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ORIGINAL FILED O N
UNITED STATES DISTRICT COURTDISTRICT OF NEW HAMPSHIRE
O C T 3 1 200 3
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U .S. DISTRICT COURTDISTRICT OF N H
IN RE SMARTFORCE PLC No_ 02-CV-544-BSECURITIES LITIGATIO N
THIS DOCUMENT RELATES TOALL ACTIONS CrC~~~
CONSOLIDATED CLASS ACTION COMPLAIN TFOR VIOLATIONS OF TILE SECURITIES EXCHANGE ACT OF 193 4
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TABLE OF CONTENT S
1 . NATURE OF THE ACTION ., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i
II . JURISDICTION AND VENUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
III . THE PARTIES__ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
A . Lead Plaintiffs . . . . . . . . . . . . . . . . . . . . . . . . . . _ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
B. Defendants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
IV. THE FRAUDULENT SCHEME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 5
A. Overview of The Company's Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 5
B . Defendants ' Fraudulent Accounting Practices . . . . . . . . . . . . . . . __ . . . . . . . . . 1 9
I . The Individual Defendants Directed the Company' s
Fraudulent Accounting Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 9
2 . Defendants Improperly Recognized Revenu e
from Software Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
a. GAAP Provisions Applicable T o
Software Sales . . . . . . . . . . . . . . . . . . . . 2 2
b. Defendants Improperly Backdated Revenu e
Through The "Hayes Calendar" . . . . . . . . . . . . . . . . . . . 2 5
c . Defendants Improperly Recognized Revenu e
From Reseller Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 9
d. Defendants Improperly Recognized Revenu e
From Multi-Year Subscription Agreements . . 3 2
c . Defendants Improperly Accounted For
"Additional Rights " Granted to Customers . . . 3 3
f. Defendants Improperly Recognized Revenue
From Barter Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 5
3. Defendants Improperly Capitalized Expenses ---------- 36
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a . GAAP Provisions Applicable To Capitalize dExpenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
C . Defendants Admit To Reporting Falsifie d
Financials Throughout The Class Period. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
1 . Defendants Admit To Improperl yRecognizing Revenue From Bundled Software Sales . 3 7
2. Defendants Admit To Prematurel y
Recording Revenue From Courseware SalesThat Granted Customers "Additional Rights" . . . . . . . . 3 7
3. Defendants Admit To Prematurely Recognizin gRevenue From Reseller Agreement sBefore the Contractual Obligations Were Fulfilled . . 3 8
4. Defendants Admit To Improperl y
Recognizing Revenue From Barter Transactions . . . . . 3 9
5 . Defendants Admit To Improperly Capitalizin g
Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 9
6. Defendants Admit To Improperl y
Recording Research And Development Costs . . . . . . . . . . 40
7 . Defendants Admit To Irnprupeily Recoidin gForward Foreign Currency Transactions As Hedges . . 4 1
0 S . Defendants Admit Tu Improperl y
Reporting Recourse Loans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
9. Dufcudauts Admittedly Failed To
Write Down Assets That Were Permanently Impaired . 43
10. Defendants' Admit To Additional Accountin g
Violations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
D. Defendants' Restatement Had A n
Enormous Effect On The Company's Financial Results . . . . . 45
V. THE SCHEME UNRAVELS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
A . Defendants' Improper Accounting Practices Disclosed . . . . . . . . 5 3
B. The SEC Launches An Investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 5
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VI . ADDITIONAL SCIENTER ALLEGATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 6
A . The Individual Defendants Had Direc tKnowledge Of And Directly Participated In The Fraud . . . . . . . 5 6
B . Insider Trading . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 9
C . Defendants Falsified SmartForce's Financia l
Statements To Meet Analysts ' Expectations . . . . . . . . . . . . . . . . . . . . . . . . 6 3
D . Defendants ' Strategy of "Growth By Acquisition . . . . . . . . . . . . . . . 6 4
E . Defendants' History Of Securities Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 7
VII . FALSE STATEMENTS DISSEMINATED DURING
THE CLASS PERIOD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 7
A . First Quarter Fiscal Year 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
B . Second Qua rter Fiscal Year 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 8
C . Third Quarter Fiscal Year 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
D . Fou rth Quarter and Year - End Fiscal Year 1999 . . . . . . . . . . . . . . . . . . . . 7 1
E . First Quarter Fiscal Year 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 3
F . Second Qua rter Fiscal Year 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . .s . . . . . . . . . . . . 74
G . Third Qua rter Fiscal Year 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
H. Fvuitli Quarter And Year-End Fiscal Year 2000 . . . . . . . . . . . . . . . . 77
I . First Quarter Fiscal Year 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 0
J . Second Quarter Fiscal Year 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2
K . Third Quarter Fiscal Year 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 3
L . Fou rth Qua rter And Year-End Fiscal Year 2001 . . . . . . . . . . . . . . . . . . 84
M . First Qua rter Fiscal Year 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 7
N . Second Quarter Fiscal Year 2002 . . . . . . .---------- ._ _ . . . . . . ._-------- . . 8 8
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0. Revenue Recognition Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 9
P. Joint Proxy Statement/Prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 3
X . CLASS ALLEGATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100
XI . LEAD PLAINTIFFS' INVESTIGATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
XII . FRAUD ON THE MARKET PRESUMPTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
XIII . THE SAFE HARBOR PROVISION IS INAPPLICABLE . . . . . . . . . . . . . . . . . 10 5
1COUNT IAgainst All Defendants For Violation sOf Section 10(b) Of The Exchange Ac tAnd Rule 10b-5 Promulgated Thereunder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 6
COUNT II
Against All Defendants For Violations Of Section 14(a )Of The Exchange Act And Rule 14a-9 Promulgated Thereunder . . . . . . . . . . . . . . 11 0
COUNT IIIAgainst The Individual Defendants For Violation sUnder Section 20(a) of The Exchange Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 I 1
PRAYER FOR RELIEF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
JURY TRIAL DEMANDED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 3p
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I . NATURE OF THE ACTIO N
This action is brought as a class action by Lead Plaintiffs, Teachers
Retirement System of Louisiana ("Louisiana Teachers ") and the Louisiana Sheriffs'
Pension and Relief Fund ("Louisiana She ri ffs") (collectively "Lead Plaintiffs"), pursuant
to Section 21D of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U .S .C .
§ 78u-4, on behalf of themselves and all other persons and entities who purchased th e
1 common stock , or Ame rican Depository Shares ("ADSs"), of SkillSoft PLC (the
"Company") between April 27, 1999 through and including November 18, 2002 (th e
"Class Period") . I
2 . Defendants Gregory Priest, SkillSoft's Chairman of the Board and Chie f
Stiatcgy Officer, David Drummond , SmartForcc's former Chief Financial Officer (CFO) ,
Patrick Murphy, Sma rtForce 's former CFO and Vice President of Finance and Jac k
1Hayes, SmartForce's former Group Financial Controller embarked on a fraudulent
scheme to artificially inflate SmartForcc' s revenues and earnings in order to meet Wai l
1Street's earnings expectations - at all costs . As detailed herein , throughout the Clas s
Peri od, Defendants spearheaded a pervasive and intentional accounting fraud, whic h
spanned more than three years, and significantly overstated SmartForce's financial result s
/ in violation of Generally Accepted Accounting P rinciples ("GAAP") .
3 . Faced with severe revenue shortfalls due to a catastrophic decline in sale s
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and dete riorating market conditions , Defendants , at the end of SmartForce's fiscal
' The Class includes persons or entities whop i) purchased Smart-Force PLC ("SmartForce") ADSs
trading on the Nasdaq National M ar ket ("NASDAQ") under the ticker symbol "SMTF' from April 27,
1999 through September 6, 2002 ; ii) acquired SmartForce ADSs as p art of the merger between SkillSob
Corporation ("Skillsoft Corp .") and SmartForce on or about September 6, 2002 ; or iii) purchased theCompany's ADSs trading on NASDAQ under the ticker symbol "SKIT.." frun September 0, 2002 tluough
1 and including November 18, 2002 .
quarters, artificially manufactured millions of dollars in revenue through a variety of
accounting shenanigans. A core group of SmartForce's senior management - including
Defendants Priest, Murphy, Drummond and Hayes - participated in end-of-quarter
"revenue meetings" to falsify and manipulate SmartForce's revenues and expenses to
satisfy Wall Street's expectations . These Defendants, among others, frequently extended
SmartForce's reporting periods through an improper device called the "Hayes Calendar"
1 - engineered by Defendant Hayes - to prematurely recognize millions of dollars i n
additional revenue in one reporting period when, in fact, the transactions giving rise to
that revenue did not occur until the next period, and directed the backdating of contracts
and deposit slips to create the illusion that the affected revenue was earned in those prio r
reporting periods . Moreover, Defendants directed that revenue from multi-year licensin g
agreements and multi-year subscription agreements be improperly recorded upfront, at1
the time a contract was executed, instead of ratably over the term of the agreement and a s
the services were delivered and the revenue was earned .
