IN THE UNITED STATES DISTRICT COURFOR THE NORTHERN DISTRICT OF ILLINOI S

EASTERN DIVISION

~~J 1)IN RE: SEARS, ROEBUCK AND CO . JUD S ACES D1sI [0

SECURITIES LITIGATION ) No. 02 C 070V

Judge Elaine E. Bucklo

NOTICE OF FILING~

1~' -7

To: Counsel on the Attached Service Lis t

PLEASE TAKE NOTICE that on Monday, June 16, 2003, we filed with the Clerk of the

United States District Court for the Northern District of Illinois , Eastern Division, 219 South

Dearborn Street, Chicago, Illinois, the Consolidated Amended Class Action Complaint fo r

Violations of Federal Securities Laws, a copy of which is hereby served upon you.

Dated: June 16, 2003 By:Marvin A. MillerJennifer Winter SprengelLori A. FanningMILLER FAUCHER and CAFFERTY LLP30 North LaSalle Street, Suite 3200

Chicago, Illinois 60602(312) 782-4880

aftort-14JUN

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CERTIFICATE OF SERVIC E

I, Dom J. Rizzi, one of the attorneys for plaintiff, hereby certify that I caused ConsolidatedAmended Class Action Complaint for Violations of Federal Securities Laws to be served on allcounsel on the attached service list by placing a copy of the same in the United States Mail at 30North LaSalle Street, Chicago, Illinois this 16" day of June, 2003 .

Marvin A. Miller

Service List

Harold C. HirshmanChristopher Qualley KingJohn Claiborne KoskiElissa Eun Choo Rhee-LeeSONNENSCHEIN, NATH & ROSENTHAL233 South Wacker Drive8000 Sears TowerChicago, IL 60606(312) 876-8000

Attorneys for Sears, Roebuck & Co,Alan Lacy, Paul J. Liska, Glenn Richterand Thomas E. Bergmann .

Walter C. CarlsonScott R. SassarRussell J . Kelle r

SIDLEY AUSTIN BROWN & WOOD10 South Dearborn Stree tChicago, Illinois 60603(312) 853-7000

Attorneys for Kevin Keleghan

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IN THE UNITED STATES DISTRICT COURTFOR THE NORTHERN DISTRICT OF ILLINOIS

EASTERN DIVISION

IN RE: SEARS, ROEBUCK AND *fzt~ }SECURITIES LITIGATION 014 -,9 0

0) No. 02 C 07527

I

JVN I ~ 200 3JUDGE EL,, . .~c ~ . BUCKLO

UNITED STATES DiSIRICT COURI

FILE D

Judge Elaine E . Bucklo JUN 16 2003

JUVUL ELAINE E . $UCKLO°9iIUU SIATE$ DISTRICT COUR t

CONSOLIDATED AMENDED CLASS ACTIONCOMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAW S

Plaintiffs, through their attorneys, bring this action on behalf of themselves and all other s

similarly situated, on personal knowledge as to themselves and their activities, and on informatio n

and belief as to all other matters, based on investigation conducted by counsel, including, inter alia ,

review of United States Securities and Exchange Commission ("SEC") filings by Sears, Roebuck

& Co. ("Sears" or the "Company"), press releases and other public statements issued by the

Company, securities analysts' reports and advisories about the Company, newspaper articles an d

reports from the media, interviews with former Sears employees, and consultations with experts i n

the credit card industry and in forensic accounting . Plaintiffs believe that substantial additiona l

evidentiary support will be developed for the allegations set forth herein after a reasonabl e

opportunity for discovery .

Ub

SUMMARY OF THE COMPLAINT

1 . This is a class action brought by Plaintiffs under the Securities Exchange Act o f

1934 (the "Exchange Act") on behalf of themselves and all other persons who purchased the

securities of Sears between October 24, 2001 and October 17, 2002, inclusive (the "Class Period") .

Plaintiffs complain of a fraudulent scheme and deceptive course of business, described in detail

herein, that injured purchasers of Sears securities during the Class Period .

2. Defendant Sears is one of North America' s largest retailers . Although its retail sales

operations have historically been the largest and most important aspects of Sears's business, prior

to the Class Period Sears's credit card business had become an increasingly significant part o f

Sears's operations and overall business plan . For example, as of 1999, Sears's retail credit card

portfolio (consisting of Sears customers who had Sears store charge accounts) was larger -- at more

than 60 million accounts -- than the portfolios of the ten next biggest retail credit card issuers

combined. Moreover, as Sears faced growing competition from other large retailers (such as Wal-

Mart) in the late 1990's, Sears's credit operations also became an increasingly significant contributor

to Sears's overall financial performance and profitability . For example, although Sears Credit

accounted for only about 11 % of the Company's revenues by the late 1990's, during the same period

its credit operations accounted for approximately 58% of Sears's operating income .

3 . Unfortunately for Sears, the prospects for continued growth in its store credit card

business (and related home improvement account business) were limited, due to competition from

other credit card providers (such as banks that issue Visa Cards and MasterCards) . For example, by

1999 Sears customers were charging only 48% of their Sears purchases to a Sears store card,

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compared to 60% in 1993 -- and nearly 24 million Sears store card accounts had gone inactive o r

failed to carry a balance (and hence were no longer generating income) .

4. In an effort to generate more income from its credit operations -- and to compensat e

for the continuing deterioration of Sears's retail sale operations -- in 2000 Sears made a decision o f

major importance to investors : to launch its own MasterCard product, and to convert many of it s

already huge base of existing Sears store credit card holders into holders of a new Sears Gol d

MasterCard ("Sears MasterCard") . Because the new Sears MasterCard could be used anywhere

MasterCard was accepted -- and not just at Sears stores -- the new Sears MasterCard had the

potential to generate significant additional fee income for Sears (which would collect a fee wheneve r

the customer used the new card to buy goods or services from non-Sears vendors ) . Significantly ,

the Sears MasterCard would -- unlike existing Sears store cards -- also carry an annual fee, thereby

potentially generating a major new stream of recurring fee income .

5 . Prior to and during the Class Period, the defendants repeatedly represented tha t

Sears's efforts to convert its store credit card accounts into Sears MasterCard accounts was goin g

well, that Sears's growing credit card account base was of unusually strong credit quality, and that

Sears's credit extension policies and procedures for establishing loan loss reserves in connectio n

with the new MasterCard program were not merely adequate, but were "conservative" compared t o

the credit card industry as a whole . In addition, despite continuing declines in its retail business,

throughout the Class Period defendants portrayed Sears as a company that was experiencing (and

would continue to experience) significant growth and profits from its Credit Services busines s

generally, and from its store card and new Sears MasterCard portfolios in particular ,

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6. In reality, however, by no later than sixteen months into the launch of the Sear s

MasterCard program (i .e., no later than the beginning of the Class Period in October 2001) -- a s

Sears and its senior officers knew but did not disclose -- the true condition of Sears's credit busines s

was starkly different from and far more risky than the defendants' public portrayals . For example ,

far from utilizing conservative underwriting standards for its new MasterCards, Sears had

deliberately employed numerous aggressive marketing strategies that were targeted to lower-incom e

or unstable borrowers, including the use of unsolicited direct mailings which offered, inter alia ,

balance transfers at low "teaser" rates, free "convenience checks," and pre-approved credit limits tha t

were often well in excess of what the prospective cardholder would have ordinarily qualified for .

7. As a result of its aggressive marketing tactics and lowered underwriting standards ,

throughout the Class Period the creditworthiness of Sears's credit card portfolios was actuallyworse

than those of its competitors, and resulted in steadily increasing delinquencies . However, as part o f

its efforts to conceal and/or misrepresent the true condition of its portfolios, defendants consistentl y

assured investors that Sears's portfolio quality was "strong" with "stable," or even decreasing,

delinquency (late payment) rates . In reality, the rates of delinquent or completely uncollectibl e

accounts (charge-offs) for both the Sears MasterCard and the Sears store card portfolios had --

unbeknownst to investors -- steadily increased throughout the Class Period. Thus, for example :

• In a press release in January 2002, Sears announced that delinquencies in itsportfolios for the fourth quarter of 2001 had remained "flat" as compared to the p rioryear . However, as defend ants knew but did not disclose , Sears MasterCarddelinquencies had increased from a rate of 0 .38% to a rate of 1 .97% . Meanwhile,Sears's proprietary card delinquencies had increased by .12 % as compared to the prioryear .

• In a press release in April 2002, Sears reported a 7% increase in charge-offs from theprior year period, and that "[y]ear-over-year delinquencies decreased 19 basis points

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from 7 . 50 percent to 7 .31 percent, indicating stable portfolio quality ." However, asdefendants knew but did not disclose, Sears MasterCard charge-offs had increasedby 230%, and MasterCard delinquencies had increased by 122 %, while Sears'sproprietary store card charge-offs had increased by 16.4% and its store carddelinquencies had increased by 11.6% ;

• In a press release in July 2002, Sears reported that "[t]he net charge-off rate for thequarter decreased to 5.32 percent from 5.42 percent last year . . . . Year-over-yeardelinquencies decreased39 basis points from 7.26 percent to 6 .87 percent, indicatingstable portfolio quality ." However, as defendants knew but failed to disclose, SearsMasterCard chargeoffs had increased by 232%, and MasterCard delinquencies hadincreased by 114%. Meanwhile, Sears's proprietary card chargeoffs had increasedby 7.2%, while its store card delinquencies had increased by 14% .

The truth conce rn ing the deteriorating condition of Sears's credit operations was therefore artfully

concealed by defendants, who relied on a combination of outright misrepresentations , half-truths ,

and selective report ing of cherry-picked statistics to paint a patently false and misleading picture o f

Sears's credit card business . This deception also facilitated defendants' fraudulent inflation of th e

Company's publicly reported financial performance, as defendants' failure to establish adequat e

reserves for the materially greater-than-announced accounts of doubtful collectibility cause d

defendants to materially overstate Sears's reported income and earnings per share throughout th e

Class Period .

8. Defendants also concealed the deterioration in their credit card portfolios by assurin g

investors that Sears's portfolios were performing as well as, or better, than its competitors' in th e

credit card industry. However, such statements, which drew favorable comparisons between Sear s

and its competitors, were materially false and misleading because Sears's methodologies fo r

determining its delinquency and charge-off rates were not comparable to other leading credit car d

issuers . For example:

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• although bank card issuers are permitted to "cure" or "re-age" delinquent accountsonly if the borrower makes three consecutive on-time minimum payments, Sears "re-aged" delinquent accounts after only two consecutive minimum payments ;

• Sears promoted usage of its cards by frequently offering zero-percent financing orzero-pay deals on purchases of Sears products that were charged to a Sears card,which allowed Sears cardholders to minimize or even avoid any payment obligationsfor up to a year . As a result of such deferred payment terms, Sears - in contrast toits bank card competitors - was effectively able to delay having to categorize a largenumber of these accounts as delinquent for as much as a year, regardless of theaccount holder's ability to pay; and

• although bank card issuers charge-off credit card loans after they have beendelinquent for 180 days, Sears did not charge-off loans until they had been delinquentfor 240 days .

9. By fraudulently misrepresenting the quality and performance of its credit car d

portfolios during the Class Period, and by misrepresenting that its delinquency and charge-off rates

were comparable to or better than those of other leading credit card issuers, defendants also helpe d

conceal another key fact -- namely, that Sears's bad debt reserves were grossly inadequate . In sum,

although defendants' rapid expansion of Sears's MasterCard program enabled the Company to

recognize revenue on hundreds of millions of dollars worth of new account fees and issuer fees fro m

customer transactions, Sears's credit operations contained a hidden credit time bomb for which

defendants knowingly or recklessly failed to reserve adequately in violation of Generally Accepte d

Accounting Principles ("GAAP"), and that defendants fraudulently concealed from investors .

10. Although defendants embarked on their fraudulent scheme to mislead the publi c

concerning Sears's credit business by no later than the beginning of the Class Period (October 24 ,

2001), investors did not learn of the true extent of Sears' severely weakened financial condition unti l

October 2002, when the Company made the following series of disclosures, each more stunning than

the last :

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(a) On October 4, 2002, the Company announced that Sears's Executive Vic e

President and the President of Sears Credit and Financial Services -- defendant Kevin T .

Keleghan -- had "left the company" and was being replaced by defendant Paul J . Liska, and

that Liska's prior duties as Sears 's CFO were being assumed by defendant Glenn Richter ;

(b) On October 7, 2002, defendant Lacy (Sears's CEO) disclosed that he had

asked defendant Keleghan to leave "because I lost confidence in his personal credibility" --

and also disclosed that Sears was revising its prior forecast that operating income from Credi t

would experience low double-digit growth to a forecast that it would experience only "mi d

single-digit" growth . Although defendant Lacy attempted to blunt the impact of thes e

disclosures by claiming that Keleghan's departure was "not related to business performance "

and that Sears still expected its overall earnings per share ("EPS") for 2002 to increase b y

22% compared to 2001, Sears stock reacted to this news by falling over $5 .00, from $37 .64

on October 4 to $32 .25 on October 7 -- a one-day decline of over 14% ;

(c) On October 17, 2002, the Company issued a press release announcing that

Sears would be increasing its allowance for bad debt by a staggering $222 million in the third

quarter, that the resulting charge would reduce Sears's earnings for the 3rd quarter by 26 %

compared to the previous year, and that the performance of Sears's credit operations had

actually declined compared to the prior year . The Company also announced that Sears now

expected its EPS for 2002 to grow by only 15% -- or approximately 1/3 less than the 22%

EPS growth projection that defendants had expressly re-affirmed just 10 days earlier .

11 . The revelations of October 2002 did not end here , however . During a conference cal l

held later in the day on October 17, defendant Lacy retreated from his prior claim that Keleghan' s

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departure was not related to business performance, and instead publicly blamed Keleghan an d

defendant K.R. Vishwanath for withholding material information relating to the true state of Sears' s

credit business . As defendant Lacy now asserted :

[I]t became clear that Kevin [Keleghan] was not being forthcoming about these issues thatthis business was facing . . . and [that he] had become a barrier to getting an objective situationassessment as to what was happening in our business, and I terminated him for basically mypersonal loss of confidence in him relative to his personal credibility . . . You should alsoknow that during the course of our analysis we determined that the VP of Risk Managementand Credit [defendant K.R. Vishwanath] had also withheld information and had led us toterminate his employment effective yesterday .

12. In the wake of these disclosures, by the close of trading on October 17, 2002 the price

of Sears common stock had plummeted from $33 .95 per share the previous day to $23 .15 --

representing a stunning one-day decline of 32%, and an overall decline of more than 60 % from its

inflated Class Period high (on May 31, 2002) of $59 .05 per share . By this Complaint, Plaintiffs now

seek a recovery for themselves and all other class members to compensate for the substantia l

damages that they have suffered as a result of defendants' fraud and their repeated violations of the

securities laws and their disclosure obligations thereunder .

JURISDICTION AND VENUE

13. The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a) o f

the Exchange Act [15 U .S.C. §§ 78j(b) and 78t(a)] and Rule 10b-5 promulgated thereunder by th e

SEC [17 C .F.R. § 240 .10b-5] .

14. This Court has jurisdiction over the subjectmatterofthis action pursu ant to 28 U.S .C .

§§ 1331 and 1337 and Section 27 of the Exch ange Act [15 U . S.C . § 78aa] .

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15 . In connection with the acts alleged in this complaint, defendants, directly o r

indirectly, used the means and instrumentalities of interstate commerce, including, but not limite d

to, the mails, interstate telephone communications and the facilities of the nationa l

securities markets .

16. Venue is proper in this District pursuant to Section 27 of the Exchange Act, and 2 8

U.S .C. § 1391(b) . Many of the acts charged herein, including the preparation and dissemination o f

materially false and misleading information, occurred in substantial pa rt in this District .

Additionally, defendant Sears maintains its chief executive offices and p rincipal place of business

within this District .

PARTIES

17. Lead Plaintiff, The Department of the Treasury of the State of New Jersey and it s

Division of Investment , by John E. McCormac , State Treasurer, purchased the common stock of

Sears at artificially inflated prices during the Class Period and has been damaged thereby. The

certifications of the Lead Plaintiff and the other plaintiffs in this action have previously been file d

with the Court .

18. Defendant Sears, Roebuck & Co . is organized under the laws of New York and

maintains its principal executive offices at 3333 Beverly Road Hoffman Estates, Illinois . Sears is one

ofNorth America's largest retailers, and also provides financing to its customers through credit card s

and installment plans .

19. Defendant Alan Lacy ("Lacy") was Sears 's Chief Executive Officer, President and

Chairman of the Board throughout the Class Period . Prior to becoming CEO in 2000, Lacy served

as the President of Sears's Credit segment .

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20. Defendant Glenn Richter ("Richter") was Sears's Senior Vice President for Financ e

from the inception of the Class Period until October 4, 2002, when he became Senior Vice Presiden t

and Chief Financial Officer, and also Richter served as Sears's Controller and P rincipal Accounting

Officer from the inception of the Class Period until approximately March 2002 .

21 . Defendant Paul J . Liska ("Liska") was Sears 's Chief Financial Officer and an

Executive Vice President from the inception of the Class Period until October 4, 2002, when he

became Executive Vice President and President of Sears's Credit and Financial Products segment .

22 . Defendant Thomas E . Bergmann has been Sears's Vice President and Controller ,

Principal Accounting Officer, since approximately March 2002 .

23. Defendant Kevin T . Keleghan was President of Sears 's Credit and Financial Products

segment and an Executive Vice President from the inception of the Class Period until October 4 ,

2002, when he was forced to resign .

24. Defendant K.R. Vishwanath was Sears 's Vice President of Risk Management from

the inception of the Class Period until October 16, 2002, when his employment was terminated .

25 . Defendants Lacy, Richter, Liska, Bergmann , Keleghan, and Vishwanath are referred

to collectively herein as the "Individual Defendants" .

26 . During the Class Period, each of the Individual Defendants , as senior executive

officers and/or directors of Sears, was privy to confidential and proprietary information concerning

Sears's operations, finances, financial condition, and present and future business prospects . The

Individual Defendants also had access to material adverse non-public information concerning Sears,

as discussed in detail below . Because of their positions with Sears, the Individual Defendants ha d

access to non-public information about i ts business , finances, products, markets and present and

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future business prospects via access to internal corporate documents, conversations and connection s

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 i n

connection therewith . Because of their possession of such information, the Individual Defendant s

knew or recklessly disregarded that the adverse facts specified herein had not been disclosed to, an d

were being concealed from, the investing public, and that materially and affirmatively false an d

misleading statements as alleged herein were being made to the public .

27. Each of the defendants is liable as a direct participant in the wrongs complained o f

herein. In addition, the Individual Defendants, by reason of their status as executive officers and/o r

directors were each a "controlling person" within the meaning of Section 20 of the Exchange Ac t

and had the power and influence to cause the Company to engage in the unlawful conduct

complained of herein . Because of their positions of control, the Individual Defendants were able to

and did, directly or indirectly, control the conduct of Sears's business, and controlled and/or

possessed the authority to control the contents of Sears's reports, press releases, SEC filings, and

presentations to securities analysts (and, through these analysts, to the investing public) . The

Individual Defendants were provided with copies of the Company's reports, filings and pres s

releases alleged herein to be misleading prior to or shortly after their issuance, and had the abilit y

and opportunity to prevent their issuance or cause them to be corrected . Thus, each of the Individual

Defendants had the opportunity to commit the fraudulent acts alleged herein, and is liable for th e

misrepresentations contained in those documents .

