentations and omissions, plaintiff and other members of the Class were ignorant of their falsity and believed them to be true. Had plaintiff and the other members of the Class and the marketplace known of the true financial condition and business prospects of Legato, which were not disclosed by defendants, plaintiff and other members of the Class would not have purchased Legato securities during the Class Period, or, if they had purchased such securities during the Class Period, they would not have done so at the artificially inflated prices which they paid.

68. By virtue of the foregoing, Legato and the Individual Defendants have violated §10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.

69. As a direct and proximate result of the wrongful conduct of the defendants named in this Count, plaintiff and the other members of the Class suffered damages in connection with their purchases of Legato securities during the Class Period.

70. Plaintiff repeats and realleges the allegations set forth above as if set forth fully herein.

71. The Individual Defendants acted as controlling persons of Legato within the meaning of §20(a) of the Exchange Act as alleged herein. By virtue of their high-level positions, substantial stock holdings, participation in and/or awareness of Legato's operations and/or intimate knowledge of its internal financial condition, business practices, products and the actual progress of development and marketing efforts, these defendants had the power to influence and control and did influence and control, directly or indirectly, the decision-making of Legato, including the content and dissemination of the various statements which plaintiff contends are false and misleading. Legato controlled the Individual Defendants and all of its employees. Each of the Individual Defendants was provided with or had unlimited access to copies of Legato's internal reports, press releases, public filings and other statements alleged by plaintiff to be misleading prior to and/or shortly after these statements were issued and had the ability to prevent the issuance of the statements or cause the statements to be corrected.

72. In particular, each of the Individual Defendants had direct involvement in or intimate knowledge of the day-to-day operations of Legato and therefore is presumed to have had the power to control or influence the particular transactions giving rise to the securities violations as alleged herein, and exercised the same.

73. As set forth above, the defendants violated§10(b) of the Exchange Act and Rule 10b-5 by their acts and omissions as alleged in this Complaint. By virtue of their positions as controlling persons, these defendants are liable pursuant to §20(a) of the Exchange Act.

74. As a direct and proximate result of the wrongful conduct of defendants, plaintiff and other members of the Class suffered damages in connection with their purchase of Legato securities during the Class Period.

WHEREFORE, plaintiff, on behalf of himself and the Class, prays for judgment as follows:

A. Declaring this action to be a class action properly maintained pursuant to Rule 23 of the Federal Rules of Civil Procedure;

B. Awarding plaintiff and other members of the Class damages together with interest thereon;

C. Awarding plaintiff and other members of the Class costs and expenses of this litigation, including reasonable attorneys' fees, accountants' fees and experts' fees and other costs and disbursements; and

D. Awarding plaintiff and other members of the Class such other and further relief as may be just and proper under the circumstances.

Plaintiff demands a trial by jury.

DATED this 31st day of January, 2000.

MILBERG WEISS BERSHAD
HYNES & LERACH LLP
PATRICK COUGHLIN
 
 
 
 
 

____________________________
PATRICK J. COUGHLIN

100 Pine Street, Suite 2600
San Francisco, CA 94111
Telephone: 415/288-4545

MILBERG WEISS BERSHAD
HYNES & LERACH LLP
WILLIAM S. LERACH
DARREN J. ROBBINS
600 West Broadway, Suite 1800
San Diego, CA 92101
Telephone: 619/231-1058

Attorneys for Plaintiff