4, Defendants also improperly accounted for "additional rights" granted to
customers including contract extensions and discounts ; improperly recognized revenu e
from "swap deals" or barter transactions ; and impiupei ly accounted for expenses as pre-
1 paid assets .
5. Indeed, the magnitude of Defendants' pervasive accounting fraud enabled
SmartForee to overstate net revenues by as much as $63 .2 million, or 24 c and by $63 .9
million, or 32 .3% for Fiscal Years 2001 and 1999, respectively . Moreover, SmartForce
understated net losses by $56 .6 million and by $69 .8 million for those same periods,
respectively . In fact, Defendants' accounting manipulations enabled SmartForce t o
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report $3 million and $15 .6 million in net income for Fiscal Years 2001 and 1999,
respectively , when, in truth, SmartForce suffered net losses of $53 .5 million and $542
million, respectively , for those same periods .
6 . Defendants also cumulatively overstated accounts receivable by $127 . 1
million and cumulatively understated deferred revenues by $217 . 9 million . Further
buttressing the fraud, Defendants overstated accounts receivable and understate d
liabilities by failing to record something as simple as a recourse loan . Instead of properly
reflecting the factoring arrangement as a liability on the balance sheet, SmartForce
recorded it as a sale, thereby reducing its accounts receivable and falsely giving investors
the impression that customers were satisfied with SmartForce's product and paying their
accounts timely . Moreover, Defendants cumulatively overstated SmartForce's property,
plant and equipment account by $29 .8 million and its cash position by $2 .4 million .
7 . The cash misstatement is particularly indicative of fraudulent intent i n
light of the fact that cash is rarely subject to misstatement because of its obvious ease of
verifiability and indisputable valuation - i.e ., the money is either in zhe bank or it is not .
In fact, as stated by financial analyst Robert Renck in a Business Week cover story o n
November 26, 2001- "Short of fraud, cash flow is much less vulnerable t o
manipulation . "
8 . Defendants' fraudulent scheme was successful . As a direct result of thei r
improper accounting practices, SmartFnrce consistently met or exceeded analysts' an d
Wall Street ' s revenue and earn ings estimates and bucked the trend of declining industry
sales . SmartForce reported a record number of contract signatures and a strong
"backlog" of revenue in 2000 and 2001 . As a result of the purported success o f
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SmartForce's e-learning platform, SmartForce reported profitability in the fourth quarte r
Iof Fiscal Year 2000, making it one of the few Internet companies - and the only e-
leaming company - to achieve such extraordinary results.
9 . SmartForce's purported growth translated into inflated share prices,
reaching a Class Period high of roughly $60 per share on March 2, 2000, only to plummet
to $3.07 per share on November 19, 2002, when the truth began to emerge an d
r Defendants ' scheme began to unravel .
10 . Defendants' improper accounting practices enabled SmartForce to
consummate seven strategic acquisitions during the Class Period, using SmartForce's
artificially inflated stock as currency. Defendants' accounting manipulations also
ensured the successful September 6, 2002 merger of a subsidiary of SmartForce wit h
Skillsoft Corp . (the "Merger") . Beneath the surface of SmartForce's glowing financial
outlook, however, Defendants perpetrated a massive fraud on the investing public .
11 . Before the markets opened on November 1 9 , 2002, just two months after
consummating the Merger, the Company shocked the investing public by announcing tha ti V
during the Class Period an audit conducted in connection with SmartForce's closing
balance sheet revealed that SmartForce had prematurely recognized approximately $30
million to $32 million in revenue . The Company revealed that, as a result of thes e
"accounting issues," the Company intended to restate SmartForce's historical financial
statements for the fiscal years ended December 31, 1999 ("Fiscal Year 1999"), December
31, 2000 ("Fiscal Year 2000"), December 31, 2001 ("Fiscal Year 2001") and for the six
months ended June 30, 2002 . In addition, the Company announced that it would delay
the release of its results for the third quarter of Fiscal Year 2002 .
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12, Lawrence Carol in a SmartMoney.coin article on November 19, 2002
stated "[ i}t appears as if . . . . Skil]Soft is scouring the books of its merger partner a bit to o
late ." The statement was prophetic .
13 . The market' s reaction to the Company's November 19, 200 2
announcement was swift and severe . The price of the Company's common stoc k
plummeted 33% or $1 .57 on unusually heavy trading to close at S3 .07 per share on
November 19, 2002 .
14. Then, on February 3, 2003, the Company revealed that the Securities and
Exchange Commission ("SEC") had issued a formal order of investigation into the
accounting practices at SmartForce .
15. On September 22, 2003, more than seven months after announcing that th e
SEC had issued a formal order of investigation, the Company filed its Form 8-KIA with
the SEC reporting its restated financial results for Fiscal Years 1999, 2000, 2001, and fo r
the six months ended June 111, 2002 ( the "Restatement 8-KiA") Defendants' fraudulent
and pervasive accounting scheme required the Company to restate vi rtually every ale
income statement and balance sheet account , completely undermining Sma rtForce' s
entire financial reporting structure and giving rise to a strong inference of fraud .
16 . By restating its financial results the Company admits that SmartForce's
publicly issued financial statements during the Class Period were not prepared in
conformity with GAAP, and that SmartForce materially misstated its financial conditio n
and results of operations . Under Accounting Principles Board Opinion ("APB") No . 20,
"Accounting Changes," restatements are required to correct material accounting errors or
irregularities that existed at the time the financial statements were prepared and issued .
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Thus, the restatement is an admission that, based on information available to Defendant s
when the o riginally- issued financial statements were prepared, each of SmartForce' s
press releases and quarterly and annual reports filed with the SEC for more than three
years contained untrue statements of material fact .
17 . Prior to the collapse of the Company's share price, Defendants profited
handsomely from the inflated price of SmartForce ADSs, collectively selling 636,600
shares and reaping proceeds of more than $21 .5 million .
H. JURISDICTION AND VENU E
18 . The claims alleged herein arise under Sections 10(b), 14(a) and 20(a) of
the Exchange Act, 15 U.S .C. §§ 78j(b), 78n and 78t, and SEC Rules lOb-5, 17 C .F .R .
§ 240.1Ob-5, and 14a-9, 17 C .F .R. § 240 .14a-9, promulgated thereunder .
19 . The jurisdiction of this Court is based on Section 27 of the Exchange Act ,
715 U .S .C . § 78aa, and 28 U .S .C . § 1331 and 1337 .
20 . Venue is proper in this Dist ri ct pursuant to Section 27 of the Exchange
Act, 15 U .S .C. § 78aa, and 28 U .S .C . § 1391(b) . The Company maintains its principal
executive offices in this District, at 20 Industrial Park Drive, Nashua, New Hampshire
03062. Further, many of the acts, including the preparation and dissemination to the
investing public of the false and misleading statements and omissions at issue, occurred
in this District .
21 . In connection with the acts, transactions and conduct alleged herein ,
1 Defendants, directly and indirectly, used the means and instrumentalities of interstate
commerce, including the United States mails, interstate telephone communications an d
the facilities of the national secu ri ties exchanges and markets .
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III . THE PARTIE S
A . Lead Plaintiffs
22. Lead Plaintiff Louisiana Teachers is a public trust fund founded in 1936 to
provide retirement benefits to Louisiana public school teachers, principals and foo d
service workers as well as their beneficiaries . Louisiana Teachers' assets are estimated a t
$10.6 billion as of June 30, 2002 . Louisiana Teachers purchased 600,400 SmartForce
ADSs and suffered damages of approximately $ 5 .4 million du ring the Class Period as a
result of the violations of law alleged herein . On March 26, 2003 , the Court appointed
Louisiana Teachers as Lead Plaintiff for the Class , as defined in ¶262 below, pursuant to
Section 21D of the Exchange Act, 15 U.S .C . § 78u-4 .