28. It is appropriate to treat the Individual Defendants as a group for pleading purpose s

and to presume that the false, misleading, and incomplete information conveyed in the Company' s

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public filings, press releases, and other publications as alleged herein are the collective actions of

the narrowly defined group of defendants identified above . Each of the above officers of Sears, by

virtue of their high-level positions with the Company, directly participated in the management of the

Company, was directly involved in the day-to-day operations of the Company at the highest levels,

and was privy to confidential proprietary information concerning the Company and its business,

operations, growth, financial statements, and financial condition, as alleged herein . Said defendants

were involved in drafting, producing, reviewing and/or disseminating the false and misleading

statements and information alleged herein, knew or recklessly disregarded that the false and

misleading statements were being issued regarding the Company, and approved or ratified these

statements, in violation of the federal securities laws .

29 . As officers and controlling persons of apublicly-held company whose common stock

was, and is, registered with the SEC pursuant to the Exchange Act, and was traded on the New York

Stock Exchange ("NYSE"), and governed by the provisions of the federal securities laws, the

Individual Defendants each had a duty to disseminate promptly, accurate and truthful informatio n

with respect to the Company's financial condition and performance, growth, operations, financial

statements, business, markets, management, earnings and present and future business prospects, and

to correct any previously-issued statements that had become materially misleading or untrue, so that

the market price of the Company's publicly-traded securities would be based upon truthful and

accurate information . The Individual Defendants' misrepresentations and omissions during the Class

Period violated these specific requirements and obligations .

30. The Individual Defendants participated in the drafting, preparation, and/or approval

of the various public and shareholder and investor reports and other communications complaine d

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of herein and were aware of, or recklessly disregarded, the misstatements contained therein and

omissions therefrom, and were aware of their materially false and misleading nature . Because of

their Board membership and/or executive and managerial positions with Sears, each ofthe Individual

Defendants had access to the adverse undisclosed information about Sears's business prospects and

financial condition and performance as part icularized herein and knew (or recklessly disregarded)

that these adverse facts rendered the positive representations made by or about Sears and its busines s

issued or adopted by the Company materially false and misleading .

31 . Each of the defendants is liable as a participant in a fraudulent scheme and course o f

business that operated as a fraud or deceit on purchasers of Sears common stock by disseminatin g

materially false and misleading statements and/or concealing mate rial adverse facts . The scheme :

(i) deceived the investing public regarding Sears's business, operations, management and th e

intrinsic value of Sears common stock ; and (ii) caused plaintiff and other members of the Class t o

purchase Sears securities at artificially inflated prices .

PLAINTIFFS' CLASS ACTION ALLEGATION S

32. Plaintiffs bring this action as a class action pursuant to Federal Rule of Civi l

Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased the securitie s

of Sears between October 24, 2001 to October 17, 2002, inclusive (the "Class Period") and who wer e

damaged thereby. Excluded from the Class are defendants, the officers and directors of the

Company at all relevant times , members of their immediate families and their legal representatives ,

heirs, successors or assigns, and any entity in which defendants have or had a controlling interest .

33. The members of the Class are so numerous that joinder of all members i s

impracticable . Throughout the Class Period, Sears had approximately 315 million shares of commo n

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stock outstanding , which were actively traded on the New York Stock Exchange (the "NYSE" )

While the exact number of Class members is unknown to Plaintiff at this time and can only b e

ascertained through appropriate discovery, Plaintiffs believe that there are hundreds or thousands o f

members in the proposed Class . Record owners and other members of the Class may be identifie d

from records maintained by Sears or its transfer agent and may be notified of the pendency of this

action by mail, using the form of notice similar to that customarily used in securities class actions .

34. Plaintiffs' claims are typical of the claims of the members of the Class as all members

of the Class were similarly affected by defendants' wrongful conduct in violation of federal law that

is complained of herein .

35 . Plaintiffs will fairly and adequately protect the interests of the members of the Clas s

and has retained counsel competent and experienced in class and securities litigation .

36 . Common questions of law and fact exist as to all members of the Class an d

predominate over any questions solely affecting individual members of the Class . Among the

questions of law and fact common to the Class are :

(a) whether the federal securities laws were violated by defendants' acts as

alleged herein;

(b) whether statements made by defendants to the investing public during th e

Class Period misrepresented material facts about the business and operations of Sears ; and

(c) to what extent the members of the Class have sustained damages and th e

proper measure of damages .

37. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all members is impracticable . Furthermore, as the

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damages suffered by individual Class members may be relatively small, the expense and burden o f

individual litigation make it impossible for members of the Class to individually redress the wrong s

done to them. There will be no difficulty in the management of this action as a class action .

SUBSTANTIVE ALLEGATION S

Background Facts

38. Sears is one of North America' s largest retailers , operating over 800 stores selling a

wide variety of products . During the Class Period, Sears had four primary business segments : (i)

Retail and Related Services, (ii) Credit and Financial Products, (iii) Corporate and Other, and (iv )

Sears Canada.

39. Sears's Credit and Financial Products segment ("Sears Credit") issues proprietar y

retail credit cards to Sears customers . Proprietary retail cards may only be used within the issuin g

store to make purchases . In addition to being limited to usage in the issuing store, such cards differ

from general purpose credit cards ("bank cards") in a number of other ways beyond their limited

permissible uses . Typically, proprietary cards offer higher levels of interest , and tower spending

(credit) limits, than bank cards . Proprietary cards are also favored by retailers as a marketing tool

to induce consumers to do their shopping at the issuing store . During the Class Period, Sears offere d

four basic types of credit cards : the Sears Card, the Sears ChargePlus, the Home Improvement

Account (together, "Sears Cards"), and the Sears Gold MasterCard .

40 . In credit card lending, as with any kind of lending, one of the critical factors is t o

ensure that the borrower is capable of repaying the loan, and that the debt will not ultimately turn

out to be uncollectible due to the borrower's financial instability . Because statistical models can

reasonably predict the amount of losses that a loan portfolio will experience, Generally Accepte d

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Accounting P rinciples ("GAAP") require lenders to establish reserves for uncollectible debts . All

other things being equal, a loan portfolio that is comprised of borrowers with riskier credit profile s

will require a larger "bad debt reserve" to cover the cost of uncollectible debts associated with tha t

portfolio . Increases in a company's bad debt reserves must be funded by an offsetting charge agains t

the company' s earnings . Accordingly, any increase in bad debt reserves will invariably result in a

corresponding decrease in corporate earn ings . In short, in determining the profitability of the lending

operation, accurate assessments of the credit-weakness are essential and must be performe d

regularly.

41 . Investors in lending companies are very attentive to the size of loan loss reserves ,

because they are an indicator of the stability and riskiness of the loan portfolio, and of a lending

company's ability to absorb losses without having to take additional future charges against earnings .

42. For many years, Sears has been one of the largest credit card issuers in the countr y

and, until very recently, was the largest single issuer of private retail cards . In 1999, Sears 's retai l

card portfolio was larger than those of the next ten retail card issuers combined .

43 . Moreover, although revenues from Sears Credit were far below those from its Retai l

segment for several years immediately preceding the beginning of the Class Period, Sears Credi t

contributed more than half of Sears's operating income . For example, according to Sears's 10-K for

2000, filed March 21, 2001, in the years 1998 and 1999 Sears's Retail Segment was responsible fo r

nearly 89% of its revenues , but only 29% of its operating income . During the same period, Sear s

Credit accounted for only 11% of the Company' s revenues, but an astonishing 58% of the

Company' s operating income . These statistics have led analysts in recent years to describe Sears as

"a credit-card company with stores ."

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44. For many years, Sears did not accept any credit cards in its stores other than its own

Sears cards, and its own proprietary creation, The Discover Card . In 1993, Sears sold The Discover

Card and began accepting other credit cards in its stores . At that time, 60% of purchases in Sears

stores were made using a Sears card . Over the next few years, however, usage of Sears cards

dropped drastically, so that by 1999 only 47.9% of Sears sales were charged to a Sears proprietary

card. By mid-2000, although Sears's credit card operations continued to generate profit, they had

been flat for the past year and a half, and 24 million out of a total of 60 million Sears credit card

accounts were either inactive or failed to carry a balance, and hence were no longer generating

income for Sears .

45 . At the same time as its credit card operations were declining, Sears's retail segmen t

was also suffering . For example , Sears was steadily losing market share in its profitable "soft line"

items , like apparel , to discount retailers like Wal-Mart and Kohl's . Although Sears's sales of "hard

line" appliances were better th an its soft line sales , those items had relatively low profit margins in

part due to the enormous amount of floor space necessary to display them. Indeed , as defendant

Alan Lacy himself stated in a presentations to analysts on November 8, 2002 (reported in various

publications covering the event) : "[W]e've disappointed people in the last few years . . . We

recognize we don 't make enough money in the retail business," "[wje accept the fact that the retai l

performance overall is too varied and is not delivering consistent sales growth as we would have

liked," "[w]e're not happy with the underlying financial performance," and "[t]here's no question

that softlines has not performed up to the levels of our expectations over the last three years ." (See

Financial Times, November 9, 2000; AFX News, November 8, 2000 ; Chicago Tribune, November

9, 2000 ; WWD, November 9, 2000) .

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46 . In October 2000, Sears's then-President and CEO Arthur Martinez retired, and was

replaced by defendant Alan Lacy. Lacy had formerly headed Credit Services at Sears and had als o

served as the Company's CFO .

47. At the time Lacy assumed his new responsibilities , as part of Sears 's efo rts to boost

the profitability of its credit business, Sears was in the early stages of launching its Sears Gol d

MasterCard program. The new Sears Gold MasterCard (" Sears MasterCard") was a general -purpose

credit card, which, unlike the proprietary Sears store charge card ("Sears store card" or "Sears

Card"), would be accepted wherever MasterCard was accepted . Unlike the Sears store card, the

Sears MasterCard carried an annual fee and would generate additional fee income to Sears whenever

it was used at an outside location . Because the MasterCard was intended for use as a general credi t

card, it carried much higher lines of credit than had the old proprietary cards . For instance, Sears

MasterCard credit limits could run from a starting range of $2000 to $5000 up to as much as $10,00 0

to $20,000. By contrast, Sears store card limits started in only the $250 to $1,000 range, and th e

Sears ChargePlus store card limits started between $1,000 to $5,000 . Sears hoped that the new Sears

MasterCards would both stimulate Sears sales and help regain the income it had lost in recent year s

due to the declining market share of its old proprietary cards .

48 . In its press releases and communications with analysts, Sears repeatedly emphasize d

the importance of the Sears MasterCard initiative to the Company's overall strategy . For example,

in November 2000 Lacy singled out the Sears MasterCard as one of Sears's top three areas to targe t

for growth (the other two areas targeted for growth were Sears's online business and a new line o f

stores called The Great Indoors, which was intended to be a high-end rival to Home Depot Expo) .

-18-

49. Sears began its campaign to switch over its customers to the Company 's new Gold

MasterCard in 2000 by targeting those existing Sears Card holders who either paid off their Sear s

Cards every month, or whose accounts had been dormant. Sears sent mailing pieces to these and

certain other selected customers that informed the customers that they would shortly receive a Sears

MasterCard, and that their old Sears Cards would be canceled. The new Sears MasterCards offered

special "teaser" interest rates, particularly for customers who transferred balances from other card s

to their new Sears MasterCard . As Lacy explained in a February 2001 conference call, the Sear s

MasterCard was targeted for particularly creditworthy consumers : "[T]he thrust of the MasterCard

portfolio to date has been to get a more attractively priced product to people that are clearly mor e

credit worthy than the historical portfolio . "

50. ByFebruary 2001, the Sears MasterCard carried $1 .4 billion in receivables, and Sears

(through its Sears National Bank subsidiary) had become one of the top 25 bank card issuers. As

American Banker reported on February 15, 2001 :

Mr. [Kevin] Keleghan [President of Sears Credit] said Sears' private-label customersgive it a competitive advantage . Because Sears could evaluate the credit quality ofits customers with inactive accounts, it could target those with the highest creditratings for the MasterCards it sent out unsolicited .

Mr. Keleghan said Sears has succeeded in trying to resuscitate flagging Sears cardaccounts without extending bad loans. So far, half of the people who received theMasterCards have activated them, and the active customers have an average Fair,Isaac & Co . credit score of 760 . The score, which most lenders use to assesscreditworthiness, is based on a formula developed by Fair, Isaac, and 800 isconsidered about the highest score .

"It's a very pristine group, almost too pristine," Mr. Keleghan said . "We don't expectsignificant delinquencies since we're starting out with a low-risk group . "

-19-

In addition to its MasterCard portfolio of seven million accounts, Sears has 60million private-label accounts . Together, the MasterCard and private-label portfoliosinclude about $27 billion in loans, which Sears says makes it the seventh-largest U .S .card issuer. "Our objective is to be in the top five," Mr . Keleghan said.

51 . Over the next few quarters, Sears continued to invest in the roll-out of th e

MasterCard . Meanwhile, Sears's Retail segment continued to deliver disappointing results . For

example, on January 4, 2001, Sears issued a press release stating that it was closing 89 under-

performing stores, and that retail sales for the quarter were down from the prior year . The release

also announced that Sears was writing down its investment in the unprofitable Termite and Pes t

Control business . Similarly, on April 19, 2001, Sears announced that its retail sales had decline d

again in the first quarter of 2001 . In an analyst presentation that same day, Lacy admitted that Sears

was "unhappy with our retail profitability . "

52 . However, consistentwith Sears's increasing emphasis on the credit side of operations ,

at the April 19 presentation Lacy asserted that Sears' s credit segment was "a great business . It's a

fabulous franchise for us. It's strategically very important for us, not only to our retail business in

terms of driving retail results, but it's also very important to Sears Roebuck and Company from bot h

the financial standpoint and the customer relationship standpoint ." Lacy also assured investors tha t

Sears's credit segment had a "strong portfolio quality overall," and that although Sears wa s

continuing to spend money to fund "an additional MasterCard roll-out as we go to more subscribers, "

profits from the credit segment would increase as the teaser rates from the initial MasterCard rollou t

expired .

-20-

Undisclosed Adverse Facts Impactin gSears's Credit Business During the Class Period

53. In the remaining months prior to the start of the Class Period (on October 24, 2001 )

- and thereafter through the end of the Class Period on October 17, 2002 - defendants continued to

tout the purported success of Sears's credit operations, and repeatedly portrayed the quality o f

Sears's credit portfolio as "strong," "stable," and "adequately reserved," and also regularly compare d

its credit business favorably those of competing credit card issuers .

54. However, immediately prior to and during the Class Period -- and unbeknownst t o

investors -- Sears's credit operations were suffering from several severe weaknesses and problems .

Many of these problems were attributable to the fact that Sears was utilizing aggressive marketing ,

accounting, and credit scoring tactics that seriously undermined the stability of its loan portfolio, and

that rendered defendants' favorable comparisons of Sears to other card issuers materially false an d

misleading . These problems, discussed in detail below, were so deeply rooted that only six months

after the truth concerning Sears's credit operations was finally disclosed to the market, Sear s

announced that it would sell its credit business - even though this business had accounted for nearl y

70% of the Company's reported operating income during much of the Class Period .

A. Sears's Aggressive Extensions of Credi t

55 . During the Class Period, Sears engaged in a deliberate campaign to aggressivel y

market its credit cards, and in particular its MasterCard, so as to create the appearance of a growing,

profitable loan portfolio . To that end, Sears intentionally lowered its acceptable credit profile so a s

to allow more consumers to qualify, while assuring investors that it was targeting only high-quality

consumers and was employing state-of-the-art risk management technology. Sears also deliberately

-21-

avoided its customary limits for extending credit under its credit scoring policies by offering multipl e

Sears credit cards to consumers who did not qualify for an increase in the credit limit on thei r

existing cards .

56. In the lending industry, consumers are segmented according to their credit-ris k

profiles . "Prime" or "superp rirne" borrowers are the most stable, and "subprime" borrowers have

weaker or damaged histories that render them a credit risk. Although many lenders have internal

models that they use to segment consumers, industry standards are set by various criteria, includin g

the scores created by the commercial entity Fair, Isaac & Company . A Fair, Isaac score (FICO score)

of 660 or below is, in general parlance, considered "subprime ." As of June 2002, on average, th e

credit card portfolios of United States card issuers consisted of 36 .6% subprime loans .

57. As Sears would not reveal until the end of the Class Period, Sears's credit portfoli o

was heavily weighted toward the subprime market . By the end of the Class Period, nearly halfof

Sears 's portfolio consisted of subprime loans ; at the beginning of the Period, approximately 54 %

of the portfolio was subprime ;, and

58. Additionally, far from utilizing "prudent underwriting" standards, as Sears claimed

to do, Sears employed aggressive marketing strategies designed to appeal to low-income or unstabl e

borrowers, such as the use of unsolicited direct mailings, and offering free balance transfers an d

convenience checks.

59 . Sears's extensions of credit to unstable borrowers was witnessed by numerous Sear s

employees, including employees responsible for attempting to make collections on those accounts .

For example :

-22-

(a) According to a former Sears Director (a management position) who worked

out of Sears headquarters at Hoffman Estates ("Sears Director"), and who was personally familia r

with how the MasterCard rollout was conducted, Sears deliberately made consumers whose accounts

were inactive - i .e., consumers for whom Sears had little or no data - a primary target of th e

MasterCard rollout campaign. The Director explained that Sears intentionally avoided giving th e

MasterCard to loyal users of Sears 's proprietary store charge cards so as not to "cannibalize" thos e

accounts, but instead extended massive amounts of credit to consumers whose credit histories were

inevitably less familiar to Sears .

(b) According to another former Sears manager (the "Collections Supervisor" )

who worked out of one of Sears's collection centers throughout the Class Period , and who

supervised a large number of collectors and other managers that handled past due accounts, th e

balances that Sears allowed to be incurred on the MasterCards were frequently too high for th e

quality of the applicant . Based upon the customer credit reports he observed, the amount of credi t

extended, and his own experiences attempting to collect balances due, this supervisor stated that

Sears was clearly approving many applicants who should not have been approved .

(c) Another former Sears employee, who worked at Sears headquarters i n

Hoffman Estates, also confirmed that the MasterCard was issued to Sears customers with low credi t

limits on their Sears proprietary cards, often those with low income . As an example, this employee

cited a family member, who had approximately a $300 limit on his proprietary Sears store card an d

did not qualify for a higher credit line on this card, but who was nonetheless offered an unsolicited

Sears MasterCard with an $800 limit . Indeed, according to this former Sears employee, it was

-23-

widely believed among Sears employees at headquarters that, as aresult of such aggressive practices ,

the Company had significantly under-reserved for doubtful accounts .

(d) Similarly, according to another former Sears employee who worked in severa l

managing positions during the entire Class Period at Sears headquarters in Hoffman Estates, it wa s

"common knowledge" among headquarters employees that Sears had lowered its credit standards

when issuing the MasterCard . This former employee also recalled having conversations with Sears

employees who worked at headquarters in early 2002, and who had also had experience wit h

Montgomery Ward, who said that they "saw basically the same writing on the wall" - and wh o

predicted that losses in the credit division would ultimately lead Sears to shed the credit segmen t

entirely .

(e) Similarly, according to a former Sears information analyst who worked at a

major regional Sears customer service center in the Midwest ("Information Analyst"), Sears

continued to extend credit even to delinquent accounts throughout the Class Period, and ground level

Sears employees repeatedly complained that those accounts should have been closed earlier than they

were, instead of Sears continuing to extend them credit .

(f) According to a former Sears store manager, the criteria for getting credit a t

Sears was dropping by 2002 . For example, the store manager recalled that in 2002 there wer e

numerous occasions when customers remarked to him that they were surp rised to get Sears credi t

because of their poor credit histories .

(g) According to a Quality Assurance specialistwho worked at Sears headquarters

until November 2001, Sears altered its credit model in 2001 to allow more people to qualify for

credit, which helped send uncollectibles sky high.

-24-

(h) A former Sears customer service representative who worked at the Sears credit

center in Rancho Cucamonga, California during late 2001 and early 2002 (the "Cucamonga

Representative") also observed during this period that Sears was granting credit more easily, an d

personally knew people who received credit despite being unemployed .

B. Rising Delinquencies

60. The loosening of Sears's credit standards had its predictable effect in the form of

increasing trouble with delinquent accounts . The rise in delinquencies was severe enough to attrac t

the attention of many Sears employees. For example :

(a) As described by the Collections Supervisor , who was familiar with Sears' s

practices for handling delinquent accounts, in early 2002 "roll rates" (the percentage of accounts that

were 180 days past due that "rolled" into the 210 days past due category) drastically increased fro m

60% to 67% or 68% in the center where this person worked . The Collections Supervisor also

advised that this experience was common across the country, that most credit centers had roll rates

above 70% by early 2002, and that Boston had risen to nearly 80%. These statistics were

communicated to Sears headquarters in regular reports and conference calls with headquarters, an d

the high roll rates were a frequent topic of conversation among this supervisor's coworkers .

(b) The Collections Supervisor attributed the high roll rates to the MasterCard .

When the MasterCard was first issued, delinquencies were handled onlybythe Boise and Louisville

credit centers . In early 2002, the MasterCard delinquencies were distributed to all of the call centers ,

and thereafter the skyrocketing roll rates were observed widely throughout Sears's collections

operations . Many of the balances on the MasterCard were in the $10,000 to $15,000 range, and were

simply uncollectible .

-25-

(c) Similar observations were made by a former Sears credit representative wh o

worked at Sears's call center in Boise, Idaho during the Class Period (the "Boise Representative") ,

and who had regular telephone contact with Sears customers who had problems with their account s

(and who accessed customers' credit histories for such calls) . This credit representative stated that

delinquencies were clearly increasing during the Class Period because, when a customer's history

appeared on the screen, "I would more often than not see a delinquent account than a paid u p

account."

(d) According to one Sears manager who worked in collections during the entir e

Class Period in several regional credit centers and in Sears headquarters at Hoffman Estate s

("Hoffman Manager"), shortly after the collections departments for the Sears card and th e

MasterCard merged in 2002, collections personnel found that their jobs had become harder becaus e

it was so much more difficult to collect on the growing number of past-due MasterCard balances.

(e) Similarly, the Information Analyst confirmed that the collections departmen t

there had a great deal of trouble collecting on the MasterCard accounts during the Class Perio d

because of the higher balances on those accounts .

C. Disguising Delinquencie s

61 . Sears also deliberately took various steps to avoid revealing the rising delinquencie s

and charge-offs to the public, both through the misleading statistics it selectively chose to release to

the public, and through the methods it used to avoid classifying accounts as delinquent or charged-

off in the first place . Through these techniques, Sears was able to present the false and misleading

picture that its credit operations were stable and increasingly profitable, and compared favorably t o

those of the credit card industry as a whole .

-26-

1 . Selective Reporting of Delinquency and Charge-Off Rates

62 . During the Class Period, Sears reported the charge-off and delinquency rates of it s

cards to the public on a portfolio-wide basis, without reporting the performances of the Sears Card s

and the Sears MasterCards separately . But certain key differences in the characteristics of th e

portfolios caused such reporting methods to present a materially misleading picture of portfoli o

performance .

63 . Sears offered the Sears MasterCard with higher credit lines than had been traditionally

offered under the Sears proprietary card . Additionally, the brand-new MasterCard accounts had

delinquency and charge off rates that were lower than those of the proprietary card . These factors,

in combination with the dramatic increases in MasterCard receivables, declining Sears proprietary

card receivables, the fact that the Sears proprietary card portfolio was much larger than the ne w

MasterCard portfolio, created an interesting phenomenon during the Class Period . When the two

portions of the portfolio were examined separately, they revealed a striking rise in delinquencies an d

charge-offs every quarter. However, when the portfolio was considered as a whole, the

delinquencies and charge-offs appeared to be relatively stable, because the Sears Card receivables

overweighted the average of the two groups . This phenomenon is demonstrated by the followin g

graphs on the following page :

-27-

Sears Credit Portfolio Net Charge- Off and Delinquency Data

Net Charge-Off%

800 %

BD4 %

400%

200 %

ODORQtr i Utr 2 Qtr 3 Qtr 4 Year Qtr 1 Qtr 2 Qtr3 12tr 4 Year

2001 2002

Sears 2002 Report on Form 10-K, page 26

Sears Q 31d

378% 603% 5.78% 5 71 6,16% 8.20% 0 6.2195 9°x6 Taal

6 .07% 342 6 5162 6 523`E 532E 5.43% 632% 3 -55 % 540% 5.42%

3 324%

2.99% 4U 'S

2 .6 WsterCard

60-Plus Day Delinquency Rates

121)01 Sears Card

1034 %

10 0% 974 %891% 0 .77% 8 .75 %

8.13 %7RB 7261 Tota l8 .00%

7 .30% 7 .269E 7,41% 750% 7 .8966 .00%

7 .31%0 .87%

7 .24%

4DD% 2 00%3 .78 %

197°d 2 .56% 2_1 7% .sterl d

1 03 %2 .00% 1 .15% 120 6

0010 . ,Ctr 1 Qr 2 Rv 3 Qtr 4 Ow 1 Qor 2 g r 3 Or 4

2001 2002

2. 10 .90 %

0 .80 %

Sears 2002 Report on Form 10-K, page 24

-27A-

64. As shown by these charts, the middle line, representing the charge-off and

delinquency rates when the portfolios are considered together, makes it appear as though charge-offs

and delinquencies were holding steady --- or slightly decreasing - at around 5 .3% and 7 .4%,

respectively, immediately prior to and during the Class Period . In fact, both Sears Card and Sears

MasterCard charge-off and delinquency rates were increasing at an alarming pace during this period .

Nonetheless, defendants conveyed only the "combined" delinquency data charted on the middle line

to investors during the Class Period - and concealed the data that showed the actual deterioratio n

of the portfolios .

65 . It was only after the end of the Class Period, when Sears filed its quarterly report fo r

the third quarter of 2002, that Sears finally broke out the separate data for the two major credi t

portfolios . The graphs above are reproduced from Sears's own Annual Report on Form 10-K for

2002, filed on March 12, 2003, which charts the relevant data through the end of 2002 .

2 . Failing to Record Delinquencies and Charge-Offs

66. In 1995, Sears created the Phoenix-based Sears National Bank, thereby avoidin g

certain state usury laws . Because the Sears National Bank, formed for limited purposes, was not

subject to the same rules and regulatory oversight as ordinary bank card issuers, it was easier fo r

Sears to adopt more lenient policies relative to its competitors with respect to recording accounts a s

delinquent or uncollectible . For example, Sears "re-aged" its delinquent accounts (a practice whic h

effectively converted delinquent accounts to current status) and charged-off bad debts on terms tha t

were decidedly more lax than its bank card competitors. These practices served to disguise th e

losses inherent in the portfolio until the end of the Class Period . For example :

-28-

(a) Ordinarily, federal regulations require banks to charge-off credit card loan s

that are delinquent after 180 days . Sears, however, did not charge-off such loans until 240 days ha d

passed . Thus, Sears was able to avoid charging-offuncollectible lo ans for an additional two month s

past the point when other card issuers would have recorded a loss .

(b) Sears employed generous "renewal" policies that also had the effect of

understating charge-off ratios . For accounts that were 150 days past due, Sears would offer to mak e

the account "current" if the customer made a single minimum payment (which would be in an

amount substantially less than the total balance due) . Sears would then close the account, and us e

a workout installment plan to collect the rest of the balance due, which would usually allow th e

customer 50 to 52 months to pay off the debt . In fact, according to an credit card expert consulte d

by plaintiffs, workout programs are typically considered generous in the industry if they permit

payment schedules as long as 24 months . Sears's use of such extraordinarily generous workou t

programs allowed Sears to avoid recording the account as a charge-off .

(c) Federal regulations permit delinquent accounts to be "cured" ("re-aged") afte r

three consecutive on-time minimum payments, but forbid re-aging more th an once in twelve month s

or twice in five years . Sears, however, had a policy of re-aging accounts after only two consecutiv e

payments, and did not forbid re-aging more than twice in five years .

(d) Sears promoted its cards, pa rt icularly the MasterCard , by frequently offerin g

zero percent financing promotions - or zero-pay deals - for certain purchases in its stores . These

promotional programs allowed cardholders to minimize, or even completely avoid, payments fo r

periods up to a year. By making it difficult, or even impossible, for cardholders to fall behind i n

-29-

their payments prior to the end of the zero-pay or zero-finance period, Sears was able to delay

reporting such accounts as delinquent, regardless of how unstable the borrowers were .

(e) During defenadnt Keleghan's tenure as President of Sears Credit, the

Company repeatedly altered its policies so as to lower minimum monthly payments . This had the

effect of permitting people with poorer credit histories to purchase higher priced items on more

extended payment schedules, thus increasing Sears's income from finance charges, but also

increasing its exposure to bad debt and delaying charge-offs .

(f) Sears would not report accounts as delinquent until they became 60 days past

due; in contrast, it is industry practice to report delinquencies after 30 days, or even sooner . In this

way, Sears (which frequently compared itself favorably to other credit card lenders) reported its

delinquencies on a different -- and laxer -- basis than its competitors .

67. These policies, individually and collectively, distorted the reported quality of Sears' s

portfolio. Worse, they misled investors because Sears represented that its statistics were compared

favorably to those of its competitors, when in fact such comparisons only appeared to be favorable

because, inter alia, they were done on an "apples to oranges" basis . However, as Sears itself

ultimately admitted at the end of the Class Period, Sears's results were "not directly comparable"

to its competitors in the bank card industry.

D. Fraudulent Billings

68. During the Class Period, Sears employees were strongly encouraged to induce

consumers to purchase additional services, such as life insurance, credit protection, and extended

warranties on appliances. The incentives to make such sales were so strong that it became a regular

practice for salespersons to put such items on customers' accounts without their knowledge o r

-30-

consent . Additionally, the reckless manner in which Sears distributed its new MasterCards had th e

predictable result of drastically increasing the potential for credit card fraud. These practices,

described below, helped drive up the high levels of reported receivables that the Company knew to

be uncollectible .

"Add-on" Services

69 . As reported by former employees :

(a) According to the Hoffman Manager, the Direct Response Unit at Sears wa s

responsible for selling financial "add-ons ," such as credit insurance or life insurance . The Hoffman

Manager stated that there were widespread problems with Direct Response products being billed t o

customers who had not ordered them, and that cardholders constantly complained that they had no t

requested the add-ons and refused to pay for them . Although it was Sears's stated policy to requir e

that the add-on had been authorized, this former manager stated that in some instances items were

added to accounts where the cardholder had actually been dead for years . The former manager also

noted that Direct Response workers received commissions, and did not lose the commissions when

the sale became uncollectible . Thus, as defendants knew, Direct Response workers were motivate d

to simply get the "add-on" onto the account .

(b) According to another former Sears employee who worked as a collector an d

then as a manager at Sear's Louisville call center during the Class Period, perhaps 20% of th e

MasterCard balances came from promotional Sears financial products such as life insurance - an d

Sears customers repeatedly claimed that they had not authorized the charges . For instance, many

elderly consumers missed fine print on their papers and were mystified as to the source of the ne w

charges. This former manager stated that he saw "a ton " of accounts with such problems, and that

-31-

he had been instructed by management always to tell the customer that they had a "confirmation of

approval" for the charges, such as a signature, even though he was unaware of any "confirmations ."

This former manager also believed that Sears's top management was aware of the problems, becaus e

of the sheer size of the problem . Out of 110 calls per day, he recalls 20 or 30 would involv e

challenges to these kinds of billings .

(c) The Boise Representative similarly stated that the Boise call center frequentl y

received calls from elderly people who had been charged for services that they claimed they had no t

authorized, such as credit card insurance. This former employee spoke to thousands of customers

and found that most of the unauthorized charges appeared during 2002 . This former employe e

further stated that the Company had an incentive program to sell these services , but that ifemployees

did not sell the services "we would get our hand slapped." The Boise Representative observed tha t

employees were under such pressure that they abused the program by signing people up withou t

authorization . This former employee further confirmed that the problem was nationwide .

(d) According to a former account specialist who worked at Sears Credit in

Rancho Cucamonga, California, during the Class Period and who handled 100 calls per day, half o f

those calls involved complaints about unauthorized charges for items like insurance and credi t

protection. Customers not only refused to pay for the unauthorized charges, but became leery o f

paying for the legitimate ones because they suspected that some third party might have gotten hold

of the card and they did not want to pay for a compromised account . This former employee recalle d

that charges for insurance, extended warranties, and credit protection would appear on accounts tha t

had been closed for years .

-32-

(e) The Cucamonga Representative also stated that the Cucamonga call cente r

fielded lots of calls from angry customers who complained about unauthorized charges for extende d

warranties on appliances .

(f) A customer service representative from Philadelphia who worked at Sear s

during the entire Class Period also stated that there were many complaints from consumers regardin g

services for which they had never signed up, particularly life insurance and credit card protection .

(g) Additionally, the Information Analyst confirmed that he heard that customer s

frequently complained that they were billed for promotional items that they had not requested .

2 . Reckless Card Distribution

70 . In addition to what has been alleged above, as described by former Sears employees :

(a) The Hoffman Manager also stated that the initial MasterCard rollout involve d

inactive- or even closed- Sears card accounts . Consumers were notified thirty days in advance that

they would be receiving a MasterCard, and that they would have to call Sears to have it canceled .

Most consumers never noticed the original mailing, and thus were unaware that a card was due t o

arrive. According to the employee, the combination of unsolicited cards sent to inactive account s

with higher credit limits "exponentially" increased the opportunities for fraud . Letters and card s

were often sent to addresses that were years out of date .

(b) According to a former Sears Vice President who worked at Sears during th e

Class Period, Sears sent MasterCards to dormant accounts without running proper checks on the

recipients .

-33-

FALSE AND MISLEADING STATEMENTS ANDOMISSIONS DURING THE CLASS PERIO D

71 . The Class Period begins on October 24, 2001 . On that day, Sears issued a pres s

release, filed as an 8-K and signed by defendant Glenn Richter, announcing its results for the third

quarter of 2001 . The Company announced that it had increased ea rn ings by 5 .3% per share over the

prior year, despite a decline in revenues in its retail segment . The release further stated with respec t

to Sears Credit :

The net charge-off rate increased to 5 .62 percent from 4.97 percent a year ago . Thisincrease was expected due to higher credit customer bankruptcy filings this year .Bankruptcy filings have declined in the third quarter from second quarter levels .Delinquencies at the end of the third quarter improved to 7.41 percent versus 7.47percent in last year's quarter .

72. At a meeting with analysts on that same day, Lacy stated that the Company' s credit

segment had posted "our first increase in four quarters as we're now coming out of that period wher e

we've been investing behind growth in new products, in particular the MasterCard . "

73 . Defendant Paul Liska, Sears 's CFO, praised the performance of the credit segment ,

repeatedly emphasizing the quality of the portfolio, and the credit-worthiness of Sears's customers :

[A]verage management . . . receivables grew to $26 .1 billion. $600 million increaseover last year reflecting the continued success of the MasterCard roll-out . Kevin[Keleghan] will talk to you about that success story. Our portfolio yield declinedabout 36 basis points to 19 .34%. Basically it was due to lower late fees due to lowerdelinquencies which is important to know when I talk about the quality of ourportfolio, our delinquencies are actually going down . That's why we're feelinggood about our portfolio . . . .

74. Liska also stated that although charge-offs had increased due to a generally higher rate

of bankruptcies, the MasterCard "is a higher quality portfolio that we're adding into the Sears '

portfolio," and affirmed that "we feel very comfortable with our portfolio going forward again . "

-34-

Liska assured investors that "[o]ur watch rate of 5 .76% is again, is a 12-month lag loss rate was

slightly ahead of MBNA and Bank One and significantly better than Capital One or Discover s o

again, another metric why we feel comfortable about it going forward ." Liska also told investors tha t

"[O]ur 60+ day delinquency rates or trends remain very stable . While the . . . the 60+ delinquency

rate at the end of the third quarter was slighter higher than quarter two, it was down from the prio r

year and overall, the 60+ delinquency rates continues . . . [to show] continued strength in this

portfolio ."

75 . Because of the purported "quality" of Sears's credit portfolio, Liska assured investor s

that Sears had established adequate reserves for uncollectible debt :

Given the stability of our portfolio quality . . . we continue to still believe that it isvery adequately and conservatively reserved in the current environment . . . . Alsoyou have to remember that our portfolio [is] significantly benefitting by the fact thatthe growth is actually coming from the Sears Gold MasterCard, which by nature,is a better quality receivable . So again, given all these facts, we expect thechargeoff rate to decline . . . . All else being equal, we believe we're appropriatelyreserved and well-positioned to mitigate any . . . further economic downturns theremaybe.

76. Defendant Keleghan was even more enthusiastic about the quality of the Company' s

credit card portfolio :

As far as our credit quality performance is concerned, for a number ofyears nowwe've been very prudent with our underwriting . We have invested very heavily inscoring technology and systems technology to do a better j ob of discriminating creditrisk in the new account environment .

Now we use a lot of customer segmentation . We have fourteen different new accountscorecards to make sure that we're doing a very targeted approval process to get thebest credit risk customers and the customers with the most profit potential to drivesales in the store .

-35-

We continue to hold quality improvements on recent vintages . We've been verytargeted in improving the risk over the last four or five years . . .[W]e're bringingmuch more of that upper class customer who is lower risk . Another way of lookingat this is in the direct mail. We've continually improved the quality ofthe accountsthat we've booked. . . [W]e're doing a much better job of underwriting .

So to summarize, our portfolio quality has continually improved over the lastseveralyears . . .

On the portfolio side, or, also in acquisition, our ability to do risk based pricing isallowing us to attract a better quality customer also . So . . . if we target very goodrisk customers with quality products with a low price offer we'll still get a very goodreturn for our shareholders and increase this response rate lower to the cost of foreignaccounts and as a result we're attracting better quality balances.

And, as Paul [Liska] mentioned, since the delinquency rate of these customers is avery pristine group, is about half of that is Sears Card and the mix grows moretowards MasterCard there will be a lower allowance requirement, but these are verygood credit quality accounts . So, you'll see as our delinquencies goes down, as ourbankruptcy filings go down, and as our Mastercard receivables continue to grow, thepressure on [bad debt] allowance is just not there .

77 . Keleghan also attested to Sears's advanced technology for monitoring the credit card

portfolio for any hint of instability :

On the portfolio side, most of our competition has what they call a behavior score where theylook at internal information and credit year information and they score an account once amonth . We have the capability to look at the account on a daily basis, so as a result, in oursystem, if an account goes another five days past due, if they bounce a check, if they goover limit, we have 12 different triggers. That night, we rescore the account, re-identifytheir credit quality and then as a result, that score can dynamically drive how we work withour customers in the future, so it'll control the point of sale profit, where we can immediatelyshut down a very high risk account at the point of sale, we can manage their credit linesdown, particularly if they are delinquent customers and then we can drive a collectionstrategy to immediately move an account into collection . So the fact that we're up to dateon a daily basis, we feel we can address a high risk account much sooner than thecompetition . . . So, in summary, we're achieving our credit quality objectives. We'remitigating the economic pressures due to very good risk management and pricingflexibility . . . .

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78 . Keleghan also spoke of particular initiatives that were helping to drive MasterCard

growth :

And we're seeing a lot of strong convenience check and balance transfer responsewhich is very profitable for us . . . . . We're also experimenting with MasterCard indirect mail and the point of sale right now, and as we get results and if they'repositive we'll roll that out .

79 . Finally, Keleghan assured investors that Sears targeted only the most creditworthy

consumers by comparing Sears to a subprime credit card lender, Providian . Providian had

announced stunning losses only days earlier, resulting in the resignation of its chairman :

You know, a couple of you earlier asked me about Providian . . . Providian really hasa different business model. They have been targeting the subprime markets for anumber of years . . . We don't target the subprime market, we avoid it and we tryto target the middle market.