23. Lead Plaintiff Louisiana Sheriffs is a public retirement system for th e
benefit of current and retired employees of the various Sheriffs' offices in the State of
ILouisiana . Louisiana Sheriffs' assets are estimated at $820 .1 million as of June 30, 2002 .
Louisiana Sheriffs purchased 45,200 SmartForcc ADSs prior to the Merger and
exchanged 8,900 SkillSoft Corp . shares for 21,069 SmartForce AQSs pursuant to the1
Merger and suffered damages of approximately $300,000 during the Class Period as a
result of the violations of law alleged herein . On March 26, 2003, the Court appointed
Louisiana Sheriffs as Lead Plaintiff for the Class, as defined in J262 below, pursuant to
Section 21D of the Exchange Act, 15 U .S .C . § 78u-4 .
B. Defendants
1 24. Defendant SkillSoft PLC (referred to herein as the "Company") provides
an Internet-based management and technology platform for training courseware, seminars
and reference materials geared toward business and IT professionals . The Compan y
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maintains its p rincipal executive offices at 20 Industrial Park Drive, Nashua, New
Hampshire 03062 . The Company's ADSs trade on the Nasdaq National Market Syste m
("NASDAQ") under the ticker symbol "SKIL." The Company is the product of the
September 6, 2002 Merger between SkillSoft Corp . and a subsidiary of SmartForce
pursuant to an Agreement and Plan of Merger dated June 10, 2002 (the "Merger
Agreement") .
1 25. Pursuant to the Merger Agreement, SkillSoft Corp . merged with Slat e
Acquisition Corp . ("Slate"), a subsidiary of SmartForce . SkillSoft Corp . shareholders
were issued SmartForce ADSs in the Merger . Specifically , SkillSoft Corp . shareholders
received 2 .3674 validly issued and fully paid ordinary shares of SmartForce ( represented
by ADSs ) for every share of SkillSoft Corp . owned as of August 2, 2002 . Prior to
October 20 , 1999, SmartForce was known as CBT Group PLC ("CBT") .
26. SkillSoft Corp . was considered to be the accounting acquirer even though
SmartForce emerged as the surviving entity . On September 6, 2002, the Compan y
1 announced that it would conduct its post-merger business under the operating name
"SkillSoft." Thereafter, at a shareholders' meeting held on November 19, 2002 ,
shareholders of the new company approved a corporate name change from "SmartForce
1 PLC d /b/a SkillSoft" to "SkillSoft PLC."
27. According to the Registration Statement on Form S-4/A filed with the
SEC on July 30, 2002, SkillSoft Corp . conducted extensive due diligence prior to
1 consummating the Merger . In contemplation of the Merger, the companies exchanged
financial information on several occasions between April 17, 2002 and May 8, 2002 . On
1May 9, 2002, SkillSoft Corp . and its financial advisors mct with SinaitFoice to discus s
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the possible merger and to receive additional financial information concernin g
SmartForce .
28. In its Form 8-K dated September 6, 2002, and filed with the SEC o n
1 September 20, 2002, SmartForce described the impact of the reverse Merger as follows :
[T]he historical financial statements of SkillSoft will be the historicalfinancial statements of [SmartForce], and the assets and liabilities of[SmartForce] will be accounted for as required under the purchase methodof accounting. The results of operations of [SmartForce) will be includedin the financial statements of the merged company from September 6,2002, the effective date of the Merger .
29 . Accordingly, liability for the claims alleged in this Complaint may b e
1 imputed, as applicable, to SmartForce as a predecessor-in-interest to Skil]Soft Corp ., o r
conversely to SkillSoft Corp ., as a successor-in-interest to SmartForce, because : (i )
SkillSoft Corp . was considered the acquiring entity with respect to the Merger; and (ii )
r SkillSoft Corp. expressly assumed the obligations and liabilities of SmartForce . Al l
references to the "Company" or to "Defendants" include, without limitation, reference t o
S martForce .
30. Defendant Gregory M . Priest ("Priest") is the Chief Strategy Officer and
Chairman of the Board of Directors of the Company . Defendant Priest served as th e
Chief Executive Officer of SmartForce from December 1998 until September 6, 2002 .
P riest signed the following SmartForce or CBT reports filed with the SEC :
• Quarterly Report on Form 10-Q for the period ending March 31, 1999, which wasfiled with the SEC on May 14, 1999 ;
1 Quarterly Report on Form 10-Q for the period ending June 30, 1999, which wasfiled with the SEC on August 16, 1999 ;
• Quarterly Report on Form 10-Q for the period ending September 30, 1999, whichwas filed with the SEC on November 21, 1999 ;
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• Quarterly Repo rt on Form 10-Q for the period ending March 31, 2000, which wasfiled with the SEC on May 15, 2000 ;
• Quarterly Report on Form 10-Q for the period ending June 30, 2000, which wasfiled with the SEC on August 9, 2000 ;
• Qua rterly Repo rt on Form 10-Q for the period ending September 30, 2000, v hichwas filed with the SEC on November 14, 2000 ;
• Quarterly Report on Form 10-Q for the period ending March 31, 2001, which wasfiled with the SEC on May 15, 2001 ; y
• Quarterly Report on Form 10-Q for the period ending June 30, 2001, which wasfiled with the SEC on August 14, 2001 ;
• Quarterly Report on Form l0-Q for the period ending September 30, 2001, whichwas filed with the SEC on November 14, 2001 ;
• Quarterly Report on Form 10-Q for the period ending March 31, 2002, which wasfiled with the SEC on May 14, 2002 ;
• Quarterly Report on Form I O-Q for the period ending Iune 30, 2002, which wasfiled with the SEC on August 14, 2002 .
• Annual Report nn Form 10-K for Fiscal Year ending December 31, 1999, whichwas filed with the SEC on March 30, 2000 ;
• Annual Report on Form 10-K for Fiscal Year ending December 31, 2000, whichwas filed with the SEC on April 2, 2001 ;
• Annual Report on Form 10-K for Fiscal Year ending December 31, 2001, which
was filed with the SEC on April 30, 2002 ;
• Registration Statement on Forms S 4 and S 4/A, which were filed with the SEC
on June 20, 2002 on July 30, 2002, respectively; and
• Definitive Joint Proxy Statement/Prospectus on Schedule 14A, which was filedwith the SEC on August 6, 2002 .
31 . During the Class Period, Defendant Priest sold 525,900 shares o f
SmartForce ADSs while in possession of material, nonpublic information, reapin g
approximately $18,765,432 in illegal insider trading proceeds .
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32. Defendant Patrick E. Murphy ("Murphy") was the former acting Chie f
Financial Officer and Vice President of Finance of SmartForce from January 16, 2002
until approximately September 6, 2002 . Defendant Murphy signed the followin g
I SmartForce reports filed with the SEC :
+ Quarterly Repo rt on Form 10-Q for the period ended March 31, 2002, which wasfiled with the SEC on May 15, 2002 ;
• Quarterly Report on Form 10-Q for the period ended June 30, 2002, which wasfiled with the SEC on August 14, 2002 ;
• Annual Repo rt on Form 10-K for the fiscal year ended December 31, 2001, whichwas filed with the SEC on April 30, 2002 ;
Registration Statement on Forms S-4 and S-4/A, which were filed with the SECon June 20, 2002 and July 30, 2002, respectively ; and
• Definitive Joint Proxy Statement/Prospectus on Schedule 14A, which was filedwith the SEC on August 6, 2002 .