80. Markets reacted positively to these developments, and in the two weeks following the

conference call, Sears shares steadily rose from $37 .79 to $43 .58 .

81 . Sears reiterated its third quarter results in its Report on Form 10-Q for the quarter ,

filed with the SEC on November 9, 2001, signed by Richter.

82. However, as defendants were well aware, Sears 's repeated representations concerning

its credit operations and the Company's reported financial performance, as set forth in ¶ ¶ 71-79 an d

81, above, were materially false and misleading, for the reasons set forth in ¶¶55-70 above and It

162-63, 179-194 below . For example :

(a) Sears represented that "our delinquencies are actually going down, "¶ 73, and

that "ourportfolio quality has continually improved, "1 76, and focused on comparing its reporte d

charge-off and delinquency rates of 5 .62% and 7 .41 % for the third quarter of 2001 for the combine d

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portfolio to the rates that had been reported in the third quarter of 2000 (4 .97% charge-offs and

7.47% delinquencies) . In truth :

• During the third quarter of 2001, Sears Card charge-offs rose to 6 .03% and SearsCard delinquencies rose to 8 .13%.

• The nascent Sears MasterCard portfolio had already reached 2 .02% charge-offs and1 .93% delinquencies, up from 0 .90% charge-offs and 1 .20% delinquencies from theprior quarter, and continuing in its steady quarter-over-quarter rise in losses .

Contrary to defendants ' representations, these statistics demonstrated portfolio delinquencies were

not going down, and quality had not improved, but instead had deteriorated.

(b) Despite such representations as "We don't target the subprime market," ¶ 79 ,

as the Company would not reveal until the end of the Class Period, Sears had systematically targeted

the subprime market for years, and at the time of these statements, more than halfof Sears's credi t

portfolio consisted of subprime borrowers . By contrast, in June 2002, the average credit card

portfolio for the industry contained 36 .6% subprime loans ;

(c) Despite Sears's comparisons of its results to those of other lenders, such as

such as MBNA, Bank One, Capital One, and Discover, ¶ 74, as Sears would later admit in its post-

Class period SEC filings, ¶¶ 169, 176-177, the techniques Sears employed to delay recordin g

delinquencies and charge-offs rendered its results "not directly comparable " to the results of its

competitors. As Bear Stearns reported after the end of the Class Period : "[W]e believe that [Sears

has] the most aggressive policy in the credit card industry and that it is disguising the real loss rate

to a certain extent ."

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83 . On November 26, 2001, Liska held another conference call with analysts, where h e

again represented that Sears's portfolio was "adequately reserved" and that "we think the quality of

our portfolio is quite good and we are very happy with where we're positioned right now ."

84. However, Liska's November 26, 2001 statements were materially false an d

misleading for the reasons stated in 1155-70, 162-163, 179-194 .

85 . On January 10, 2002, Sears issued a press release, filed on an 8-K with the SEC and

signed by Liska, announcing preliminary results for the fourth quarter of 2001 . The release stated

in pertinent part :

Sears, Roebuck and Co . (NYSE: S) today announced preliminary fourth quarter andfull-year 2001 earnings . The company anticipates that earnings per share, excludingnon-comparable items, for the fourth fiscal quarter of 2001, ended December 29, willincrease by 11 percent to approximately $2 .02, versus $1 .82 in the fourth quarter oflast year. For the full-year 2001, earnings per share, excluding non-comparable items,will be approximately $4 .22, essentially flat with comparable 2000 earnings per shareof $4.21 .

The Credit and Financial Products segment delivered very strong operating profitgrowth in the fourth quarter . "We continue to be pleased with the improving trendsin the balance and revenuegrowth in our credit business, "said Lacy . "In addition,portfolio quality remains solid, with delinquency levels flat compared to the prioryear period. "

In reaction to the release, the next day the Chicago Sun-Times reported :

Sears , Roebuck and Co . said Thursday that December ' s sales decline was not asgloomy as its gloomiest outlook , and it forecast fiscal 2001 fourth -quarter earningsthat will exceed Wall Street's expectations .

The news pushed Sears shares up $2 .28, or 4.6 percent, to $51 .73 . The stock is upmore than 70percent since dipping under $30 in the aftermath oftheSept. 11 attacks.Sales fell 2.4 percent at Sears stores open at least a year, short of the 3 percent to 5percent drop Sears CEO Alan Lacy had predicted.

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Cost-cutting, credit-card profits and lower operating expenses are the key to theHoffman Estates-based retailer 's prediction of an 11 percent jump in fourth-quarter earnings , to $2.02 from $1 .82 the same period last year .

86. On January 17, 2002, Sears issued another press release regarding its 2001 fourth

quarter, filed with the SEC and signed by Richter . The release stated that for the quarter, th e

portfolio delinquency rate was 7 .58%, as compared to the delinquency rate for the fourth quarter of

2000 of 7 .56%. The charge-off rate for the quarter was listed at 5 .23%, as compared to the charge-

off rate for the prior year of 4 .79%. The release then explained :

Credit and Financial Product s

Operating income excluding non-comparable items increased by $86 million or 25 .3percent to $426 million as favorable funding costs and higher revenues offset higherprovision expense .

Fourth quarter domestic credit and financial products revenues increased 1 .8 percentfrom a year ago, to $1 .33 billion due to higher average receivable balances . Creditreceivables at the end of the fourth quarter grew 2 .2 percent over the prior year to$27.6 billion . . . .

Portfolio quality remains stable with flat year-over-year delinquencies. Thedomestic allowancefor uncollectible accounts of $.1.1 billion is flat as a percentageof ending credit receivables.

87. Finally, the release declared that, for all of 2001, Sears had earned $2 .202 billion in

operating income, with a whopping $1.5 billion coming from Sears Credit alone, despite the fact that

Sears Credit accounted for only 12 .6% of the Company's revenues .

88. Also on January 17, 2002, Sears held a conference call with investors to discuss it s

results for the fourth quarter of 2001 . Lacy stated that "Our credit business also had a very goo d

fourth quarter . Driving this performance in credit were higher receivable balances and credit revenu e

and increased credit revenue and lower funding expenses . Importantly, the quality of ou r

receivables portfolio has remained strong and our outlook is stable looking into 2002 . . . . In

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regard to 2002 , our preliminary earnings guidance is that earnings per share on a comparable basi s

would grow 13 to 15% . - . . This is conservative guidance which we believe is appropriate . . . . "

89. Liska provided further detail :

The strong receivable growth reflects the success of the Sears Gold MasterCardproducts which stood at over $5 billion in balances at the end of the year. . . . Theprovision for uncollectible accounts increased by $52M in the quarter to $391 M. Theprovision reflects a $26M addition to the allowance . . . . The addition to the reservewas made to reflect growth in receivables and not because of concern aboutportfolio quality. Our leading indicators of portfolio quality remain stable withbankruptcy filings having moderated from the highs we've experienced early in 2001and 60+ days delinquencies essentially flat with a year ago at 7.58%. . . . Wecontinue to monitor the macro economic picture very closely . At thispoint we feelvery comfortable that credit quality will remain in good shape throughout 2002.As you know from the presentations we've made on this topic, we made numerousinvestments in the credit business to help us manage credit risk to respond timelyand dynamically to changes that we observe. . . . Our credit and financial productswe anticipate that receivables will grow in the low single digit range and continuegrowth in the Sears Gold MasterCard product . We expect that the next charge offrates will remain roughly flat with 2001 with stable credit quality in the portfolio .

90 . In response to an analyst's question about the unexpected growth of the MasterCar d

portfolio, Lacy also stated : "I think that we've had, we now have 19 million accounts on th e

MasterCard product. People are, in large measure, using it as their primary payment product an d

therefore it is becoming a very important part of their purchasing activity which is driving as we

anticipate substantially higher average balances than they would have had on their prior Sears card .

So, I think the strategies are working very well . The credit team has really been executing it

superbly. "

91 . The market responded favorably to the defendants ' statements concerning Sears' s

fourth quarter 2001 results . For example, the day of the conference call, Sears shares closed a t

$52.70, up from the previous closing price of $51 .47 (and up from $49 .45 on the day before Sears' s

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January 10 press release), and almost reached a 52-week high . The next day, UBS Warburg raise d

its price target for Sears shares, and issued a report that stated :

EPS improvement was driven by 6% retail operating income improvement and 25%growth in credit operating income . . . Gold MasterCard receivable growthcontinues to more than offset a shrinking proprietary card portfolio . . . . Searshas outperformed the S&P by roughly 28% since October . . . . Receivable growthof 2 .2% was stronger than expected for the third consecutive quarter, and was drivenby 279% in Gold MasterCard receivables to $5 .3 billion . . . Importantly, creditquality remained strong in thefourth quarter, with a $26 million net increase inthe allowancefor doubtful accounts the result of strong receivables rather thancredit deterioration . Additionally, a 44 bps [basis point] increase in the net charge-off rate was attributed to the spike in bankruptcy filings experienced earlier in theyear, which the company indicated have returned to more normalized levels .

92. However, as defendants were well aware, Sears's repeated representations concernin g

its credit operations and the Company's reported financial performance, as set forth in 1185-9 0

above, were materially false and misleading, for the reasons set forth in It 55-70 above and ¶¶ 162-

163, 179-194 below . For example :

(a) Although Sears represented that delinquencies had remained "flat," that charge-

offs had increased from 4.79% at year end 2000 to 5 .23% at year end 2001 (an increase of 9%), and

that the portfolio was "stable ," in truth :

• Sears Card delinquencies had increased to 8 .91 %, representing a drastic increase ascompared to the Sears Card delinquency rate of 7 .94% for the fourth quarter of 2000 .Meanwhile, Sears Card charge-offs had increased to 5 .78%, a 20% increase over thereported 4 .79% charge-off rate at year end 2000 .

• Sears MasterCard delinquencies had jumped from a delinquency rate of 0.38% atyear-end 2000, and 1 .94% in the third quarter of 2001, to 1 .97% in the fourth quarterof 2001 . Meanwhile, MasterCard charge-offs had increased from 2 .02% in the thirdquarter to 2 .09% in the fourth quarter.

(b) Despite such representations as "[W]e feel very comfortable that credit quality

will remain in good shape throughout 2002," and "We expect that the next charge off rates wil l

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remain roughly flat with 2001," 189, the Company had experienced, and knew it would continu e

to experience, rising delinquency and charge-off rates .

93 . On March 7, 2002, UBS Warburg issued a report discussing Sears's credit car d

business that stated :

We recently visited with Kevin Keleghan, President of Sears' Credit business, togain a better understanding of the growth prospects of the business that in FY :01represented close to 70% of Sears' consolidated operating income . . . . Credit qualityseems to have remained benign in recent months, presumably benefiting in part,from the rapid growth of the Gold MasterCard portfolio . . , . While managementseems focused on employing a prudent and risk averse growth strategy, its annual5% operating profit growth target would require total receivables growth of greaterthan 5% . . .

With regards to credit, we note the inherent quality of risk of every credit business,though we believe that Sears has invested the requisite time and dollars needed tomonitor credit quality properly .

94 . UBS Warburg's report of credit quality and management's "risk averse" growth

strategy clearly repeated statements by Keleghan to UBS Warburg with the intention that such

statements be repeated to the market. However, these statements were false and misleading for th e

reasons stated in It 55-70 .

95 . On March 14, 2002, Sears filed its Report on Form 10-K for 2001, signed b y

defendants Lacy, Liska, and Bergmann. The Report repeated the financial information contained i n

the January 17 8-K, and further stated :

Management maintains a system of internal controls that it believes providesreasonable assurance that, in all material respects, assets are maintained andaccounted for in accordance with management's authorizations and transactions arerecorded accurately in the books and records. The concept of reasonable assuranceis based on the premise that the cost of internal controls should not exceed thebenefits derived . To assure the effectiveness of the internal control system, th e

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organizational structure provides for defined lines of responsibility and delegationof authority . The Company's formally stated and communicated policies demand ofemployees high ethical standards in their conduct of its business . These policiesaddress, among other things, potential conflicts of interest; compliance with alldomestic and foreign laws, including those related to financial disclosure ; and theconfidentiality of proprietary information . As a further enhancement of the above, theCompany's comprehensive internal audit program is designed for continualevaluation of the adequacy and effectiveness of its internal controls and measuresadherence to established policies and procedures .

96. The Report went on to state :

In 2001, total Retail and Related Services revenues decreased 1 .8% to $31 . 4 billionand comparable store sales decreased by 2.3%.

The percentage of merchandise sales and services transacted with Sears credit cardsin 2001 declined to 47 .0% from 47 .4% in 2000, due to a greater preference for otherpayment methods . However, the Sears Gold MasterCard product, which waslaunched in 2000, has been successful in offsetting the declining trend in averagemanaged balances in 2001 .

Credit and Financial Products selling and administrative expense increased 2 .8% in2001 from 2000 levels . The increase is primarily due to an increase in consumerfraud costs, payroll and benefits, customer notification expenses and costs associatedwith the continued roll-out of the Sears Gold MasterCard product .

Charge-offs increased by $446 million reflecting the inclusion in 2001 of charge-offsfor the previously sold and securitized receivables and an increase in the net charge-off rate in 2001 to 5 .32% from 5.12% in 2000, primarily due to increased customerbankruptcy filings . Despite the increase in bankruptcy filings in 2001, thedelinquency rate for 2001 remained relatively flat with 2000. At December 29,2001, the year-end allowance as a percent of on-book receivables was 4.04%, or$1.1 billion versus 4.03% or $649 million at year-end 2000 . . . .

The Company grants retail consumer credit based on the use of proprietary andcommercially available credit histories and scoring models . The Company promptlyrecognizes uncollectible accounts and maintains an adequate allowance foruncollectible accounts to reflect losses inherent in the owned portfolio as of thebalance sheet date.

Credit card receivables are shown net of an allowance for uncollectible accounts . TheCompany calculates an allowance for uncollectible accounts using a model thatanalyzes factors such as bankruptcy filings, delinquency rates, historical charge-offpatterns, recovery rates and other portfolio data . The Company's calculation is the n

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reviewed by management to assess whether, based on recent economic events,additional analyses are required to appropriately estimate losses inherent in theportfolio.

97. In addition, the Company reported total assets of $44.317 billion, of which $28 .15 5

billion - or 64% - were credit card receivables .

98. But despite Sears's reported "flat" delinquency rate for the year as compared to 2000 ,

as is clear from the chart at 163, both the Sears Card and the Sears MasterCard had seen thei r

delinquencies rise every quarter . Thus, by the end of the year , Sears Card delinquencies had

increased by 13% from 7 .86% at the beginning of the year to 8 .91% at year's end . For the Sears

MasterCard, the numbers were even more striking - delinquencies had increased 73% over the

course of the year, from 1 .15% in the first quarter to 1 .97% in the fourth .

99. Additionally, the statements contained in the 2001 10-K were also mate rially false

and misleading for the reasons stated in ¶¶ 55 .70, 179-194 .

100. On March 14, 2002, The American Banker carried a story titled "A Catalog Reasons

for Sears' Card Profits," detailing the reasons for Sears's "success" in the credit-card business . The

article observed that Sears placed "a heavy emphasis on risk management," and reported that "Mr .

Keleghan brags that Sears's portfolio nearly equals the market leader MBNA in its chargeoff rate . "

101 . Keleghan's statements were materially false and misleading for the reasons stated at

$T 55-70 .

102. On March 28, 2002, the Chicago Sun-Times reported :

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Sears credit card switch hikes customer spendin g

Sears, Roebuck and Co. said customers who switched to the retailer's GoldMasterCard from its in-store card are spending more at the chain's stores than before .

Those who changed in 2000 increased spending during the next 11 months anaverage 35 percent from the prior period, said Kevin Keleghan, president of creditand financial products .

Sears has transferred about 19 million of its 60 million card holders to theMasterCard to help boost profit while sales at its stores slump . The MasterCardoffers customers a higher credit line than Sears' regular one, and can be usedelsewhere, so Sears can earn more from interest and fees if shoppers use it as a maincard .

"Credit's been a positive for them," said analyst Matt Spitznagle of Northern TrustGlobal Investments, a division of Northern Trust Corp . that has 1 .4 million Searsshares in its $330 billion in assets . "Most of the operating income growth is comingin the credit business . "

Sears' credit cards and financial services accounted for $1.53 billion, or 69percent, of operating income last year, spokesman Bill Masterson said . That is anincreasefrom 65 percent in 2000 and 58 percent in 1999.

The income has provided Sears with the funds to improve stores and invest in newprojects, investors said . Sears' same-store sales fell or were little changed in the past10 months .

103. On April 10, 2002, Sears issued a press release , filed with the SEC and signed by

Bergmann, announcing preliminary earnings for the first quarter of 2002 that beat Wall Street

projections by more than 50%. Although store sales declined in March from the prior year, just as

they had done for the previous two months, the Company reported that operating earnings increased

107% for the quarter due to cost-cutting in the Retail segment and "a very strong quarter" in Sears

Credit, resulting in an earnings increase of 20%. As a result, Sears increased its earnings projections

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for 2002, to growth of 17% over the prior year . Previously, Sears had projected an earnings increase

of only 13 to 15% per share .

104. In response, Sears shares shot up to hit their highest point in four years, befor e

finishing the day at a 52-week high of $54.18, or 6% higher than the previous day's closing .

105. On April 18, 2002, Sears issued another press release, filed on Form 8-K and signe d

by Liska, repeating the numbers cited in its earlier Ap ri l 10 release and stating :

Credit and Financial Product's operating income, excluding non-comparable items,increased by $78 million or 21 .4 percent to $443 million as favorable funding costsand higher revenues offset higher provision and selling and administrative expenses .

First quarter domestic Credit and Financial Products comparable revenues increased1 .4 percent from a year ago, to $1 .32 billion due to higher average receivablebalances . Credit receivables at the end of the first quarter grew 5 .1 percent over theprior year to $27.0 billion .

The provision for uncollectible accounts on a comparable basis, increased by $37million or 11 .1 percent over last year's period . The net charge-off rate for thequarter increased to 5.43 percent from 5.07 percent last year primarily due toincreased customer bankruptcy filings over last year . Year-over-year delinquenciesdecreased 19 basis points from 7.50 percent to 7. 3 .1 percent, indicating stableportfolio quality. The domestic allowance for uncollectible accounts of $1 .1 billionis 4 .13 percent of ending credit receivables compared with 4 .14 percent at the end oflast year's quarter.

106 . The release further reported that out of the total operating income for the quarter,

$443 million was attributed to Sears Credit, with only $87 million attributed to the Retail segment.

Most strikingly, although prior press releases - including the one issued just 8 days earlier - had

described Sears as "a leading U.S. retailer of apparel, home and automotive products and services, "

the new press release issued April 18 described the Company as "a broadline retailer with significant

service and credit businesses ."

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107. Also on April 18, Sears held a conference call with analysts to discuss the Company' s

first quarter results . During the call, Lacy represented that it had been a "record first quarter" for

Sears, and that "Our credit and financial products business had an outstanding quarter, with operating

income growing by 21 % on a comparable basis . This was the result of higher revenues and favorabl e

funding costs . The Sears Gold Mastercard product continues to be a valuable growth vehicle fo r

its, with balances now over $6 billion ." Lacy reiterated Sears's new projection of a 17% increas e

in earnings for the year, characterizing the projection as "conservative . "

108 . During the April 18 call, Liska also represented that although Sears had expecte d

decreased Retail revenues for the quarter, Sears's actual results for the Retail segment were eve n

worse than Sears had expected However, with respect to Sears Credit, Liska reported :

The receivable growth reflects the continued success of the Sears Gold MasterCard

product which now how has a receivable balance of over $6 billion . For the quarter,

credit and financial products revenue increased 1 .4% to $1 .3 billion primarily due to

higher average balances . The allowance stands at $1 .1 billion , or 5.13% of any

receivables. In rate terms, this is flat with the prior year and up slightly versus theend of 2001 . The net charge-off rate in the quarter increased by 36 basis points over

last year to 5 .43%, primarily the reflection of an uptick in bankruptcy filings . The

60 plus days delinquencies are down in the first quarter, approximately 20 basis

points to 7.31% versus a year ago at 7 .5% . Combined, all factors point towardoverall stable portfolio guali .

For credit and financial products, while the current macro economic outlook remainsuncertain at this point, we feel good about our credit quality and feel comfortablethat it will remain in good shape throughout 2002. The consensus economicforecast seems to point to a rebound in the economy. However, as an improvementin unemployment may somewhat lag that of the broader economy, there may someincremental charge off risk in the portfolio for the balance of the year . However, aswe have consistently stated, our investments in risk management systems andprocesses well position us to manage the situation and any potential risk of acharge off line should be quite modest in relation to the Credit Segment 's overallresults. . . . On an operating income basis, we are cautiously optimistic that credi t

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will do better than the mid-single digit increase guidance we previouslycommunicated.

109. In response to a question, Lacy reiterated "[W]e are feeling better about the organic

growth of theportfolio in aggregate because of the continued success of MasterCard. Yeah, there

is the yield shift that takes place with that, but I think that, we feel right now that the credit

environment 's pretty stable, that we've got an improving visibility to top line with MasterCard' s

success." When an analyst asked about the adequacy of the allowance forbad debt, Liska responded

" We're very comfortable with the absolute level o that reserve ."

110 . During the April 18 call, Lacy further touted Sears ' s success in encouraging bal ance

transfers on to the MasterCard :

We've been very successful to date on balance transfer activity to the MasterCard,which we think is a very encouraging sign . . . . So, I would say that the balancetransfer activity, we are pleased, we've done some things in terms of accountstimulation program to activate more third party spend on the MasterCardproduct.

111 . After the main presentation concluded, Lacy and Liska accepted questions from th e

analysts , resulting in the following inquiry :

Q: Good morning, thanks for your time . I also have an interest, a question on credit . Iknow it's early in the period of seasoning of the MasterCard portfolio, and you'vestated that you believe and these folks are very much better credits relative to thestore card borrowers, but what specifically, have you said or can you say about whatyou expect your loss experience to be with the MasterCard portfolio?

112. With this question, Lacy and Liska were squarely presented with the choice of comin g

clean and disclosing the true condition of the portfolio, or continuing the fraud by refusing to infor m

investors that both the Sears Card segment, and the Sears MasterCard segment, were experiencin g

gross escalations in delinquencies and defaults . Faced with this clear opportunity to set the market

straight, Lacy and Liska gave the following responses :

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Liska: [W]e're approaching this on a portfolio basis, because as you probably know,we originally. . . substituted people out of the Sears card into the Sears GoldMasterCard that were of better credit quality or had stopped using their Searscard. So, we look at it more as managing a portfolio and we're probablynever going to be in that position that we're going to talk about them asdiscreet portfolios because we don't manage it like that. And it wouldprobably be misleading if we did that. So , we're just going to comment onit on a total portfolio basis .

Lacy : I think in terms of the specific numbers of the loss experience and so on,Paul [Liska]'s exactly right . I think that we have started off because we feltwe had, with the most pristine credits within the Sears proprietary cardbase, because those are the people that like Sears but they weren't using thepayment product . . .[I]n the 19 million accounts that we've done to date,they've been very much focused on those people that are very strong creditqualitypeople. Now, as we go forward, that's going to get more blended . .. . So, I think to date a very pristine credit quality group . As we goforward, it might actually look a little bit more, not ultimately probably, butwill look maybe a little bit more like the normal portfolio .

113. Following the conference call and the press release on April 18, Sears shares rose

from a closing price of $53 .71 on April 17 to a closing price of $54 .60 on April 19 .

114. On May 7, 2002, Sears filed a 10-Q for the first quarter of 2002, signed by Bergmann .

The 10-Q repeated the financial information contained in the 8-K, and stated :

Credit and Financial Products revenues increased 1 .4% to $1 .3 billion for the 13weeks ended March 30, 2002 from the comparable prior year period . . . . The SearsGold MasterCard portfolio has continued to grow with balances now over $6 billionat March 30, 2002 .

Credit and Financial Products selling and administrative expense as a percentage ofCredit and Financial Products revenues increased to 17 .3%, an increase of 240 basispoints in the first quarter of 2002 from the comparable 2001 period . The increase wasprimarily due to higher customer notification costs and increased consumercollection costs.

Excluding the impact of securitizations, charge-offs increased by $38 millionreflecting an increase in the net charge-off rate in 2002 to 5 .43% from 5 .07% in2001, primarily due to increased customer bankruptcy filings . Despite the sligh t

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increase in bankruptcy filings in 2002, the delinquency rate for 2002 decreased l9basis points compared with 2001. At March 30, 2002, the period-end allowance asa percent of on-book receivables was 4 .13%, or $1.1 billion, versus 4.14% or $567million atperiod-end 2001.

115. However, as defendants were well aware, Sears's repeated representations concernin g

its credit operations and the Company's reported financial performance for the first quarter of 2002 ,

as set forth in ¶¶ 103, 105-110, 112 and 114, above, were materially false and misleading, for th e

reasons set forth in ¶¶ 55-70 above and 11162-163, 179-194 below . For example :

(a) Sears contended, inter alia, that credit quality remained "stable," ¶ 105, reporte d

that delinquencies had decreasedby "19 basis points" as compared to the first quarter of 2001, and

reported a 7% rise in charge-offs from 5 .07% to 5 .43%. In fact :

• Sears MasterCard charge-offs had soared from .80% in the first quarter of 2001 to2 .65% in the first quarter of 2002 , an increase of 230%, while MasterCarddelinquencies had shot up from 1 .15% in the first quarter of 2001 to 2 .55% in thefirst quarter of 2002 , an increase of 122% (or 140 basis points) ; and

• Sears's proprietary card charge-offs had gone up from 5 .29% in the first quarter of2001 to 6 .16% in the first quarter of 2002, an increase of 16.4%, while its store carddelinquencies had jumped from 7 .86% in the first quarter of 2001 to 8 .77% in thefirst quarter of 2002, an increase of 11.6% (or 91 basis points) .

(b) Despite such representations as "[W]efeelgood about our credit quality an d

feel comfortable that it will remain in good shape throughout 2002," ¶ 108, the Company had

experienced, and knew it would continue to experience, rising delinquency and charge-off rates .

116. On May 9, 2002, Sears announced that its April store sales had decreased from the

prior year . At a shareholders meeting that day, Lacy admitted that the environment for Sears' s

softlines remained "challenging," and that the only turnaround that could be expected in apparel sale s

would not come until 2003 .

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117. Days later, in an attempt to shore up its struggling apparel sales, Sears announced on

May 13 that :

Sears, Roebuck and Co . (NYSE: S) and Lands' End, Inc . (NYSE: LE), have enteredinto a definitive agreement for Sears to acquire the direct merchant in a cash tenderoffer for $62 per Lands' End share, or approximately $1 .9 billion. Upon completionof the transaction, expected in June, Lands' End will become a wholly ownedsubsidiary of Sears and will continue to be headquartered in Dodgeville . Lands' Endis the largest specialty apparel catalog company and seller of apparel on the Internetin the U .S .

Lacy said the transaction does not alter Sears outlook for the year. The transaction isexpected to be slightly dilutive to break-even in 2002 and 2003 and significantlyaccretive in 2004 . "Considering the minimal impact to 2002 earnings, we continueto expect 2002 full year comparable earnings per share, including Lands' End, toincrease approximately 17 percent from the prior year amount of $4 .22," Lacy said .Sears does not expect to record a special charge for the Lands' End transaction .

118. The announcement brought an immediate surge in Sears's stock price, causing it t o

jump 9% in one week from its closing price of $51 .81 on May 10 to $56 .46 on May 17 . On May 14,

2002, the New York Times reported "Alan J . Lacy, chairman and chief executive of Sears, said he

expected that 15 percent to 20 percent of all the apparel for sale in Sears would be from Lands' En d

by next year," The article went on to observe: "The acquisition , . . . surprised many analysts, who

nevertheless cheered it as a wise strategic move. . . . The company plans to borrow $1 .5 billion to

complete the purchase sometime next month. Mr. Lacy said the sale was taking place at ` a

reasonable and attractive price and clearly within our means."'

119. On May 14, 2002, UBS Warburg issued a report stating "We are upgrading our rating

on Sears to Buy from Hold, reflecting our enthusiasm for its announced planned acquisition o f

Lands' End (LE) . This acquisition significantly alters our previously negative view of the prospect s

for S's [Sears's ] apparel business ." H&R Block reported : "We believe the addition of the Lands '

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End brand should serve as a catalyst for revising sales in the softlines category as well as the overal l

Sears brand . . . . We believe the addition of the Lands' End should help Sears obtain destination

status, something its existing portfolio of brands could not do . We also believe it provides a

competitive advantage in both the moderate and department store channels . "

120. On May 23, 2002 and on June 6, 2002, Sears used its financing subsidiaries, Sear s

Roebuck Acceptance Corp . and Sears Credit Accounts Master Trust II, to raise the funds necessary

to complete the Lands' End acquisition . The acquisition was completed on June 17 , 2002. Of the

$1 .6 billion raised in these offerings, $629 million was directly backed by Sears's credit car d

receivables .

121 . On May 31, 2002, Sears shares hit their class period high of $59 .05 .

122. On July 16, 2002, the business world was shaken by an announcement by Capital

One, a previously successful consumer lending company that provides loans and other financia l

products, including credit cards . On July 16, Capital One announced that bank regulators had

required it to increase its capitalization and reserves, and to tighten its risk controls, in light of it s

significant proportion of loans to subprime consumers . The company also disclosed that of its loa n

portfolio, 39 .8% of its loans were to subprime consumers, as compared with the industry averag e

of 36.6%. On the day after the announcement, Capital One shares dropped from their previou s

closing price of $50.60 to $30 .48. Deutsche Bank reduced its rating on Capital One, stating : "The

subprime percentage is much higher than the company had indicated to us in the past . "

123. The announcement made investors skittish with respect to all credit card lenders ,

prompting numerous inquiries to Sears about the stability of its own operations . In the two days

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following the announcement, Sears share prices fell from $47 on July 15, 2002 to $44 .33 on July 17,

2002 .

124. On July 18, 2002, Sears issued a press release , filed with the SEC on Form 8-K and

signed by Bergmann, reporting results for the second quarter of 2002 . The release stated :

Sears, Roebuck and Co . today reported record second quarter 2002 net income of$420 million, or $1 .31 per share, a 36 percent per share increase over the prior year .comparable second quarter of $0 .96 per share. The increase is due to the continuingperformance improvements in the company's retail and credit businesses.

"Profits for the quarter showed solid increases across all segments," said Chairmanand Chief Executive Officer Alan J. Lacy. "Margin rate improvements continue tobenefit the retail businesses, while Credit and Financial Products results weredriven by thegrowth of the Sears Gold MasterCard product and a favorable interestrate environment."

"First half earnings exceeded our expectations," said Lacy . "As a result, we nowexpect 2002 full year comparable earnings per share to be approximately $5.15,a 22 percent increase over the prior year amount of $4.22." . . . . Previousexpectation was for full year comparable earnings per share to increaseapproximately 17percent.

Credit and Financial Products ' operating income, excluding non-comparableitems, increasedby $67million or 19.4percentto $412 million as favorable fundingcosts and higher revenues offset higher provision and selling and administrativ eexpenses .

Second quarter domestic Credit and Financial Products revenues increased 3 .5percent from a year ago to $1 .3 billion, due primarily to higher average receivablebalances . Credit receivables at the end of the second quarter grew 8 .8 percent overthe prior year to $28 .2 billion. . . .

The net charge-off rate for the quarter decreased to 5 32 percentfrom 5.42 percentlast year primarily due to decreased customer bankruptcy filings.

Year-over-year delinquencies decreased 39 basis points from 7 .26 percent to 6 .87percent, indicating stable portfolio quality . The domestic allowance fo r

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uncollectible accounts of $1.4 billion is 5.10 percent of ending credit receivablescompared with 5.24 percent at the end of last quarter.

Overall, Sears reported total operating income for the quarter of $666 million, of which $412 millio n

came from Sears Credit .

125 . The press release also announced an "accounting change" :

The company announced a change in its accounting for the allowance foruncollectible accounts in the credit business . Sears historical allowance methodologyprovided for uncollectible principal and accrued finance charges on past dueaccounts. Sears has changed its allowance methodology to include current balancesand accrued credit card fees in the methodology. The company believes that thischange in its methodology moves it appropriately to a more conservative position inregard to its allowance for uncollectible accounts . As a result of the accountingchange, the company recorded a cumulative effect, non-cash charge of $191 millionas of the beginning of the fiscal 2002 year . The change did not impact second quarter2002 results .

In other words, Sears admitted that until this point, it had entirely failed to create reserves for

probable losses for accounts that were not delinquent, thus creating a false impression that it s

portfolio was larger and more profitable than was actually the case . Moreover, the error was

compoundedby the fact that Sears's lax payment policies allowed it to delay categorizing an accoun t

as "delinquent" in the first instance . With more accounts classified as "current ," Sears, until now,

could avoid estimating the losses likely to be associated with those accounts . '

126 . Also on July 18, 2002, Sears held a conference call with analysts to discuss its secon d

quarter 2002 results, and to reassure investors that Sears's loan portfolio did not suffer from the same

types of problems that had recently afflicted Capital One . As Lacy told investors :

'Sears would ultimately be required to restate its first and second quarter 10-Qs, due to itsfaulty insistence on backdating this accounting change to the first quarter, thus avoiding taking aprospective charge to earnings .

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[I]n light of recent announcements in the credit card industry, there is increasedconcern regarding the credit quality of our portfolio . The general concern seems torevolve around the quality of receivables growth of certain issuers . . . . The creditquality of our receivables portfolio has also improved. Both our delinquency andthe charge-off rates have improved versus last year . Furthermore, we have madeinvestments in risk management systems and processes that position us well tomanage in this uncertain economic environment . Therefore we continue to feelgood about our credit quality and feel comfortable that our credit business wil lperform well this year .

127. Additionally, although Sears announced that it was changing its accountin g

methodology in a manner that would increase its allowance for uncollectible accounts, Lacy assure d

investors that the change was in no way indicative of any concerns about portfolio quality :

In light of the current environment every company is stepping back and reviewingtheir accounting policies . We are no different . We have reviewed our accountingmethod with regard to the allowance for un-collectable accounts relative to theindustry. There is a wide-range of practices. Although our previous method wasboth acceptable and consistently applied , we believe our new method is preferable .This new method moves us to a more conservative position in regard to theallowance for uncollectible accounts . Most importantly, it is non-cash and does notimply any change in our portfolio credit quality or the economics of our creditbusiness.

128 . During the July 18, 2002 conference call, Lacy concluded by again increasing Sears's

earnings projections for the year :

Finally, we are delighted with the progress that we are making in our strong first-halfresults. And as a result, we are increasing guidance for comparable 2002 earningsper share growth to $5 .15, a 22% increase over last year .

129. Liska then reinforced Lacy's remarks :

I want to highlight that this is a change in accounting method only . This changeis a non-cash item . It has no economic impact and doesn 't reflect any underlyingchange and portfolio quality. In fact, delinquency in net write-offs have bothimproved versus last year. While the previous method was acceptable under GAAPconsistently applied again within industry practice, we believe this new methodologymoves us to a more conservative position . . . . In summary, while the previous

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method was clearly proper this change makes it more conservative, and once againlet me remind you that it has no effect on our operations, our outlook, or theeconomics of our credit business.

** *

Turning to the credit of financial products segments , receivables are up 8.8% versus

last year at the end of the quarter to $28.2 billion . This receivable growth reflectsthe continued success of the Sears Gold MasterCard product, which now has areceivable balance of over $8 .5 billion. . . . The net charge off rate in the quarterimproved by 10 basis points from last year to 5.32%. And as I said before, 60 + daydelinquencies improved in the second quarter 39 basis points to 6.87% versus ayear ago at 7.26% . These two factors indicate stableportfolio quality. . . . CreditSG&A [selling, general , and administrative expense] increased in the quarter $52million or .4%/.5%. This was the result of a combination of increased marketingspent behind the Sears Gold Mastercard and increased fraud losses . . . . Overall,credit and financial products operating income increased strongly by 19 .4% to $412million in the second quarter .

[W]e anticipate that receivables will grow in the mid-single digit range, andcontinued growth in the Sears Gold Mastercard product . . . . We continue to feelgood about our credit quality and feel comfortable that it will remain in goodshape for the remainder of 2002. We expect that write-offs will remain stableversus 2001. Delinquency rates are forecasted to decline throughout the year . On

an operating income basis, we are confident that credit will deliver solid

performance with improvement in the low double digits, an increase from our

previous guidance of a mid-single digit increase .

130. In addition, when an analyst specifically asked about Capital One during the July 1 8

call, Lacy gave the following response :

Obviously, CapOne was an interesting announcement that basically for us to followtoday, this given how people often are overly concerned of our credit business . But,

in any event, you know there is no question, and I think the regulators who lookedto CapOne and have said, you know, they have been growing very rapidly andbasically without me knowing too much about their situation, have come in andstated that they need to do some things from a reserve standpoint . In our case, weare about 180 degrees different than CapOne. We are growing our credit businessnow by actually having a product that is more fitting for better credit qualitycustomers than our old product . You know, we have never intentionally lended tosubprime people, people as they get into trouble do migrate to being subprime, bu t

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we never intentionally lent to subprime people, but I think very importantly here,what we've been about with our MasterCard product, is having a product that has abetter rate structure and more convenience, that's more appealing to better creditquality customers . So, our growth, and I guess I would say perhaps in contrast toCapOne, our growth is being based on a paymentproduct that is appealing to evenbetter risk customers and therefore, as we grow, we are in fact improving the overallcredit risk of our portfolio .

131 . Lacy then went on to compare the Sears po rtfolio to other issuers generally :

I guess to just to overkill this maybe for the moment. . . . We had historically thoughtof our credit business as a business that could be leveraged conservatively at a 9 :1debt equity ratio . . . . That capital ratio is significantly less leveraged than thetraditional monoline credit card issuers. Credit card issuers typically are leveragedin the 15:1 category. So we have a balance sheet today that has afar lower levelof leverage relative to our credit business than the monoline credit cards.

132 . In response to another question about the MasterCard, Lacy added :

Sears billed MasterCard balances at the end of the quarter were $8 .5 billion, so thishas been a very successful product launch for us. In fact, it's gone better todaythan we thought it might. We've been very, very pleased with the pace of growthin that product and the customers' response to it. We have not projected forwardhow much receivables we will have on the MasterCard product . I think it isjust safeto say that it is a very important product launch , not onlyfor Sears credit, but alsofor Sears Roebuck & Company , because we do view that as being the principlegrowth vehicle going forward. In terms of the basis of competition in the industry,we have historically had, I think, a surprising success with a proprietary store card .I mean, the Sears Card, I think, has been a remarkable product in the scheme of thefinancial services industry and that it's been $20 plus billion dollars worth ofbalances for a very long time, it's very profitable, and we've had very goodperformance from it .

133 . Finally, at the end of the July 18, 2002 conference call, Liska also reassured investors

that :

On the risk management side, we've also invested significantly in riskmanagement systems and capable people and feel that, having had some issues backin the mid-90's that we clearly were under investing there and have brought that upto, we think, a very contemporary capability as well . So our risk managementsystems, our operating systems, I would also say that our collections systems havealso been upgraded, so wefeel very good about the systems environment . We'veputa lot of money and time there over the last few years.