1 33. Defendant David C . Drummond ("Drummond") served as Chief Financia l
Officer of SmartForce from July 1999 until January 16 . 2002 . Defendant Drummon d
signed the following SmartForce reports filed with the SEC :
1• Quarterly Report on Form 10-Q for the period ended March 31, 2000, which was
filed with the SEC on May 15, 2000 ;
• Quarterly Report on Form 10-Q for the period ended June 30, 2000, which wasfiled with the SEC on August 9, 2000 ;
Quarterly Report on Form 10-Q for the period ended September 30, 2000, whichwas filed with the SEC on November 14, 2000 ;
• Quarterly Report on Form 10-Q for the period ended March 31, 2001, which wasfiled with the SEC on May 15, 2001 ;
• Quarterly Report on Form 10-Q for the period ended June 30, 2001, which wasfiled with the SEC on August 14, 2001 ;
• Quarterly Report on Form 10-Q for the period ended September 30, 2001, whichwas filed with the SEC on November 14, 2001 ;
1 1
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1 • Annual Repo rt on Form 10-K for the fiscal year ended December 31, 1999, whichwas filed with the SEC on March 30, 2000 ;
1
• Annual Report on Form 10-K for the fi scal year ended December 31, 2000, whichwas filed with the SEC on Apri l 2, 2001 .
34. During the Class Period, Defendant Drummond sold 90,700 shares of
SmartForce ADSs while in possession of material, nonpublic information, reapin g
1 approximately $1,997,653 in illegal insider trading proceeds .
35. Defendant Jack Hayes ("Hayes") served as Group Financial Controller and
Director of CBT/SmartForce from 1991 to 2000 . Defendant Hayes served as Vice
President of Finance and Principal Accounting Officer of SmartForce from 1999 to 2000 .
Defendant Haves signed the Company's Annual Report on Form 10-K for the fiscal year
ending December 31, 1999, which was filed with the SEC on March 30, 2000 . During
the Class Period, Defendant Hayes sold 20,000 shares of SmartForce ADSs while i n
pnssession of material, nonpublic information, reaping approximately $828,000 in illegal
insider trading proceeds .i
36. Defendants Priest, Murphy, Drummond and Hayes are often referred to
herein as the "Individual Defendants ." The Individual Defendants and the Company are
/ collectively referred to herein as "Defendants . "
37 . By reason of their positions at SmartForce, each of the Individual
Defendants named in this Complaint had access to internal company documents, report s
1 and other information, including adverse non-public information about its business ,
financial condition and future prospects, and attended management and/or board o f
director meetings . As a result, they were responsible for the truthfulness and accuracy of
1 SmartForce's public reports, statements, and releases . Among the documents th e
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1Individual Defendants reviewed or were provided with, as set forth in detail herein, were
SmartForce's operating plans, budgets and forecasts, and reports of actual operations
compared thereto, as well as other periodic documents unique to SmartForce, such as
"Revenue Logs," "Pipeline Reports," "Forecast Reports," "Exception Reports" and
"Contract Information Worksheets . "
38. It is appropriate to treat the Individual Defendants as a group for pleading
1 purposes and to presume that the false and misleading information contained in
SmartForce's public filings, press releases and other statements, as alleged herein, are th e
collective actions of this narrowly defined group of defendants . By virtue of their high-
level positions at SmartForce, each of the Individual Defendants directly participated i n
the management of SmartForce and were privy to confidential, proprietary informatio n
rabout SmartForce 's business , operations and accounting practices . The Individua l
Defendants were involved or participated in drafting, producing, reviewing, approving
and/or disseminating the false and misleading statements alleged in dhis Complaint, an d
thus were aware that the statements were being made, or approved"and ratified them, i n
violation of the federal securities laws .
39. As officers and/or directors and controlling persons of a publicly-held
company the common stock of which was, and is, registered with the SEC pursuant to the
Exchange Act, trades on NASDAQ, and is governed by the provisions of the federal
securities laws, the Individual Defendants each had a duty to disseiuiuate promptly,
accurate and truthful information with respect to SmartForce's financial condition an d
performance, operations, business, business practices, management, earnings and
business prospects, and to correct any previously-issued statements that had becom e
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Imaterially misleading or untrue, so that the market price of SmartForce's publicly-trade d
securities would be based upon truthful and accurate information . The Individua l
Defendants ' misrepresentations and omissions during the Class Pe riod violated these
1 specific requirements and obligations .
40. The Individual Defendants participated in drafting, preparing, and/or
approving the various public, shareholder and investor reports and other communication s
1 complained of herein, and were aware of, or in a severely reckless manner disregarded ,
the misstatements contained therein and omissions therefrom, and were aware of thei r
materially false and misleading nature . By virtue of their Board membership and/o r
executive and managerial positions with SmartForce and/or SkillSoft, each of th e
Individual Defendants had access to the adverse undisclosed information abou t
7
SmartForce's business practices, prospects and financial condition and performance, a s
particularized herein and knew, or in a severely reckless manner disregarded, that thes e
adverse facts rendered the positive representations made or adopted by the Individua l
1Defendants about Smart-Force materially false and misleading .
41 . The Individual Defendants, because of their positions of control an d
authority as officers and/or directors of SmartForce, were able to, and did, control th e
1 content of the various SEC filings, press releases, and other public statements pertainin g
to SmartForce during the Class Period . Each Individual Defendant was provided with
copies of the documents alleged herein to be misleading prior to, or shortly after, thei r
1 issuance , and had the ability and opportunity to prevent their issuance or to cause them t o
be corrected . Accordingly, each of the Individual Defendants is responsible for th e
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accuracy of the public reports and releases detailed herein and is, therefore, primarily
liable for the representations contained therein .
IV. THE FRAUDULENT SCHEME
A. Overview of The Company 's Business
42. The Company develops and provides electronic learning ("e-learning")
courseware, software and referenceware products for business and IT professionals . The
Company has approximately 1,200 training courses encompassing a range of professional
skills including management, communications, customer services, finance, marketing and
sales and strategic planning. The Company recognizes the majority of its revenu e
pursuant to software license agreements, which typically have one to three-year terms .
Customers may either host the courseware on their own intranet site or access the course s
0from Company-managed servers via the Internet .
43 . The Company also provides a range of professional services to customers
who license its products , including installation support , implementation consulting an d
technical support . The Company employs a multi-prong sales strategy, consisting of a
direct sales force for larger accounts, such as Dell Computers and Deloitte & Touche
Consulting; a telesales force for lead generation and resellers, such as General Physics,
Executrain and PMI for small and mid-sized accounts and for some international markets .
44. In November 1999, SmartForce transformed from a CD-ROM model to a n
Internet - based e-learning model , and launched the e- learning module MySmartForce .co m
("MySmartForce") . The migration of approximately 80% of SmartForce's core business
in North America to e-learning was complete by the end of Fiscal 2000 . Rental access t o
15
1the Internet-based e-learning model replaced CD-ROMs as the major component o f
SmartForce's revenue .
45. Under the CD-ROM model, the majority of revenue was recognized
0 immediately upon delivery of the product . In contrast, GAAP, as described below,
required SmartForce to recognize revenue from rental subscription contracts ratably ove r
the life of the contract, thereby deferring a substantial portion of a contract's revenu e
stream to future periods as it is earned . As a result, SmartForce's contract "backlog" -
which refers to the unearned revenue stream from guaranteed contracts - became a ke y
metric in forecasting the company's outlook . According to a January 19, 2000 Merrill
Lynch Capital Markets' report, "[w]hile not a new metric, backlog has become
increasingly important since the company now recognizes revenues ratably over the
contract life as opposed to at time of sale ." A research report the same day by Hamrecht1
and Quist Inc. observed that "the more successful that SmartForce is in migratin g
customers to e-Learning, the lower 2000 revenues will be, which means that backlog wil l
become the key metric going forward . "
46. SmartForce reported stellar revenue and net income growth for Fiscal
Years 1999, 2000 and 2001 . For thirteen of the fourteen quarters during the Class Period ,
1 SmartForce met or exceeded analysts' estimates .
47. Beneath the surface of SmartForce's glowing financial outlook, however,
Defendants perpetrated a massive fraud on the investing public . According to a former
Vice President of Business Development, who reported directly to Defendant Priest ,
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customer demand for SmartForce's products was dramatically declining in 2001, and
"SmartForcc was off by 50% in signing new contracts, but Priest was hiding the declin e
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in new business during conference calls and meetings ." According to that former Vice
President of Business Development, SmartForce "managed its earnings" by holding back
revenue "as a cushion ." In fact, SmartForce regularly dipped into its "backlog" of
revenue to "make up for known shortfalls at the end of the year" in direct violation o f
GAAP and its own internal revenue recognition policy.
48. According to a former Regional Account Manager for the Midwes t
Region, no one in his region was making their numbers, and according to a forme r
Learning Manager, the shortfall in contract renewals in early 2001 was a nationwid e
problem for the sales force . A former Sales Analyst in SmartForce's Redwood City
Eoffice revealed that SmartForce's sales consistently fell short of quotas, and that "it wa s
evident that [SmartForce] was not going to make year-end numbers in 2001 . "
I49. The Individual Defendants and other members of SmartForce's senio r
management not named as defendants, including Jeff Newton ("Newton"), SmartForce' s
former Chief Customer Otticer and Executive Vice President of Global Sales an d
Partnerships for the Reseller Division; Tom Parry ("Parry"), SmartForce's former Vic e
President of North American Sales and, later, the former Vice President of Global Sales
for the Direct Sales Division; and Bill Lewis ("Lewis"), SmartForce's fuanci Exccutivc
1 Vice President of Global Sales and, later, the former Executive Vice President o f
Strategic Development "definitely knew" of the Company's shortfalls, according to a
former Vice President of Business Development .
50. Indeed, several former employees, including a former director of Business
Administration and Planning, revealed that "Revenue Logs" and "Pipeline Reports, "
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which detailed SmartForce' s dismal sales performance and declining revenue, were
emailed to the Individual Defendants weekly .
51 . By the third quarter of 2001, due to the catastrophic decline in sales and
the rampant contract cancellations as a result of the widespread platform defects plaguing
MySmartForce, SmartForce's backlog was gone . More than a dozen former employees .
including a former Director of IT Professional Services, who was responsible for
implementing SmartForce's e-learning platforms, revealed that MySmartForce "did not
work," and that the Individual Defendants and senior executives - including Newton an d
Parry - were warned repeatedly of the pervasive problems. Similarly, a former Senior
Technical Support Specialist confirmed that MySmartForce failed to integrate the
customers' servers, and that customers were unable to access SmartForce's e-learning
module . As a result, a significant number of customers in 2000 and 2001 cancelled their1
contracts or demanded concessions such as rebates, discounts or extensions . A former
Global Account Executive, and a former Regional Account Manager confirmed similar
technical problems and contract cancellations .
52. Despite the severe decline in SmartForce's business, Defendants publicly
touted SmartForce's revenue growth and backlog purportedly as a result of the success o f
I its e-learn ing platform. In fact, the Company reported a 55% revenue increase for Fisca l
2001 .
53 . Internally, SmartForce put tremendous pressure on its sales force to
1 "make the numbers at the end of each quarter," as senior management was propelled to
meet Wall Street's expectations - at any cost . According to a former Vice President o f
Global Services who reported to Newton, "everything was set to meet or beat analyst s
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targets ." According to a former Senior Sales Director , the Individual Defendants an d
senior management directed the accounting department to "tilt to the tight - to be less
conservative" in the way they booked revenue .
0 54. The reality w as that the Individual Defendants spearheaded a massiv e
scheme to prematurely book millions of dollars in revenue in violation of GAAP and
SmartForce's revenue recognition policies . According to a former Sales Analyst, th e
0 Individual Defendants enforced a culture of "creative accounting ." That former sale s
analyst revealed that "it was more than a coincidence that anytime there was a question
about whether we could make the numbers, all of a sudden we'd make the numbers ."
B . Defendants' Fraudulent Accounting Practice s
1 . The Individual Defendants Directed the Company's
Fraudulent Accounting Practices
55 . Former Situ utFoicc cniployces, including two former senior accountants,
provide details concerning the falsification of SmartForce's financial results, which
resulted in the restatement of SmartForce's financial results for Fiscal 1999, 2000, 2001,
and for the first two quaitcLs of Fiscal 2002 . A former Vice President of Global Services ,
a former Vice President of Marketing, a former Senior Sales Analyst, a former Senior
Sales Director and two former Senior Accountants in SmartForce's accountin g
idepaturucnt cach confirmed that , at the end of each quarter du ring the Class Period , senior
management and members of SmartForce ' s finance department held regular meetings in
the executive conference room on the second floor of SmartForce 's Redwood City offices1
to "shuffle" revenues and expenses to satisfy Wall Street' s expectations .
56. Defendants Priest, Drummond and Murphy attended the meetings as di d
1 Greg Porto ("Porto"), SmartForce's former Chief Operating Officer, who was responsibl e
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for contract negotiations and who reported to Defendant Drummond; Newton who
reported directly to Defendant Priest ; Patrick Trinh ("Trinh"), SmariForce's former U .S .
Controller; Kathy Trudeau ("Trudeau"), SmartForce's former Group Controller ; and Jean
Scully ("Scully"), a former finance manager . Defendant Haves was in Dublin . Ireland
and participated in the meetings via telephone .
57 . A former Senior Accountant in SmartForce 's finance department i n
1Redwood City, who reported to Trinh and who was responsible for preparing
SmartForce's profit and loss statements and compiling SmartForce's quarterly revenue s
and expenses, revealed that the Individual Defendants directed Trinh and Trudeau to1
inflate SmartForce's revenues each quarter by, among other things, prematurely
recording millions of dollars in revenue from multi-year agreements (discussed below) .
58 . Trinh and Trudeau were responsible for SmartForce's general ledger an d
reported directly to Defendants Murphy and Drummond . Scully was responsible fo r
summarizing or "rolling up" the revenues from the different departments .
1 59. According to a former Director of Business Planning and Administration,
the Individual Defendants and Parry, Newton and Trinh were emailed Excel spreadsheets
containing Revenue Logs, Pipeline Reports and Quarterly Reviews, which summarize d
1 SmartForce's global sales, channel sales and direct sales activity . Revenue Log s
contained detailed summaries of SmartForce's backlog of contracts, as well as ne w
1contract executions . Pipeline Reports contained information about contracts nearin g
execution, including the percentage of completion for each deal .
60. Moreover, the Individual Defendants and SmartForce's sales force ha d
access to the Siebel "Customer Relationship Management" ("CRM") System which,1
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according to a former Regional Account Manager, provided real-time access to deals
closed, deals in-progress and prospective deals .
61 . Trinh reviewed SmartForce's quarterly consolidated revenues, expenses,
net income, and days sales outstanding ("DSO") on accounts receivable as well as other
important financial information each quarter . Trinh passed the information on to Trudeau
and to the Individual Defendants, who, equipped with this information, were full y
apprised of the accounting manipulations necessary to conceal SmartForce's decline in
sales and to artificially inflate SmartForce's revenue each quarter .
62 . According to a former Senior Accountant in the finance department at
SmartForce's Redwood City headquarters, the Individual Defendants directed the
accounting manipulation of SmartForce's revenues and expenses each quarter .
Specifically, the Individual Defendants directed Trinh and Trudeau to book revenue
prematurely from SmartForce's backlog in an effort to satisfy Wall Street's earning s
expectations . Defendant Hayes often finalized the financial repuiciug in Dublin, Ireland .
Despite Trinh's protestations, the former senior accountant stated "we did what we were
told in terms of posting the numbers . No matter what [Trinh] decided using accounting
standards, [the Individual Defendants] would supeicede it . They would do whatever the y
I wanted . "
63. A former Senior Accountant also stated that he made adjustments t o
SmartForee's general ledger under the direction of the Individual Defendants and of
Trinh and Trudeau, and that the inter-company ledgers were used to manipulate and
move excess expenses . The former senior accountant estimated that millions of dollars i n
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expenses and revenues were "shuffled" at the direction of the Individual Defendants eac h
quarter in what he characterized as "creative accounting . "
64. During the Class Period, the Individual Defendants and SmartForce' s
senior management fabricated the appearance of growth . They accomplished thi s
through improper revenue recognition schemes and balance sheet manipulations, all of
which were intended to, and did, artificially inflate SmartForce's reported results .
enabling SmartForce to continually meet its earnings expectations . Specifically, the
accounting shenanigans included : (i) backdating transaction documentation, an d
extending reporting periods through the "Hayes Calendar" ; (ii) prematurely recognizing
revenue from multi-year reseller agreements ; (iii) prematurely recognizing revenue from
multi-year subscription agreements; (iv) improperly accounting for "additional rights"
granted to customers including contract extensions and discounts; (v) improperl y1 C
recognizing revenue from "swap deals" or barter transactions ; and (vi) improperly
accounting for expenses as pre-paid assets .