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134 . The market again reacted favorably to Sears's statements concerning its secon d

quarter 2002 performance . For example, on the day of the July 18 conference call, Sears stock

closed at $45 .75, up from the previous day's closing price of $44 .3 3

135 . Wall Street analysts also reacted favorably to Sears's announcements . For example :

(a) In an analyst report dated July 18, 2002, UBS Warburg reported :

Importantly, credit quality remained strong in 2Q, and in factimproved versus the prior year . Performance bucked the trend ofrecent credit woes at some mono-line card issuers . . . . Anaccounting change was made retroactive to 1Q, which essentiallyincreased the allowance . . . in a one-time event that represents a shifttowards more conservative allowance measures by the company. . .. [M]anagement reiterated that this was an optional move on theirpart, and that the old method continues to be allowed under currentaccounting standards . . . We view the move as a proactive shifttowards a more conservative management of risk in anticipation offuture receivables growth.

(b) Similarly, in an analyst report dated July 19, 2002, Bank One reported :

The Credit quality has improved, as demonstrated by lower charge-offs and delinquencies versus last year . . . . Within the creditoperations, debt/equity is roughly 9 times, a much lower figure thanthose of other competitors in the consumer credit business .Moreover, Sears does not lend to subprime customers , a segmentthat has attracted increased scrutiny given the problems at CapitalOne .

(c) Additionally, in an analyst report dated July 18, 2002, Merrill Lynch stated :

Sears announced a change in the way in which they manage theirallowance for uncollectible accounts . . . . The charge and the changewill have no effect on operations . By increasing the allowance, thenew method reflects increased conservatism in Sears credit divisionaccounting.

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In response to concerns over the growth of the credit card business(especially in light of recent difficulties for credit card issuer CapitalOne), management differentiated their credit business by stressing :(1) current growth is coming from the Sears MasterCard product,which is aimed at higher quality customers than the Sears store card,(2) Sears does not engage in any sub prime lending , and (2) theSears credit division debt/equity ratio is currently 9x, well below thetypical 15x of traditional monoline credit card issuers .

136 . However, as defendants were aware, Sears's repeated representations concerning it s

credit operations and the Company's reported financial performance, as set forth in ¶¶ 124-13 3

above, were materially false and misleading, for the reasons set forth in 1155-70 above and ¶¶ 162-

163, 179-194 below . For example :

(a) Sears contended, inter alia, that delinquencies had decreased by "39 basis point s

from 7 .26 percent to 6.87 percent," and that charge-offs had decreased from "5 .32 percent from 5 .42

percent." In fact :

• Sears MasterCard charge-offs had soared from .90% in the second quarter of 2001to 2.99% in the second quarter of 2002, an increase of 232%, while MasterCarddelinquencies had shot up from 1 .20% in the first quarter of 2001 to 2 .57% in thefirst quarter of 2002, an increase of 114% (or 137 basis points) ; and

• Sears 's proprietary card charge-offs had gone up from 5 .78% in the second quarterof 2001 to 6.20% in the second quarter of 2002, an increase of 7.2%, while its storecard delinquencies had jumped from 7 .86% in the second quarter of 2001 to 8.75%in the second quarter of 2002 , an increase of 14% (or 89 basis points) .

(b) Despite such representations as "we are about 180 degrees different than

CapOne," and "1WJe have never intentionally lended to subprime people, people as they get into

trouble do migrate to being subprime, but we never intentionally lent to subprimepeople ," ¶ 130 ,

as the Company would not reveal until the end of the Class Period, Sears had systematically targete d

the subprime market for years, and at the time of these statements, more than halfof Sears's credit

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portfolio consisted of subprime borrowers . By contrast, in June 2002, the average credit card

portfolio for the industry contained 36 .6% subprime loans ;

(c) Despite Sears's comparisons of its operations to those of other lenders, $$131 ,

as Sears would later admit in its post -Class period SEC filings, ¶ 169,176-177, the techniques Sear s

employed to delay recording delinquencies and charge-offs rendered its results "not directly

comparable" to the results of its competitors . Indeed, as Bear Steams reported after the end of the

Class Period: "[W]e believe that [Sears has] the most aggressivepolicy in the credit card industry

and that it is disguising the real loss rate to a certain extent."

137 . Moreover even as Sears was admitting that up until now, its financial statements had

been entirely out of compliance with GAAP for failing to create reserves for outstanding loans that

were not yet delinquent, Sears nonetheless portrayed itself as "conservative" with respect to it s

accounting.

138 . When W. R. Hambrecht & Co. initiated coverage of Sears on July 31, 2002 , it stated

that, due to "little evidence for consistent organic retail growth," it was "thus inclined to value Sear s

. . . as a credit card company . "

139. In part in reaction to the Capital One problems, the OCC, the Federal Reserve, the

Federal Deposit Insurance Corp . ("FDIC"), and the Office of Thrift Supervision (together, FFIEC )

issued draft new guidelines on credit card lending on July 22, 2002. These guidelines provided, inter

alia, that

(a) Card issuers should carefully consider risk exposure not only when increasin g

lines of credit, but also when issuing additional cards ;

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(b) "Workout" programs should not permit payments to extend longer than 48

months ;

(c) Lenders should utilize proper risk controls to ensure that they have adequatel y

reserved for losses .

140 . In an interview with Bloomberg reported on July 25, 2002, when asked about Sears' s

reaction to new guidelines on credit-card lending, Keleghan stated, "From everything I read, I fee l

we're already there ." Keleghan falsely reassured investors that the problems at Capital One woul d

not impact Sears : "I don't suspect we'll come under the same scrutiny . We don't do subprime

lending at all in the MasterCard portfolio . All my growth is coming from prime and superprime."

141 . The Bloomberg article appeared on July 25, 2002 . The next day, Sears stock closed

at $47.17, up from the July 24, 2002 closing price of $46 .32 .

142. However, the above statements were false or misleading because, inter alia :

(a) Sears was not in compliance with the new guidelines, in that: (1) Sears

recklessly issued new cards to consumers who did not qualify for extensions of credit on their

existing accounts ; (2) Sears workout programs typically lasted 50 to 52 months (and, in fact, even

the 48 month maximum set by the OCC was far longer than industry practice) ; and (3) Sears di d

not create proper allowances for loan losses in accord with agency requirements .

(b) Keleghan falsely stated that "all of' Sears's MasterCard growth came fro m

"prime" and "superprime" consumers, even though Sears had drastically lowered its lending criteri a

in order to extend MasterCard credit ; and

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(c) Keleghan falsely implied that Sears's reported financial results could b e

compared to those of other credit card lenders, even though, as Sears would later admit, such result s

were "not directly comparable" because of Sears's aggressive accounting policy.

143. On July 30, 2002, The American Banker reported on Sears's plans to partner with

other retailers who would then accept the Sears store card at their own establishments . The article

explained that Keleghan was not concerned that Sears store cardholders might be too risky to justify

the plan . As the article explained :

Mr. Keleghan downplayed the credit quality concern . "The majority of thesecustomers are very creditworthy," he said, adding that customers typically have fivecredit cards in their wallets . "There is a risk there, but we think it's minimal. "

144. However, this statement was mate rially false and misleading because, inter alia :

(a) As would later be revealed, ¶ 162-163, the Sears portfolio was heavily weighte d

toward risky, subprime consumers .

(b) As would later be revealed, delinquencies and charge-offs in the Sears Card

portfolio had been steadily increasing for a year and half, thus demonstrating the extremely unstabl e

quality of the portfolio .

145. On August 5, 2002, UBS Warburg issued a report stating:

Late last week we hosted a roadshow with EVP and CFO Paul Liska . . . Key pointsmade during presentations included : . . . (2) credit risk being tightly controlled andaccelerated receivables growth is of high quality .

Credit business very conservatively managed and we are confident that receivablesgrowth is of high quality . Sears has invested heavily in risk management technologydu ri ng the past few years and is putting that technology to good use as evidenced byimproving delinquency and charge off rates relative to banks and monolinecompanies . . . . We believe that accelerated conversion of Sears private labelcardholders to Gold MasterCard reflects the fact that a large number of the 60million private label card holders are not sub -prime .

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However, these representations , which parroted Liska' s comments that had been made with the

intention that they be communicated to the market, were materially false and misleading for the

reasons stated 1$ 55-70, 162-163 .

146 . On August 9, 2002, Sears filed its 10-Q for the second quarter of 2002, signed b y

Bergmann. In addition to repeating information contained in its July 18, 2002 8-K, the secon d

quarter 2002 10-Q explained Sears's change in accounting policy as follows :

During the second quarter, the Company compared its methodology for computingthe allowance for uncollectible accounts to the methodologies of participants in thebank card industry . The Company felt that a comparison to bank card issuers wasappropriate given the growth of the Sears Gold MasterCard product(approximately $8.5 billion in balances at the end of the second quarter of 2002)and the recent changes to the Sears Card product that are meant to provide a widerrange of services to the Sears Card holder (e.g., balance transfers, conveniencechecks, broader acceptance, etc.) . . . . Based on its comparison , the Company haschanged its methodology to provide an allowance for principal and finance chargebalances on current and past due accounts as well as for credit card fee balances . TheCompany believes that this new methodology for determining its allowance ispreferable, as it is consistent with more conservative industrypractices in this area .

147. Sears's second quarter 2002 10-Q further stated :

Credit and Financial Products selling and administrative expense as a percentage ofCredit and Financial Products revenues increased to 20 .0%, an increase of 340 basispoints in the second quarter of 2002 from the comparable 2001 period . The increasewas primari ly due to higher account services expenses , increased marketing and in-store credit card promotions and increased fraud losses, experienced due to theconversion of accounts to the MasterCard product.The domestic provision for uncollectible accounts increased by $43 million to $393million for the 13 weeks ended June 29, 2002 from the comparable prior year period.Charge-offs increased by $17 million despite a decline in the net charge -off rate to5.32% in 2002 from 5.42% in 2001 and a decline in customer bankruptcy filings.The increase in the provision and charge-offs is primari ly due to the increase in thereceivables portfolio . The delinquency rate for 2002 decreased 39 basis pointscompared with 2001 . At June 29, 2002, the period-end allowance as a percent ofreceivables was 5 . 10%, or $1 .4 billion .

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148. However, these statements were materially false and misleading for the reasons give n

in ¶¶ 134. Additionally, the Company's claim that "a comparison to bank card issuers wa s

appropriate," ¶ 146, was false and misleading because, as the Company would later reveal, the

information released on its portfolio was not comparable to bank card issuers because Sears had

"the most aggressive policy in the credit card industry" that "disguis[ed] the real loss rate" with

respect to characterizing loans as performing and delaying the recognition of charge-offs . As the

Company's SEC filings would later admit after the close of the Class Period : "[T]he Company' s

delinquency rate is not directly comparable to participants of the bankcard industry." ¶ ¶ 169. 176-

177 .

149. On August 12, 2002, Sears filed an 8-K in which, pursuant to the requirements o f

Sarbanes-Oxley Act, Lacy and Liska personally attested to the accuracy ofthe Company's 2001 10- K

and all reports filed thereafter.

THE TRUTH BEGINS TO EMERG E

150. In October 2002, a series of announcements by Sears suddenly began to reveal th e

true condition of its credit portfolios that had been concealed from investors .

151 . On Friday, October 4, 2002, Sears abruptly issued the following press release :

Sears, Roebuck and Co. has named Paul Liska executive vice president andpresident, Credit and Financial Products . Liska, 46, who joined Sears as executivevice president and chief financial officer in June 2001, succeeds Kevin Keleghan,who has left the company . In his new position, Liska retains his responsibilities foroverseeing Sears' information technology, supply chain, real estate and corporateprocurement functions .

Sears also has promoted Glenn Richter, 40, to senior vice president and chieffinancial officer, succeeding Liska . Richter most recently served as senior vicepresident, Finance . He joined Sears in 2000 as vice president and controller .

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152. On the following Monday, October 7, 2002 , Sears issued another press release :

Sears reaffirmed its 2002 full-year outlook for a 22 percent increase in comparableearnings per share to $5.15, although guidance was revised for its principle businesssegments . The company now expects comparable earnings increases in the low- tomid-thirty percent range in its retail and related services segment and in the mid-single digit percent range in its credit and financial products segment .

Although this revised guidance reflected a projected improvement in Sears's Retail business

compared to the Company's earlier projections from July 18 (which had projected that Retail woul d

grow by a "mid to upper 20's percentage"), the new guidance of only "mid-single digit" percentag e

growth in the credit area was a major downward revision from . Sears's prior July 18 guidance that

Credit would grow "in the low double digits ." In response to this news, Sears stock started to trad e

down .

153 . Later that same day, at a hastily scheduled a conference call with analysts, Lacy

explained that the Company would formally announce third quarter earnings results on October 17 ,

2002, as previously scheduled, and tried to emphasize the positive by stressing that Sears wa s

"reaffirm[ing]" its July 2002 earnings guidance for the year of a 22% increase in earnings per share .

154. With respect to Sears 's Credit business, Lacy further stated as follows :

In our credit business, receivables continue to grow and the 3`d Q average receivablesincreased approximately 10% versus the prior year. For the quarter the allowancefor uncollectible accounts also increased approximately 10% versus last year. Themajority of this increase reflects the growth in our receivables portfolio, but a part ofit also reflects a worsening economic outlook . We expect a further increase in the0Q. As a result we are revising our guidancefor the credit and financial productsegment to an operating increase in the mid single digit range versus our lowdouble digit increas&

155 . Lacy also discussed the abrupt departure of Kevin Keleghan as the President of Sear s

Credit as follows :

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Kevin left the company at my request, because I lost confidence in his personalcredibility. To discuss it further than that does not serve any purpose . His departureis not related to business performance and does not indicate a change in our creditstrategy. We will continue to grow the credit business while we reposition andrestructure our retail operations .

156. In response to the cryptic partial disclosures about the reasons for Keleghan' s

departure, and to the negative news about Sears's Credit business, on October 7, 2002, Sears share s

plunged from a previous closing price of $37 .64 on October 4, 2002 to a closing price of $32 .25 on

October 7, 2002 .

157. In subsequent reports, analysts expressed confusion about the import of Sears's

sudden announcement . As W.R. Hambrecht wrote on October 7, 2002 :

Kevin Keleghan , who had been the head of Sears credit card division , unexpectedlyleft the company last Friday. When this was announced, we initially thought it wasa matter of CEO Alan Lacy and Paul Liska further fashioning the company . . . Thismorning, however, we got incrementally bad news . . . . CEO Lacy stated that heasked Keleghan to leave because he had lost confidence in Keleghan 's personalcredibility. We don't know what that means, exactly ; but, we believe it bodes poorlyfor Sears Credit operations which represent approximately 65% of operating profitand creates even greater uncertainty about the quality of earnings at the creditdivision . . . .

158. In reality, Lacy 's assurances that Keleghan' s departure was "not related to busines s

performance," and that operating income from Sears' Credit business would continue to grow (albei t

at a reduced rate) were all materially false and misleading because, inter alia :

(a) Keleghan's departure was most definitely related to poor business performance,

and to the Company's desire to try to focus future blame for Sears's deceit on only one or tw o

individuals, in that he had systematically lied to investors about the performance of Sears Credi t

while implementing risky models that made it easier for risky borrowers to get credit ; and

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(b) Given the true condition of Sears's credit business, even the revised earning s

projections for the year could not be achieved given the current state of Sears Credit, and wer e

known at the time to be unachievable .

159. As a result of Lacy's and Sears's efforts to downplay the significance of Keleghan' s

departure , and in the absence of any further bad news, the p rice of Sears stock stabilized in th e

following week, closing at $33 .95 on October 16, 2002 .

160. But the biggest shock was yet to come . On October 17, 2002, Sears shocked the

market with a press release announcing that Sears would be increasing its allowance for bad debt by

$222 million . The charge against earnings taken to cover this increase allowance reduced Sears' s

earnings for the quarter by 26% as compared to the prior year , and also caused the Company to

reduce its projections for year-end results . Although just 10 days earlier the Company had

reaffirmed that it expected a 22% increase in earnings per share for the year, Sears announced that

it was now estimating an increase of only two-thirds that amount (i .e ., an increase of only 15%), and

that the credit segment was "down 28 percent compared to the prior year ." The release further

commented on the $222 million charge as follows :

The domestic provision for uncollectible accounts increased $222 million over theprior year period due to a $189 million increase to the allowance for uncollectibleaccounts. The allowance increase reflects receivables growth, recent increases incharge-off trends and a cautious economic outlook for the remainder of the year . Thenet charge-off rate for the quarter decreased to 5 .55 percent from 5 .62 percent lastyear, reflecting increased charge-offs offset by the effect of receivables growth .

161 . In an analyst meeting on that day, Lacy attributed Sears's problems in its credi t

business to the duplicity of Kevin Keleghan and K .R. Vishwanath, the Vice President of Risk

Management :

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[I]t became clear to me that Kevin CKeleghan] was not being forthcoming aboutthese issues that this business was facing . . . and had become a barrier to gettingan objective situation assessment as to what was happening in our business andI terminated him for basically my personal loss of confidence in him relative to hispersonal credibility . . . . You should also know that during the course of our analysiswe determined that the VP of Risk Management and Credit [defendant Vishwanath]had also withheld information and had led us to terminate his employment effectiveyesterday.

162 . When Liska took over the call to explain the credit situation , he effectively admitted

that the Company had misrepresented the quality ofitsportfolios . Specifically, even though Lacy,

Liska, and Keleghan had stated on October 24, 2001, and July 18 , July 25, and in early August 2002 ,

that the Company did not target subprime consumers , ¶ ¶ 130, 140, 145, Liska now admitted :

[I]n situations like this, where there are a number of incorrect perceptions and rumorsin the marketplace, the solution is to provide a greater degree of transparency so thatpeople have the opportunity to draw their own conclusion as they should desire . Oneof the disclosures that make today centers around a po rtion of our portfolio that isMiddle Ame rican . A large po rt ion of the proprietary card, our proprietary cardportfolio is Middle Ame rica . We will show you data all the way back to 1998 so thatyou can see that we are not increasing our exposure to this Middle Ame ricansegment .

163 . Despite the euphemism, it soon became clear that the "Middle America" that forme d

"[a] Iarge portion of the proprietary card" was simply another way of saying "subprime" . As Liska

further stated :

As you can see from this chart, a portion of the portfolio attributable to customersin the prime segments increasedfrom 23% of the portfolio a year ago, to 26% ofthe portfolio today . If you go back to 1998, as a general point of reference, the primesegment has increased from 17% to 26% . Bank segment accounts are also increasing .These bank accounts represent 23% of our portfolio in 1998, the same percentage in2001 and 26% of our portfolio in 2002 . As these higher quality credit qualityaccounts become a larger portion of our portfolio, middle America accountsbecome a smaller portion of our portfolio . In 1998 Middle America balancesrepresent 60% of our portfolio . They represent 48% today. Last year the segmentrepresented 54% of our portfolio . . . . As I told you in the very beginning of thispresentation, the majority of proprietary card accounts are middle America. It is

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generally recognized that middle America accounts deteriorate more quickly in atough economy than prime accounts do .

In other words, Sears's credit portfolio had been disproportionately subprime for years - a disclosur e

that starkly contrasted with Sears's past portrayals of the quality of its credit card portfolios .

164 . Liska then also admitted that Sears had engaged in aggressive marketing tactics tha t

had been responsible for part of the losses :

[W]e would like to be more cautious on the portion of our portfolio that isattributable to convenience checks and balance transfers . We have experiencedhigher charge-off rates on accounts that have used either convenience checks or hadbeen balance transfers . We believe that the full impact of any of the higher riskportfolio, profile customers, that use convenience checks and balance transfers, isreflected in the forecasted charge-off rate as well as our projected allowance fordoubtful accounts and what we did recently . . . . [W]e have found that there is a lotof adverse selection associated with accounts that are acquired over the web . Todaywe only approve around 6% of all web applications . While our web approval rateshave always been very low, we did reduce the approval rate by 60% in the last year .

165 . Analysts were shocked and unforgiving about Sears's October 17, 2002 disclosures .

For example, as W.R. Hambrecht reported :

This shocking 26% decrease in earnings , which was announced on the morning ofSears' very well attended Analysts meeting held at the company's headquartersoutside of Chicago, stunned the Street and all in attendance . Frankly, it was therealization of our worst-case scenario regarding the state of the company's creditoperations, which represent more than 60% of Sears's operating profit .

166. In reaction to the stunning disclosures of October 17, 2002, the price of Sears

common stock plummeted, falling $10 .80 per share - or approximately 32% - to close at $23 .15 on

October 17, on extraordinary trading volume of 36 million shares -- 12 times greater than the

Company's daily trading average of 2 .9 million shares during the Class Period .

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POST-CLASS PERIOD EVENT S

167. In the weeks that followed, the conditions of Sears continued to languish. For

example, on November 7, 2002, W .R. Hambrecht reduced its estimates in reaction to the recent

"stunning credit disaster," and criticized Sears's "extremely limited visibility" with respect to th e

makeup of its credit portfolio :

[W]e expect the shares to continue to come under pressure, especially given the lackof clarity on what exactly is going on and whether more problems will emerge .Investors were stunned by the credit blow-up, especially since management hadreaffirmed guidance a week before the analyst meeting . . . Given the extremelylimited visibility we would resist the temptation to buy on weakness . . . .

168 . On November 12, 2002, Sears filed its 10-Q for the third quarter of 2002 and, for th e

first time , revealed to investors how both the Sears proprietary card segment and the Sears

MasterCard segment had each significantly deteriorated during the Class period . The Compan y

provided charts [similar to those reproduced at ¶ 63 above] illustrating the performance of the two

segments, and gave the following explanation :

During the third quarter of 2002, delinquency rates trended upwards from first andsecond quarter levels for both the Sears Card and Gold MasterCard portfolios . The60-plus day delinquency rate for the Sears Card portfolio increased to 9 .71% atSeptember 28, 2002, compared to 8 .73% at June 29, 2002, and 8 .13% at September30, 2001 . The 60-plus day delinquency rate for the MasterCard portfolio increasedto 3.00% at September 28, 2002, compared to 2 .58% at June 29, 2002, and 1 .94% atSeptember 30,2001 . . . . Because the MasterCardportfolio has a lower delinquencyrate than the Sears Card, the growth in the MasterCard portfolio coupled with thedecline in the Sears Card portfolio led to an improvement in the total portfoliodelinquency rate as compared to the third quarter of 2001 .

169. In its 10-Q, Sears also stated "The Company charges off accounts at 240 days where

as most bankcard issuers charge off at 180 days . Therefore the Company's delinquency rate is not

directly comparable to participants of the bankcard industry. "

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170. Finally, Sears began to be more forthcoming about its re-aging policies, disclosin g

for the first time in its SEC filings that:

The Company's net charge-offs consist of principal balances charged-off less currentperiod recoveries . The Company's current credit processing system charges off anaccount automatically when a customer's number of missed monthly paymentsreaches eight, except that accounts can be re-aged once per year when a customermakes two consecutive monthly payments . Also, accounts maybe charged off soonerin the event of customer bankruptcy. Finance charge and credit card fee revenue isrecorded until an account is charged off at which point the charged off balances arepresented as a reduction of revenue . The Company provides for the estimated balanceof uncollectible finance charges and credit card fees in its allowance for uncollectibleaccounts .

171 . Tellingly, Sears ' s third quarter 10-Q also disclosed a huge jump in administrative

expenses, due in part to "higher marketing and fraud loss expenses in both the 13 and 39 week

periods, and increased collection expenses in the 39 week period" in the credit segment .

172. As The Street. com reacted to the third quarter 10-Q, "Sears' brutal stock slid e

continued Wednesday after the retailer released new data that showed a big jump in bad loans in it s

fast-growing MasterCard portfolio . . . Wednesday's new data . . . shows deep deterioration in the

MasterCard portfolio . A back-of-the-envelope calculation suggests that, ifthis rot continues, the

company may have to make loan provisions in 2003 that could wipe out a large part of the

earnings analysts currently forecast ." Moreover, other analysts continued to be unsatisfied wit h

Sears's disclosure. For example, on November 20, Bear Stearns criticized the lack of even more

disclosure by the Company:

We had hoped for increased disclosure . . . Delinquency and net charge-off rates forthe two portfolios will be disclosed on a quarterly basis, but not on a monthly basis .Sears also will not disclose FICO scores for its portfolio . . . . We believe that thecharge-off rates could significantly increase in the next 6 to 12 months until the entireportfolio seasons and we are uneasy as to whether Sears has adequately accounted forthe potential level of charge-offs . . . . Another key concern is the aggressive write-off

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policy that Sears uses . . . . [W]e [] believe that this is the most aggressive policy inthe credit card industry and that it is disguising the real loss rate to a certainextent. . . . Sears did mention that the average active SGMC [Sears GoldMasterCard] account has a FICO score of approximately 720 . We believe that thisvalue is decent but again, the average could be boosted by a relatively low numberof very high credit quality customers who opened an account for a one-time homeappliance purchase, and the majority of accounts may have much lower FICO scores .

173 . On January 16, 2003 , Sears issued a press release announcing that it was adding

another $150 million to its reserves for uncollectible accounts, in part due to "increases in the net

charge-off rate and delinquencies ."

174. On February 28, 2003, Sears fell from the list of A-rated companies when Standard

& Poor's downgraded its rating on Sears debt . Associated Press reported that S&P "attributed the

rating action to the introduction of the Sears Gold MasterCard back in 2000 ." An S&P analyst state d

that "The rating action reflects greater-than-anticipated charge-offs related to the company's Sear s

Gold MasterCard, and the adverse impact that the card has had on the credit business as a whole ."

S&P's downgrade followed earlier downgrades by Fitch and Moody's Investor Service .

175 . On March 12, 2003, Sears filed its 2002 Report on Form 10-K. The 10-K repeated

the delinquency and charge-off information that had been contained in Sears's third quarter 200 2

SEC filings, and provided additional data on the continuing deterioration at the end of the year . The

10-K explained :

During 2002, 60-plus day delinquency rates for the portfolio increased by 11 basispoints as compared to 2001 . Because the MasterCard portfolio has a lowerdelinquency rate than the Sears Card portfolio, the growth in the MasterCardportfolio coupled with the decline in the Sears Card portfolio resulted in only an11 basis point increase in the total portfolio delinquency rate as compared to 2001despite the fact that the delinquency ratesfor both the Sears Card and MasterCardportfolios experienced larger increases . The 60-plus day delinquency rate for theSears Card portfolio increased to 10 .34% at December 28, 2002, compared to 8 .91%at December 29, 2001 and 7 .94% at December 30, 2000. The 60-plus day

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delinquency rate for the MasterCard portfolio increased to 3 .76% at December 28,2002, compared to 1 .97% at December 29, 2001 and 0.38% at December 30, 2000 .

176. For the first time, Sears included a full discussion of policies that, by its own

admission , rendered its results noncomparable to bank card issuers :

The Company has historically utilized certain account management programsdesigned to support retail promotions and maximize collections . Such programs,some of which are not typical among bank card issuers , include the use of (a) nominimum payment/zero-percent financing for up to 12 months for the Company'sretail customers, (b) percentage off promotions, (c) a 240-day contractualdelinquency period, (d) a renewal or workout program for late stage delinquencies,(e) a re-aging policy . . . .

177. For the first time, the Company also disclosed the percentage of loans in "workout"

programs - numbers which, if considered as charge-offs, would demonstrate the chargeoff rates t o

be considerably higher than had thus far been disclosed . The Company also admitted :

[T]he Company contractually charges off accounts at 240 days, whereas most bankcard issuers charge off at 180 days. As a result, the Company 's delinquency ratesare not directly comparable to participants in the bank card industry.

178 . At its height, Sears's credit operations had represented almost 70% of the Company' s

earnings , and by 2003 Sears had become the third largest issuer of MasterCards (behind only

Citigroup and MBNA) . However, on March 26, 2003 the Company announced that it would seek

to sell all of its credit operations "in an attempt to create value for all investors and focus on it s

profitable core retail and related services business . "

DEFENDANTS' FALSE AND MISLEADING FINANCIAL STATEMENT S

Violations of Generally Accepted Accountin Principles 62"pj

179 . At all relevant times during the Class Period, defendants represented that Sears' s

financial statements when issued were prepared in conformity with GAAP, which are recognized by

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the accounting profession and the SEC as the uniform rules, conventions and procedures necessar y

to define accepted accounting practice at a particular time . However, in order to artificially inflat e

the price of Sears's stock , defendants used improper accounting practices in violation of GAAP and

SEC reporting requirements to falsely inflate its reported earnings and receivables in the interim

quarters and fiscal years during the Class Period .

180. Specifically, defendants caused the Company to violate GAAP by :

improperly failing to consider the loss inherent in both delinquent andnon-delinquent accounts in its impairment analysis ; and

improperly failing to adjust for various factors, including changes in the risk model,in calculating appropriate loss allowances .

181 . As set forth in Financial Accounting Standards Board ("FASB") Statements of

Concepts ("Concepts Statement") No . 1, one of the fundamental objectives of financial reporting i s

that it provide accurate and reliable information concerning an entity's financial performance durin g

the period being presented . Concepts Statement No . 1, paragraph 42, states :

Financial reporting should provide information about an enterprise's financialperformance during a period . Investors and creditors often use information about thepast to help in assessing the prospects of an enterprise . Thus, although investmentand credit decisions reflect investors' and creditors' expectations about futureenterprise performance, those expectations are commonly based at least partly onevaluations of past enterprise performance .

182. As set forth in SEC Rule 4-01(a) of SEC Regulation S-X, "[fjinancial statements file d

with the [SEC] which are not prepared in accordance with [GAAP] will be presumed to b e

misleading or inaccurate ." 17 C.F.R. § 210 .4-01(a)(1) . Management is responsible for preparing

financial statements that conform with GAAP. As noted by the AICPA professional standards :

financial statements are management's responsibility . . . . [M]anagement isresponsible for adopting sound accounting policies and for establishing and

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maintaining internal control that will, among other things, record, process,summarize, and report transactions (as well as events and conditions) consistent withmanagement's assertions embodied in the financial statements . The entity'stransactions and the related assets, liabilities and equity are within the directknowledge and control of management . . . . Thus, the fair presentation of financialstatements in conformity with Generally Accepted Accounting Principles is animplicit and integral part of management's responsibility .

A. Failure to Create Adequate Reserves Against Probable Losses

183 . As discussed at ¶40, lenders are required to establish allowances, or reserves, t o

account for the fraction of their loan portfolio that is likely to become uncollectible . "The assets of

an enterprise may include receivables that arose from credit sales, loans, or other transactions . The

conditions under which receivables exist usually involve some degree of uncertainty about thei r

collectibility, in which case a contingency exists . . . . Losses from uncollectible receivables shall

be accrued when both conditions in paragraph 8 are met . Those conditions may be considered in

relation to individual receivables or in relation to groups of similar types of receivables . If the

conditions are met, accrual shall be made even though the particular receivables that ar e

uncollectible may not be identifiable ." SFAS No . 5, at 122 .

184. GAAP provides that an estimated loss from a loss contingency "shall be accrued by

a charge to income" if. (i) information available prior to issuance of the financial statement s

indicated that it is probable that an asset had been impaired or a liability had been incurred at the dat e

of the financial statements ; and (ii) the amount of the loss can be reasonably estimated . SFAS No.

5, at ¶ 8 . SFAS No . 5 also requires that financial statements disclose contingencies when it is at least

reasonably possible (e.g., a greater than slight chance) that a loss may have been incurred . The

disclosure shall indicate the nature of the contingency and shall give an estimate of the possible loss ,

a range of loss or state that such an estimate cannot be made .

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185 . The SEC considers the disclosure of loss contingencies to be so important to an

informed investment decision that it promulgated Regulation S-X, which provides that disclosures

in interim period financial statements may be abbreviated and need not duplicate the disclosur e

contained in the most recent audited financial statements, except that, "where material contingencies

exist, disclosure of such matters shall be provided even though a significant change since year en d

may not have occurred ." 17 C.F .R. § 210 . 10-01 .

186 . The Company violated the GAAP requirement by failing to take a proper provisio n

for loan losses in its interim financial statements, as indicated by APB Opinion No . 28,117, Interim

Financial Reporting :

The amounts of certain costs and expenses are frequently subjectedto year-end adjustments even though they can be reasonablyapproximated at interim dates. To the extent possible suchadjustments should be estimated and the estimated costs and expensesassigned to interim periods so that the interim periods bear areasonable portion of the anticipated annual amount .

187. In addition, FASB Statement of Concepts No. 5 ("CONS") states, "[a]n expense or

loss is recognized if it becomes evident that previously recognized future economic benefits of a n

asset have been reduced or eliminated . . . "

188. Defendants violated GAAP in that Sears improperly failed to consider the inheren t

likely losses in both delinquent and non-delinquent accounts in its impairment analysis . For most

of the Class Period, Sears only created reserves for losses likely to occur for accounts that ha d

already become delinquent ; however, the Company did not create reserves for accounts that were

not yet delinquent, even though those receivables, just as with delinquent accounts, necessaril y

carried with them some degree of risk of nonpayment . It was only on July 18, 2002, or three quarter s

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of the way into the Class Period, that defendants announced that they would change their accountin g

and provide reserves for nondelinquent, as well as delinquent accounts . This change had the effect

of increasing Sears's reserves, its reported earnings, and reducing its receivables in the amount o f

5300 million. Moreover, Sears classified the change as anew "method" of accounting, thus allowin g

the Company to backdate the change to the first quarter of 2002, so that it would not have to absor b

a loss in its current or future earnings . In fact, the change was not one of "accounting method," bu t

was instead a re-estimate of probable loss, and as such, should have been absorbed at the time of th e

change, i .e., in its second quarter financial statements . The SEC ultimately forced Sears to restate

both its first and second quarter 10-Qs to take the charge in July, when the change was made .

189. Sears additionally failed to create adequate reserves by failing to account for the risk s

inherent in its alterations of its credit models . As described above at ¶ ¶ 55-67, Sears lowered it s

credit standards when issuing its cards during the Class Period, deliberately targeted a segment o f

the population on which it had little data, avoided its risk models by offering additional cards t o

Sears cardholders who would not qualify for credit increases, and altered payment terms so as t o

allow consumers to pay their bills over longer - and thus riskier - schedules . Nonetheless, Sears

failed to account for the additional risk of nonpayment inherent in such policies in contravention o f

GAAP . As a result , Sears ' s Class Period financial statements mate rially overstated earnings and,

to the extent that Sears's receivables were shown net of reserves, Sears's financial statement s

materially overstated the true size of the loan portfolio .

190. Finally, Sears failed to create adequate reserves by classifying fraudulent billings as

expenses in the quarter in which they came due, rather than by classifying them as bad debt an d

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building an allowance for them. Given the sheer magnitude and persistency of the problems, a s

detailed at It 68-70 - which were themselves created by Sears's heavy-handed selling tactics -

Sears knew that complaints of fraudulent billing had skyrocketed, and would necessarily lead t o

charge-offs ; however, it did not account for these probable future losses . Such accounting materiall y

understated the risk of loss inherent in the portfolio .

191 . Indeed, as the Company would ultimately admit, the net effect of these machinations

and irregularities contributed to an additional charge to earnings for uncollectible accounts of $22 2

million for the 13 week period ended September 28, 2002 as compared to the prior year, as set fort h

in the 10-Q filed on November 12, 2002 . The additional charge brought the total provision for th e

39 weeks ended September 28, 2002 to $1 .685 billion as compared to the prior year's $929 million,

a $756 million or 79% increase .

B. Improper Failure to Timely Write Down Impaired Loan s

192. GAAP, in SFAS No . 5, requires that financial statements account for existin g

uncertainties as to probable losses . Such loss contingencies must be recognized and reported as a

charge against income when : (a) information available prior to issurance of the financial statement s

indicates that it is probable (e .g ., likely) that an asset has been impaired or a liability has been

incurred ; and (b) the amount of such loss can be reasonably estimated . SFAS No . 5, ¶ 8 . When

condition (a) above has been met and a range of contingent loss can be reasonably estimated, but no

single amount within the range is a better estimate than any other amount, the minimum amount

must be charged against income . FASB 's Interpretation No. 14 .

193 . Sears, through its strategies of extending credit to risky borrowers through high limit s

and multiple cards, extending credit to delinquent borrowers, failing to charge-off accounts until the y

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were 240 days past due, and utilizing generous workout and re-aging policies, avoided writing dow n

accounts even after it became "probable" that the borrower would not be able to repay the entir e

loan .

194. Asa result of the accounting improprieties detailed at t t 183-191, defendants cause d

Sears's reported financial results to violate, among other things, the following provisions of GAAP

for which each defendant is necessarily responsible :

(a) The principle that financial reporting should provide information that is useful

to present and potential investors in making rational investment decisions and that information

should be comprehensible to those who have a reasonable understanding of business and economic

activities (FASB Statement of Concepts No . 1, ¶ 34) ;

(b) Thep rinciple ofmateriality, which provides that the omission or misstatement

of an item in a financial report is material if, in light of the surrounding circumstances, the magnitud e

of the item is such that it is probable that the judgment of a reasonable person relying upon the repor t

would have been changed or influenced by the inclusion or correction of the item (FASB Statement

of Concepts No . 2, ¶ 132) ;

(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 . 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 a n

enterprise's financial performance during a period. Investors and creditors often use informatio n

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about the past to help in assessing the prospects of an enterprise . Thus , although investment an d

credit decisions reflect investors' expectations about future enterprise performance, thos e

expectations are commonly based at least partly on evaluations of past enterprise performance .

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

(e) The principle that financial reporting should be reliable in that it represent s

what it purports to represent . The notion that information should be reliable as well as relevant i s

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

(f) The principle of completeness, which means that nothing is left out of th e

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

conditions . (FASB Statement of Concepts No . 2, 180) ;

(g) The principle that conservatism be used as a prudent reaction to uncertaint y

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

The best way to avoid injury to investors is to try to ensure that what is reported represents what i t

purports to represent . (FASB Statement of Concepts No. 2, ¶¶ 95, 97); and

(h) The principle that contingencies that might result in gains are not reflected in

accounts since to do so might be to recognize revenue prior to its realization and that care should b e

used to avoid misleading investors regarding the likelihood of realization of gain contingencies .

(SFAS No . 5, Accounting for Contingencies) .

Additional Scienter Allegations

195 . As alleged herein, during the Class Period, the Company and the Individua l

Defendants were fully aware of the problems inherent in the portfolio because of a detailed reporting

system that enabled them to monitor the credit ratings of each consumer on a regular basis . Thus ,

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by issuing false and misleading statements about the size, profitability, and quality of Sears's credi t

portfolio, the Company and the Individual Defendants knowingly and/or recklessly deceived th e

investing public as to the true value of Sears . The following additional allegations provide furthe r

support for plaintiffs' scienter allegations .

196. The Sears Director stated that the MasterCard was Alan Lacy' s "brainchild ."

197. Sears management was well aware that it deviated from industry standards when i t

came to reporting charge-off data ; for instance, the Hoffman Manager stated that she had attende d

meetings where Sears discussed tightening the criteria for charging-off accounts to bring them mor e

in line with bank card issuers, but ultimately no change was made .