2 . Defendants Improperly Recognized Revenuefrom Software Sale s
a . GAAP Provisions Applicable To Software Sale s
65 . In 1997, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position ("SUP") 97-2 ,
"Software Revenue Recognition ," as amended by SOP 98-4 and SOP 98-9. SOP 97-2 i s
/ the GAAP standard gove rn ing revenue recognition of software transactions , which do no t
require significant production , modification or customization of the software and is
effective beginning with fiscal year ended December 15, 1997 . As detailed herein, th e
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majority of SmartForce's revenue arises from software license agreements and, therefore ,
is gove rned by SOP 97-2 .
66. SOP 97-2 articulates the following four criteria, all of which must be me t
before revenue may properly be recognized. First, persuasive evidence of an
arrangement must exist, which is typically evidenced by a contract signed by both parties .
Second the company must have delivered the product. Third, the vendor's fee must b e
fixed or determinable, meaning that the vendor has an unconditional obligation to pay .
Lastly, it must be probable that the revenue will be collected .
67. In the instance of multiple element arrangements, SOP 97-2 states tha t
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revenue may be allocated to each element and recognized separately upon meeting the
criteria above, if vendor specific objective evidence is available to ascertain the fair
values of each element . If there is insufficient evidence of each element's fair value, al l
the revenues from the arrangement must be deferred and recognized ratably over the ter m
of the arrangement .
68 . SOP 97-2 adopted the straightforward and well-recognized revenue
recognition principles articulated by the Financial Accounting Standards Board
("FASB") in Financial Accounting Concept Statement No . 5, "Recognition and
Measurement in Financial Statements of Business Enterprises," which requires under th e
realization principle that in order to properly recognize revenue, the revenue must be
earned, the earnings process complete and an exchange have taken place . FASB
Concepts No . 5, 1183, 84, adopted in SOP 97-2,196 . According to SOP 97-2, th e
I
earnings process is not complete until collection of the sales price is reasonably assured .
Id. The conditions for revenue recognition are ordinarily met when products and service s
23
are exchanged for cash or claims to cash, and the entity has substantially performed the
obligations, which entitle it to the benefits represented by the revenue . Generally, a
transfer of risk must occur in order to affect an "exchange" for purposes of revenu e
recognition under GAAP . In short, under SOP 97-2 "revenues are considered to hav e
been earned when the entity has substantially accomplished what it must do to be entitle d
to the benefits represented by the revenues ." SOP 97-2, 196 .
169. Consistent with SOP 97-2, SEC Staff Accounting Bulletin ("SAB") 10 1
"Revenue Recognition in Financial Statements" reiterates these same four factors as SO P
97-2 in determining when a company is permitted to recognize revenue .
70. In instances where customers are granted a right to return the product ,
GAAP does not permit revenue to be recognized immediately upon delivery, rather i t
Irequires the revenue to be deferred unless the following conditions exist :
• The buyer has paid the seller, or the buyer is obligated to pay the sellerand the obligation is not contingent upon resale of the product ;
• The seller does not have significant obligations for future performanceto directly bring about resale of the product to theliuyer; and
• The amount of future returns can be reasonably estimated .
FASB No . 48, "Revenue Recognition When Right of Return Exists," ¶6 . Even where the
above conditions have been met . an entity is still required to adequately and timel y
reserve for returns and allowances and bad debt .
1
71 . As detailed herein, Defendants improperly recognized more than $11 3
million of revenue during the Class Period, absent satisfaction of the general basi c
revenue recognition principles set forth in SOP 97-2 because :
24
• SmartForce did not have vendor specific objective evidenceavailable to support revenue recognition of particular elements inmulti-element transactions ;
• Revenue was recorded before the earnings process was complete ;
• There was no persuasive evidence of an arrangement because thecontractual terms were not yet fixed and the contract not signed :
• Fees were not fixed because customers could return the product :an d
• Collectibility was not probable.
72. Furthermore, by recording revenue as bona fide sales before the earning s
process was completed, Defendants also materially overstated SmartForce's reported
accounts receivable during the Class Period . The recording of revenues in violation o f
GAAP necessarily inflates the related accounts receivable in violation of GAAP .
Accounting Research Bulletin No. 43, "Accounting for Contingencies" requires that
entities repo rt accounts receivable at "net realizable value . "
73 . The Company also violated GAAP in that it recorded as revenue ce rt ai n
so-called "barter transactions," which are essentially nothing more than a "swap" of
SmartForce's products or services for that of another company . According to APB No .
29, "Accounting for Non-Monetary Transactions," "an exchange of product or property
held for sale in the ordinary course of business for a product or property to be sold in the
same line of business to facilitate sales to customers other than the parties to th e
exchange" does not culminate in an earnings process .
b. Defendants Improperly Backdated RevenueThrough The "Haves Calendar"
74. More than a dozen former employees including a former Senior
Accountant, a former Accounts Receivable Coordinator, five former Regional Accoun t
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Managers, a former Public Sector Account Manager, a former Inside Sales Account
Manager, a former Channel Sales Account Manager, a former Global Account Executive,
two former Sales Representatives, a former Implementation Consultant, and two former
Executive Assistants in the Company's Redwood City headquarters each confirmed that
during the Class Period, under what was commonly referred to as the "Hayes Calendar" -
named after Defendant Hayes - the Individual Defendants regularly extended the
Company's reporting periods and directed the backdating of transaction documentation .
75. The "Hayes Calendar" refers to the Individual Defendants' practice o f
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extending quarters and backdating contracts to create the illusion that revenue was
generated in one reporting period when, in reality, the revenue was generated, and, under
GAAP, should have been recognized, in the next reporting period . During the Class
Period, the Individual Defendants extended quarters from a few days to several weeks,
and directed the sales force to backdate contracts to reflect the last day of the previous
quarter as the effective date of the contract . Moreover, according to two former Regional
Account Managers and a former Sales Representative, revenue and commissions
associated with contracts signed in the extended periods were credited to sales
representatives' quotas for the previous quarter .
76. A former Accounts Receivable Coordinator, who reported to Trinh ,
confirmed that SmartForce's books regularly were held open a couple of weeks after the
end of a quarter so that additional revenue could be booked, and confirmed further that
Newton and Parry often advised him that the corresponding "paperwork was in the
pipeline." Similarly, a former Senior Accountant confirmed that the Hayes Calendar
extended SmartFurcc's quaitcis, and that Trudeau frequently booked approximately $ 1
26
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million to $2 million of revenue under the direction of Defendant Murphy after the clos e
of each quarter.
77. Under the direction of Newton and Defendant Priest , Parry sent
Company- wide emails , or "sales bulletins ," to the sales force extending the quarters and
offe ring incentives and bonuses to backdate sales contracts , according to a former Publi c
Sector Account Manager, a former Global Account Executive, a former Implementatio n
Consultant, and a former Executive Assistant . Defendant Priest sent similar emails to
propel the sales force to meet SmartForce's revenue goals .
78 . A former Public Sector Account Manager revealed that
1account managers received approximately $1,000 for backdating contracts after the end
of the quarter . Moreover, according to a former Sales Representative, customer s
1frequently were offered discounts and incentives such as free courseware or discounts o f
d o or more, to backdate contracts .
79 . Indeed, a former Regional Account Manager confirmed that backdatin g
contracts at SmartForce was "common practice," that, under management's direction,
contracts were "backdated all the time," and that Newton and Defendant Priest were wel l
aware of this practice . A former executive assistant in SmartForce's Redwood Cit y
I headquarters, who received sales contracts via facsimile and recorded them in Revenu e
Logs, which were emailed to Parry, Newton and the Individual Defendants, revealed tha t
she often was instructed to backdate contracts to a previous quarter, and that Smart?orc e
1 frequently "shifted deals" from one quarter to the next to meet revenue objectives .
80. According to a former Global Account Executive, Avaya, Inc ., a
communications scrvicc pwvider headquartered in Basking Ridge, New Jersey, execute d
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Ia three-year $2 .2 million contract with SmartForce for courseware and services . The dea l
was consummated in Apri 12002, the beginning of SmartForce's second quarter of Fisca l
2002 . At the behest of SmartForce's senior management, however, the former global
account executive backdated the contract so SmartForce could recognize revenue in the
first quarter of Fiscal Year 2002 .