198. Management represented in Sears's 2001 1O-K that management maintained a syste m

of internal controls to ensure proper accounting and financial disclosures, and that managemen t

reviewed loan loss reserves to ensure that such reserves were adequate to account for likely losse s

inherent in the portfolio . Additionally, both Lacy and Liska filed separate statements, under oath,

attesting to the accuracy of the 2001 10-K and all SEC filings dealing with Sears's performance in

2002.

199. The Individual Defendants repeatedly disclosed selected pieces of information about

the MasterCard segment and the Sears Card segment separately , thus demonstrating that they had

knowledge of the performances of these segments on an individual basis and were aware of th e

delinquency and charge-off rates for each . For instance, each of the Company's quarterly and annua l

financial statements discussed the average receivables for the Sears MasterCard and the Sears Car d

separately, and each discussed the fees and interest charges for these two segments separately .

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200. Additionally, as explained in ¶112, defendants Lacy and Liska admitted on April 18 ,

2002, that they were aware of the separate performances of the Sears MasterCard and Sears Card

segments. When directly confronted with a question about the charge-off rate of the Sears

MasterCard, the defendants averred that such data would be "misleading," thus demonstrating that

they had both sets of data, and had made a choice to reveal only information about the combine d

portfolio.

201 . All of Sears's policies for extending credit and increasing credit lines were create d

by top Sears executives, as explained below ; thus, Sears was fully aware of its lowered standard s

during the Class Period .

202. Sears's policies for granting credit, and its risk profiles, were developed at Sear s

National Bank in Arizona. The President of the Bank reported directly to Kevin Keleghan, and

worked directly with Vishwanath, to develop profiles for extending credit . These policies were built

into models used by customer services representatives operating at the ground level at Sears' s

regional credit centers . There was no discretion at the ground level - extensions of credit, an d

exceptions to credit policies, were entirely controlled by policies set at by Sears . Moreover, if a

customer wanted a grant of credit beyond what the profiles would allow, the representative woul d

have to call the Sears National Bank for authorization .

203 . Collections and account services were handled from regional credit centers . Each

center had a collections division and an account services division . The collections division handled

matters pertaining to payment, and account services handled initial grants of credit, alterations o f

credit limits, and general consumer inquiries . For each division, ground level service representative s

or collectors were organized into teams of 10 to 15 people . Each team had a team manager, who ,

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reported to a department manager . Each department manager handled 2-4 teams, and so forth, up

to the Director of Asset Management and the Director of Account Services, each of whom controlle d

their region. These regional directors each reported to a National Director . The National Director

of Asset Management reported to the Vice President of Asset Management and Risk Management ,

and the National Director of Account Services reported to the Vice President of Account Services .

These two Vice Presidents reported to Keleghan, as the President of Sears Credit, and worke d

directly with Vishwanath, who also reported to Keleghan .

204. Every month, information was gathered from the regional centers and compiled int o

reports detailing delinquency and charge-off rates . Every quarter, the entire Sears portfolio woul d

be rescored for credit history based both on Sears' s internal data, and on external data from th e

various credit bureaus . Reports were compiled detailing the credit scores of Sears cardholders .

These reports were provided to, inter alia, Vishwanath, Keleghan, and Lacy for their review .

Additionally, as Keleghan attested , Sears would rescore particular credit profiles immediately upon

receiving new information about the customer, ¶ 77 .

205 . Further, Sears would hold quarterly meetings for all of the managers and directors

responsible for collections around the country . These meetings, typically held at Hoffman Estates ,

were led by Keleghan . Usually, Lacy would attend, as well . These meetings would involv e

extensive discussions of promotional policies, such as the zero-pay and zero-finance charg e

arrangements, as well as discussions of delinquency statistics, credit scores, the effectiveness of th e

collections operations, and so forth . At each meeting, there would also be discussions of similar

reports that were generated and available at headquarters, and in the field, detailing payment ,

delinquency, and charge-off data on a monthly basis .

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206 . Through these reports, Sears 's top management ( including the Individual Defendants)

were made personally aware of the credit scores of the entire Sears credit portfolio . Thus, the

defendants were fully aware throughout the Class Period of the creditworthiness oftheir cardholders .

207 . Defendant Vishwanath was particularly familiar with the performance of th e

portfolio . As Vice President of Risk M anagement , it was Vishw anath's job to develop models for

granting and extending credit, models for the expected delinquencies and charge-offs associated with

grant or extension of credit, and to then monitor the actual performance of the portfolio to determin e

whether the accounts were behaving as predicted by the models .

208. Each Sears cardholder had a billing cycle, lasting about one month, but the cycle start

and end dates varied among accounts . Vishwanath would receive reports from the regional credit

centers on at least a weekly basis detailing the payment, delinquency, and charge-off rates for eac h

the cycles that had been completed in that past week . Through such detailed information,

Vishwanath was kept fully aware of the true status of delinquencies and charge-offs within the Sear s

portfolio.

209. Moreover, Sears was made aware ofthe problems in the MasterCard portfolio throug h

the difficulties encountered in collecting on those accounts . Not only did Sears employees

responsible for collections recognize that MasterCard balances were much harder to collect than

balances on the proprietary card, ¶ 160, but Sears's financial statements show increases in

administrative costs associated with collections .

210. Indeed, Sears was no stranger to precisely the kinds of problems that occur whe n

credit is extended to risky borrowers . In. 1993, when Sears first allowed third party credit cards to

be used in its stores, Sears had aggressively marketed its proprietary cards and lowered its credi t

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standards, doubling its card base by 1996 . In March 1997, Sears's then- President of Credit, Steve n

Goldstein, told the industry publication Credit Card Management that the rapid increase in size di d

not pose a threat to the stability of the business : "We continue to refine our models . . . We have

maintained or improved our underwriting standards over the past few years . We maintain a very

sound credit portfolio ." Despite these reassurances, by the fourth quarter of that same year, Sears

had taken a huge charge to deal with uncollectible accounts, and finished the year as a creditor i n

more than one third of all personal bankruptcies . Both Lacy and Keleghan were deeply involved

with Sears 's problems at the time - Lacy was Chief Financial Officer, and succeeeded Goldstein

when he was forced out as President of Credit in 1997 . Keleghan served as Vice President of Sears

Credit Risk Management from 1996 until he succeeded Lacy as President of Credit in 1999 .

211 . In fact, in the early days of the MasterCard rollout, Lacy explicitly promised investor s

that history would not repeat itself . In a conference call on April 19, 2001, Lacy told analysts :

It's [the credit card business] well managed . We had some issues severalyears agobut really, it's a whole new team in our credit organization and Kevin [Keleghan]in particular gets a lot of credit from me in terms of the job that he's done assemblinga best-in-class team and really taking that business to a new level . And it does haveimproving growth prospects, particularly with the MasterCard launch .

212 . Finally, Sears was aware of the problems with fraudulent billings . As reported by

Sears employees, the sheer size of the problem, coupled with specific instructions from management ,

demonstrated Sears's knowledge that a huge portion of its reported receivables were generated b y

fraud. ¶ ¶ 68-70 . Additionally, Sears 's financial statements for throughout the Class Period admi t

to ever-higher expenses as a result of increasing losses due to fraud, particularly fraud associated

with the MasterCard rollout.

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213 . Sears and the Individual Defendants were also motivated to commit fraud . Sears's

Retail segment was failing, particularly with respect to its apparel lines . By artificially inflating it s

earnings and the value of its credit portfolio, Sears was able to use credit-card backed securities an d

higher debt ratings to raise the funds to purchase Lands' End, a desperately needed addition .

214 . Sears was also able to use its phantom earnings to finance expensive initiative s

intended to revitalize its ailing Retail Segment . For instance, defendant Lacy repeatedly stated that

he placed a high priority on Sears's Great Indoors line of stores . He identified the Great Indoors as

one of three major Company initiatives in October 2000, but the stores required extremely high

startup costs and were not immediately profitable . According to one Sears employee who worke d

at Sears's Capital Investment Group at Hoffman Estates from 2000 through January 2002, th e

Company invested a "tremendous " amount of money into the Great Indoors stores , but after severa l

months, realized that profits would take years to generate. The employee explained that the stores

required a great deal of expensive staffing in order to provide hands-on assistance to customers, bu t

the Company was simply unsuccessful in enticing customers to shop there .

215 . Moreover, defendant Keleghan, in his role as President of Sears Credit, wa s

personally responsible for the implementation of Sears's risk management policies with respect t o

its credit portfolio .

216. Defendants had a duty to promptlydisseminate accurate and truthful information with

respect to Sears's credit portfolio, or to cause and direct that such information be disseminated . As

a result of their failure to do so, the price of Sears shares was artificially inflated during the Class

Period, damaging plaintiffs and the Class .

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APPLICABILITY OF PRESUMPTION OF RELIANCE :FRAUD-ON-THE-MARKET DOCTRIN E

217. The market for Sears securities was open, well-developed and efficient at all relevant

times. As a result of these materially false and misleading statements and failures to disclose,

Sears's common stock traded at artificially inflated prices during the Class Period. Plaintiff and

other members of the Class purchased or otherwise acquired Sears securities relying upon th e

integrity of the market price of Sears's securities and market information relating to Sears, and hav e

been damaged thereby .

218 . During the Class Period, defendants materially misled the investing public, thereby

inflating the price of Sears ' s securities , by publicly issuing false and misleading statements and

omitting to disclose material facts necessary to make defendants' statements, as set forth herein, no t

false and misleading. Said statements and omissions were materially false and misleading in that

they failed to disclose material adverse information and misrepresented the truth about the Company ,

its business and operations, as alleged herein .

219 . At all relevant times, the material misrepresentations and omissions particularize d

in this Complaint directly or proximately caused or were a substantial contributing cause of the

damages sustained by plaintiff and other members of the Class . As described herein, during the

Class Period, defendants made or caused to be made a series of materially false or misleadin g

statements about Sears's business, prospects and operations. These material misstatements and

omissions had the cause and effect of creating in the market an unrealistically positive assessmen t

of Sears and its business, prospects and operations, thus causing the Company's securities to b e

overvalued and artificially inflated at all relevant times . Defendants' materially false and misleading

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statements during the Class Period resulted in plaintiff and other members of the Class purchasin g

the Company' s securities at artificially inflated prices, thus causing the damages complained o f

herein .

220. At all relevant times, the market for Sears's securities was efficient for the followin g

reasons , among others :

(a) Sears's stock met the requirements for listing, and was listedand actively traded on the NYSE, a highly efficient andautomated market ;

(b) As a regulated issuer, Sears filed periodic public reports withthe SEC and the NYSE;

(c) Sears regularly communicated with public investors viaestablished market communication mechanisms, includingthrough regular disseminations of press releases on thenational circuits of major newswire services and throughother wide-ranging public disclosures, such ascommunications with the financial press and other similarreporting services

221 . Sears was followed by several securities analysts employed by major brokerage firms

who wrote reports which were distributed to the sales force and certain customers of their respective

brokerage firms. Each of these reports was publicly available and entered the public marketplace .

222. As a result of the foregoing, the market for Sears' s securities promptly digested

current information regarding Sears from all publicly available sources and reflected suc h

information in Sears's stock price . Under these circumstances, all purchasers of Sears's securitie s

during the Class Period suffered similar injury through their purchase of Sears's securities a t

artificially inflated prices and a presumption of reliance applies .

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NO SAFE HARBOR

223 . The statutory safe harbor provided for forward-looking statements under certai n

circumstances does not apply to any of the allegedly false statements pleaded in this complaint .

Many of the specific statements pleaded herein were not forward looking, but were instead fals e

representations of the current value of Sears's holdings and false representations of Sears's interna l

risk management policies . Additionally, many of the statements were included in documents tha t

were claimed to have been prepared in accordance with GAAP, thus excluding them from the safe

harbor. To the extent there were any forward -looking statements , any cautions provided to investor s

were inadequate to warn of the precarious state of Sears's investment portfolio . Moreover ,

defendants are liable for those false forward-looking statements because at the time each of thos e

forward-looking statements was made, the particular speaker knew that the particular forward-

looking statement was false, and/or the forward-looking statement was authorized and/or approved

by an executive officer of Sears who knew that those statements were false when made.

COUNT I

Violation Of Section 10(b) O fThe Exchange Act Against And Rule 10b-5

Promulgated Thereunder Against All Defendant s

224. Plaintiffs repeat and reallege each and every allegation contained above as if fully set

forth herein.

225. During the Class Period, defendants carried out a plan, scheme and course of conduct

which was intended to and, during the Class Period, did : (i) deceive the investing public, includin g

plaintiff and other Class members, as alleged herein ; and (ii) cause plaintiff and other members o f

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the Class to purchase Sears's securities at artificially inflated prices . In furtherance of this unlawfu l

scheme, plan and course of conduct, defendants, and each of them, took the actions set forth herein .

226. Defendants (a) employed devices, schemes, and artifices to defraud; (b) made untrue

statements of material fact and/or omitted to state material facts necessary to make the statement s

not misleading; and (c) engaged in acts, practices, and a course of business which operated as a fraud

and deceit upon the purchasers of the Company's securities in an effort to maintain artificially high

market prices for Sears's securities in violation of Section 10(b) of the Exchange Act and Rule lOb-

5 . All defendants are sued either as primary participants in the wrongful and illegal conduct charge d

herein or as controlling persons as alleged below .

227 . Defendants, individually and in concert, directly and indirectly, by the use, means or

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, operation s

and future prospects of Sears as specified herein .

228. These defendants employed devices, schemes and artifices to defraud, while in

possession of material adverse non-public information and engaged in acts, practices, and a cours e

of conduct as alleged herein in an effort to assure investors of Sears's value and performance an d

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 Sears and its business operations and future prospects in the light of th e

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 Sears securities during the Class Period .

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229 . Each of the Individual Defendants' primary liability, and controlling person liability ,

arises from the following facts: (i) the Individual Defendants were high-level executives and/or

directors at the Company during the Class Period and members of the Company' s management team

or had control thereof; (ii) each of these defendants, by virtue of his responsibilities and activitie s

as a senior officer and/or director of the Company was privy to and participated in the creation ,

development and reporting of the Company's internal budgets, plans, projections and/or reports ;

(iii) each of these defendants enjoyed significant personal contact and familiarity with the other

defendants and was advised of and had access to other members of the Company 's management

team, internal reports and other data and information about the Company's finances, operations, an d

sales at all relevant times ; (iv) each of these defendants was aware of the Company' s dissemination

of information to the investing public which they knew or recklessly disregarded was materially fals e

and misleading ; and (v) each of the Individual Defendants either signed the materially misleadin g

statements or personally made materially misleading statements to the public .

230. The defendants had actual knowledge of the misrepresentations and omissions of

material facts set forth herein, or acted with reckless disregard for the truth in that they failed to

ascertain and to disclose such facts, even though such facts were available to them . Such defendants '

material misrepresentations and/or omissions were done knowingly or recklessly and for the purpose

and effect of concealing Sears's operating condition and future business prospects from the investing

public and supporting the artificially inflated price of its securities . As demonstrated by defendants '

overstatements and misstatements of the Company' s business, operations and earnings du ring the

Class Period, defendants, if they did not have actual knowledge of the misrepresentations an d

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S

omissions alleged, were reckless in failing to obtain such knowledge by deliberately refraining from

taking those steps necessary to discover whether those statements were false or misleading .

231 . As a result of the dissemination of the materially false and misleading information

and failure to disclose material facts, as set forth above, the market price of Sears's securities was

artificially inflated during the Class Period. In ignorance of the fact that market prices of Sears' s

publicly-traded securities were artificially inflated, and relying directly or indirectly on the false an d

misleading statements made by defendants, or upon the integrity of the market in which the securitie s

trade, and/or on the absence of material adverse information that was known to or recklessl y

disregarded by defendants but not disclosed in public statements by defendants during the Clas s

Period, plaintiffs and the other members of the Class acquired Sears securities during the Clas s

Period at artificially high prices and were damaged thereby .

232. At the time of said misrepresentations and omissions , plaintiffs 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 the truth regarding the problems that Sears wa s

experiencing, which were not disclosed by defendants, plaintiffs and other members of the Clas s

would not have purchased or otherwise acquired their Sears securities, or, if they had acquired suc h

securities during the Class Period, they would not have done so at the artificially inflated p rices

which they paid .

233 . By virtue of the foregoing, defendants have violated Section 10(b) of the Exchang e

Act, and Rule I Ob-5 promulgated thereunder.

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A ec

234 . As a direct and proximate result of defendants' wrongful conduct, plaintiff and th e

other members of the Class suffered damages in connection with their respective purchases and sale s

of the Company's securities during the Class Period .

COUNT IIViolation Of Section 20(a) Of

The Exchange Act Against the Individual Defendants

235 . Plaintiff repeats and realleges each and every allegation contained above as if full y

set forth herein .

236 . The Individual Defendants acted as controlling persons of Sears within the meaning

of Section 20(a) of the Exchange Act as alleged herein . By virtue of their high-level positions, and

their participation in and/or awareness of the Company's operations and/or intimate knowledge o f

the false financial statements filed by the Company with the SEC and disseminated to the investin g

public, the Individual Defendants had the power to influence and control and did influence and

control, directly or indirectly, the decision-making of the Company, including the content an d

dissemination of the various statements which plaintiff contends are false and misleading . The

Individual Defendants, because of their positions with Sears, controlled the contents of quarterly an d

annual reports, press releases and presentations to securities analysts . Each Individual Defendant

either signed documents alleged herein to have been misleading, or personally made publi c

statements alleged to have been misleading . Each Individual Defendant was provided with copie s

of the reports and press releases alleged herein to be misleading prior to or shortly after thei r

issuance, and had the ability and opportunity to prevent their issuance or cause them to be corrected .

Because of their positions and access to material nonpublic information available to them, each o f

these defendants recklessly disregarded that the true quality of Sears's credit portfolio, and the effec t

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I.

such losses would have on Sears, had not been disclosed to and were being concealed from the

public and that the positive representations that were being made were false and misleading .

237 . In particular, each of these defendants had direct and supervisory involvement in the

day-to-day operations of the Company and, therefore, is presumed to have had the power to contro l

or influence the particular transactions giving rise to the securities violations as alleged herein, and

exercised the same .

238 . As set forth above, Sears and the Individual Defendants each violated Section 10(b)

and Rule I Ob-5 by their acts and omissions as alleged in this Complaint . By virtue of their position s

as controlling persons , the Individual Defendants are liable pursuant to Section 20(a) of the

Exchange Act. As a direct and proximate result of defendants' wrongful conduct, plaintiffs and

other members of the Class suffered damages in connection with their purchases of the Company' s

securities during the Class Period .

WHEREFORE , plaintiffs pray for relief and judgment , as follows :

A . Declaring this action to be a class action pursuant to Rule 23(a) and (b)(3) of the

Federal Rules of Civil Procedure on behalf of the Class defined herein ;

B . Awarding compensatory damages in favor of plaintiffs and the other Class member s

against all defendants, jointly and severally, for all damages sustained as a result of defendants '

wrongdoing, in an amount to be proven at trial, including interest thereon ;

C. Awarding plaintiffs and the Class their reasonable costs and expenses incurred in this

action, including counsel fees and expert fees ; and

D . Such other and further relief as the Court may deem just and proper

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yr

JURY TRIAL DEMANDE D

Plaintiffs hereby demand a trial by jury .

Dated: June 16, 2003

l YrVarvin A. Miller

MILLER FAUCHER and CAFFERTY LLP30 North LaSalle StreetChicago, Illinois 60602(312) 782-4880

Liaison Counsel andDesignated as Local Counsel

Melvyn 1 . WeissSteven G. SchulmanWilliam C. FredericksAnita KartalopoulosAnn M. LiptonMILBERG WEISS BERSHADHYNES & LERACH LLPOne Pennsylvania Plaza - 49th FloorNew York, NY 1011 9(212) 594-5300

Lead Counsel

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