81 . The same former Global Account Executive, also revealed tha t
SmartForce senior executives engaged in the same practice with a 3-year $1 . 5 million
contract with Qwest Communication International, Inc ., a provider of broadband Internet
Icommunications headquartered in Denver, Colorado . The deal was consummated i n
April 2002, but at the request of SmartForce's senior executives, the former global
account executive backdated the agreement so SmartForce could recognize revenue in th e
1first quarter of Fiscal 2002 .
82. According to a former Implementation Consultant, The St . Paul
Companies , a Minnesota-based insurance company, executed a three -year $600,000
contract with SmartForce for courseware and access to the Company's platform .
MySmartForce . The deal was consummated in the first quarter of 2000, but th e
agreement was backdated so SmartForce could recognize revenue in the fourth quarter of
Fiscal 1999 .
83 . Indeed, a former Accounts Receivable Coordinator revealed that Trinh an d
Scully instructed him to backdate deposit slips and attach the phony slips to backdate d
rcontracts to create the illusion that revenue was earned in the previous quarter . In reality,
the deposits were made at a later date . The former Accounts Receivable Coordinato r
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confirmed that, during the Class Period, millions of dollars in deposits were backdated
including, among others, revenue from contracts with PricewaterhouseCoopers .
84 . The same former Accounts Receivable Coordinator also revealed tha t
1 Trinh kept a drawer filled with checks from customers, which were not deposited fo r
several months after they were received . SmartForce frequently managed its earnings by
depositing the checks in later reporting periods as "other income . "
85 . Backdating contracts and booking the attendant revenue in periods prior to
contract execution violates GAAP and SmartForce's stated revenue recognition policies.
By improperly recording revenue prior to the culmination of the earnings process
Defendants overstated SmartForce's revenues, earnings and net accounts receivable . In
addition, by backdating contracts, Defendants fraudulently attempted to create persuasiv e
evidence of an existing arrangement . Indeed, Defendants admit, through the restatement ,
that revenue was prematurely recognized from agreements before contractual obligations
were finalized and agreed to .
c . Defendants Improperly Recognized RevenueFrom Reseller Agreement s
86. Former SmartForce employees including a former Vice President of
Business Development, a former Channel Sales Executive, two former Regional Sales1
Managers, and a lormer bales Representative, all confirmed that, during thc Class Pcriod,
SmartForce improperly recognized revenue from reseller agreements, and improperly
accounted for revenue from resellers who failed to fulfill their contractual obligations .
87. Resellers generally executed annual of multi-year agrecmcnts, or "alliance
contracts," with SmartForce, by which a reseller committed to sell a certain amount o f
P SmartForce's products . If the reseller failed to sell its contractual commitment, th e
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0 reseller was obligated to pay SmartForce the difference at the conclusion of the contrac t
period .
88. According to a former Senior Sales Director, once an agreement wa s
executed, the full value of the agreement was entered into Revenue Logs and transmitted
to SmartForce's Redwood City headquarters where Trinh and Defendant Murphy
interpreted the agreements and determined the amount of revenue to record, depending
on whether the agreement reflected an upgrade, an extension or a new account . Trinh
and Defendant Murphy transmitted this information to Defendants Drummond and Priest .
Defendant Drummond reviewed the contracts and ultimately approved the revenue
recognized from these agreements .
89. A former Sales Representative, and a former Channel Sales Executiv e
1 stated that General Physics Corp . ("General Physics"), a workforce developmen t
company headquartered in Elkridge, Maryland, executed a three-year $1 .8 million
reseller agreement with SmartForce in the first quarter of Fiscal 2000 . General Physics
never paid SmartForce pursuant to the terms of the agreement . IN-evertheless, SmartForce
prematurely recognized the entire value of the General Physics agreement upfront in
violation of SOP 97-2 because the earnings process was not complete and, therefore,
revenue had not been earned and because collectibility was not probable .
90. According to a former Manager of Direct Sales for the Midwest Region ,
American College Testing , Inc . ("ACT"), a non-profit educational testing and research
organization located in Iowa City, Iowa, executed a three-year $1 .8 million reseller
agreement with SmartForce in December 2001 to resell the RealSkills software .
SmartForce prematurely recognized the entire value of the ACT reseller agreement in th e
30
Ifourth quarter of Fiscal 2001 in violation of SOP 97-2 because the earnings process wa s
not complete and, therefore, revenue had not been earned .
91 . According to a former Regional Account Manager and a former Channel
Sales Executive, ExecuTrain Corp . ("ExecuTrain"), an Atlanta, Georgia-based lea rn in g
solutions company , executed a three-year $ 1 .5 million to $3 .0 million reseller agreement
involving a single use license , as well as co- marketing arrangements in 1998 .
ExecuTrain refused to pay SmartForce pursuant to the terms of the agreement .
Defendant Priest was well aware of ExecuTrain' s refusal to pay and frequently
questioned the former Channel Sales Executive at annual sales meetings regarding the
status of the transaction . Nevertheless, SmartForce improperly recognized revenue from
the ExecuTrain agreement in violation of SOP 97-2 because collectibility was no t
probable .
92. In fact, when a reseller or direct customer refused to pay under the term s
of its agreement, SmartForce generated "Exception Reports" to alert senior management
that collectibility was a serious concern . Defendant Murphy and Trinh generated
Exception Reports, and Defendants Priest, Drummond and Hayes received them
periodically. A former Channel Sales Executive confirmed that the Individual
Defendants received Exception Reports on the ExecuTrain deal, among others .
93. Moreover, a former Vice President of Business Development stated tha t
in 2001, nearly two-thirds of SmartForce's resellers were unable to meet their contractua l
obligations that "[Defendants ] were having great difficulty collecting from resellers, "
and that SmartForce " took reseller revenue they shouldn't have taken . "
I
3 1
I
1 94. Several former channel employees, including a former Channel Sale s
Executive, revealed that a multitude of resellers were unable to meet their contractua l
obligations and, ultimately, refused to pay SmartForce the majority of their obligation s
► under their agreements , including KeepSmart, located in Hawtho rne , New York, whic h
executed a five-year $3 .5 million agreement in November 2000 ; New Era of Networks .
Inc . . located in Englewood, Colorado, which executed a three-year $1 .5 million
agreement in August 2000 ; Technology Training Solutions, Inc ., located in Long Island .
New York, which upgraded to a three-year $1 million agreement in 2000 ; eTrain
Holdings LLC, located in Atlanta, Georgia, which executed a three-year $250,00 0
agreement in October 2000 ; and Intellimark Holdings, Inc ., located in Little Rock ,
Arkansas, which executed a three-year $100,000 agreement in 1998 . Moreover, deal s
with several international resellers went unpaid, including an agreement with Neusoft
Co., Ltd ., headquartered in China, which fell apart when Neusoft refused to pay
SmartForce under its agreement .
95 . Nevertheless, Smanforce improperly recorded revenue in connection with
these transactions in violation of SOP 97-2 because collectibility was not probable .
Defendants admit, through the restatement, that they improperly recognized revenue fro m
1 reseller agreements , and were required to restate revenue in connection with thos e
transactions .
d. Defendants Improperly Recognized RevenueFrom Multi - Year Subscription Agreement s
96. SmartForce's direct sales division was responsible for executing multi-
year subscription agreements with customers, which typically involved multiple
1
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elements, such as access to MySmartforce for a specified number of years, perpetual
software licenses, professional services and maintenance components .
97. Former employees in SmartForce's direct sales division, including a
former Regional Account Manager, and a former Account Manager for the Midwest
Region, confirmed that, during the Class Period, SmartForce improperly recognized the
full value of multi-year subscription agreements up front .
98. The former Manager of Direct Sales for the Midwest Region stated that, in
addition to the reseller agreements discussed above, ACT also executed in Decembe r
2001 a 51 .175 million perpetual license agreement for three to five years . A former
Manager of Direct Sales confirmed that Defendants recognized the full value of the ACT
perpetual license agreement in the fou rt h qua rter of Fiscal 2001, rather than ratably over
the life of the agreement . Specifically , the former Manager of Direct Sales stated that h e
received emails from Trinh confirming Defendants' intentions to book the entire value of
the agreement in the fourth quarter of Fiscal 2001 . Moreover, he revealed that Defendant
Priest was apprised via email of the terms of the ACT agreement .
99. Defendants violated GAAP, specifically SOP 97-2, by prematurely
recognizing the full value of multi-year subscription agreements up front, rather than
ratably over the term of the agreement . Defendants admit, through the restatement, tha t
they improperly recognized revenue from multi-year agreements, and were required t o
restate revenue in connection with those transactions .
1e. Defendants Improperly Accounted For
"Additional Rights" Granted to Customer s
100. According to more than a dozen former technical employees ,
1 MySmartForce became a dismal failure after the platform was launched in Novembe r
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I
1999, MySmartForce was plagued with widespread platform and scalability problems,
language transmission problems, content loading and deployment issues, and connectio n
failure issues . In fact, customers complained routinely that they could not access
SmartForce's courseware through the Internet . According to a former Senior Director o f
Product Management, "this was a consequence of the Company building the platform to o
rapidly and going to the market way too quickly . "
1 101. Dozens of disgruntled customers, including Level 3 Communications ,
I
American Express, J .D. Edwards and ManPower Europe, escalated their complaints, and
threatened to cancel their three-year contracts as a result of the pervasive problems wit h
MySmartForce . Dozens of customers including CRI Advantage, Frontier Systems,
United Health Services, Elea, Her Majesty's Customs and Excise, SunGard Dat a
Systems, Inc ., KPMG International Investment B .V. and College Boreal, did, in fact,
cancel their contracts in 2000 and 2001 because of the technical problems .
102 . According to the same former Senior Director of Product Management,
the Individual Defendants were well aware through conference ca4ls and weekly reports
that customers were dissatisfied with SmartForce's products and services and wer e
canceling their contracts .
103 . In an effort to appease disgruntled customers, SmartForce offered special
accommodations, or "additional rights," to prevent customers from terminating thei r
agreements , and to compensate those customers for the technical difficulties . These
1"additional rights" included contract extensions, additional content, discounts and cas h
rebates .
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7
104. For example, according to a former Sales Representative, Level 3
Communications executed a three-year $1 .2 million agreement in the fourth quarter o f
Fiscal 1999 and subsequently received a six-month credit to its account because of th e
severe platform problems it experienced with MySmartForce .
105. Also, according to the former employees, SmartForce gave additiona l
courseware to Manpower Europe free of charge, American Express was granted a
contract extension at no additional cost, I .D . Edwards was granted free access to
courseware for another quarter in a rider to a $1 .2 million contract signed with
SmartForce in the fourth quarter of Fiscal 1999 and, according to the former Director of
IT Professional Services, Xerox received a Si trillion rebate, or "apology check," and
Manpower Europe received a similar $250,000 rebate check .
1106 . Defendants admit, through the restatement, that SmartForce improperly
recognized revenue where customers were granted "additional rights" after contract
execution . Revenue from contracts granting these "additional rights" should have been
recognized ratably over the term of the agreements .
f. Defendants Improperly Recognized RevenueFrom Barter Transactions
107. A former Channel Sales Executive revealed that Project Managemen t
Services, Inc . ("PMSI"), an Atlanta-based developer of training programs and a division
of Boston-based Provant, Inc ., signed a $3 million reseller agreement with SmartForce i n
the fourth quarter of Fiscal 2000 . Defendant Priest was involved in this transaction .
Pursuant to the terms of the agreement, SmartForce would have access to PMSI' s
mate rials, and PMSI would agree to resell SmartForce's products . According to a forme r
I Channel Sales Executive, the transaction was a "swap deal," or barter transaction . The
35
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former Channel Sales Executive confirmed a similar "swap deal" with Exult, Inc .
Defendants admit, through the restatement , that they improperly recognized revenue fro m
barter transactions and were required to restate revenue in connection with thos e
1 transactions.
3. Defendants Improperly Capitalized Expenses
108 . A former Senior Accountant, who was responsible for compilin g
1SmartForce's expenses and revenues each quarter and for compiling SmartForce's profit
and loss statements, confirmed that, under the direction of the Individual Defendants ,
SmartForce improperly recorded approximately $30 million to $50 million of sales
commissions as prepaid assets on SmartForce's balance sheet .
a . GAAP Provisions Applicable To Capitalized Expenses
1 109. FASB Statement of Financial Accounting Standards No . 5 ,
"Contingencies," requires that ordinary operating expenses be recorded as a charge
against income when a liability has been incurred and the amount of that liability i s
reasonably estimable . FASB No . 5, 18 . Defendants violated this basic accounting
principle by improperly recording sales commissions expense, research and development
expense and other undisclosed expenses as prepaid assets . Defendants also intentionally
failed to record other expenses at all, in violation of GAAP, to inflate SmartForce' s
earnings and to meet analyst estimates, as detailed herein .
C. Defendants Admit To Reporting Falsifie dFinancials Throughout The Class Perio d
110. The Company admits that Smartrorce improperly recognized revenue
throughout the Class Period, as follows :
1
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1 . Defendants Admit To ImproperlyRecognizing Revenue From Bundled Software Sale s
111 . In the Restatement 8-K/A, the Company admits that SmartForce
prematurely recognized revenue from multiple-element software sales transactions wher e
evidence of vendor specific objective evidence was not available , in violation of GAAP .
Specifically, in the Restatement 8-K/A, the Company concedes that :
SmartForce did not have vendor specific objective evidence of the fairvalue of its products and services as defined in American Institute ofCertified Public Accountants ("AICPA") Statement of Position ("SOP')97-2, "Software Revenue Recognition", as amended by SOP 98-4 andSOP 98-9 ("SOP 97-2, as amended"), to permit separate revenuerecognition for individual elements included in multiple-elementtransactions . As a result, these financial statements reflect a deferral ofcertain revenue that previously was recognized at the time of delivery .
Because in most cases the undelivered element related to servicesprovided over time, revenue is generally recognized ratably over the termfor which the services are provided .
Restatement 8-K/A at Note 1 (emphasis added) .
112 . Moreover, contrary to its prior filings with the SEC, and in violation of it s
stated revenue recognition policy as identified in IJ237-250 herein, SmartForce
intentionally mislead investors by affirmatively stating that "where possible the Company
allocates revenue to each element based on vendor specific objective evidence in
accordance with the provisions of SOP 97-2 . . ." when such vendor specific objective
evidence was never available .
2. Defendants Admit To PrematurelyRecording Revenue From Courseware SalesThat Granted Customers "Additional Rights "
113. In the Restatement 8-K/A, Defendants admit as follows :
SkillSoft PLC noted instances where customers that had acquired termlicenses were granted additional rights after the execution of a contract forwhich revenue had been recognized upon delivery . In these financial
37
statements, the revenue related to such courseware sales is recognizedratably over the term of the contract .
Restatement 8-KIA at Note 1 (emphasis added) .
114 . Defendants did not identify in the Restatement 8-K/A the so-called
"additional rights" customers were granted . Those rights, however, included sale s
discounts, rebates or refunds ; access to additional courseware content ; extended paymen t
terms and extending the contract period. In instances where Defendants granted
customers additional rights, revenue should not have been recognized for the full amoun t
of the sale upon delivery, but, rather, over the time in which SmartForce provided al l
I products and se rv ices that it was required to provide , as required by GAAP under SOP
97-2 .
3 . Defendants Admit To Prematurely RecognizingRevenue From Reseller AgreementsBefore the Contractual Obligations Were Fulfille d
115. Defendants prematurely recognized revenue from resellers bv: (i)
recording revenue from future periods up front ; and (ii) recording revenue from reseller
agreements, that Defendants knew were not collectable . Moreover, given the spars e
disclosure in the Restatement 8-KIA, and given the conduct of the resellers described
herein, it is doubtful in most instances that any type of contractual relationship existed t o
support revenue recognition . Defendants, in the Restatement 8-K/A, effectively conced e
these allegations acknowledging that revenue "should be deferred until the contractua l
I obligation to the end user had been fulfilled and payment had been received . "
Restatement 8-K/A at Note 1 . In other words, SmartForce recognized revenue fro m
resellers even though SmartForce neither fulfilled the obligations that would permi t
38
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revenue recognition, nor was paid for the products that it claimed to have sold, in
violation of SOP 97-2 .
4. Defendants Admit To ImproperlyRecognizing Revenue From Barter Transactions
116 . "SmartForce entered into several arrangements with customers pursuant t o
which SmartForce contemporaneously arranged both to buy and sell goods or services
The Company recorded revenue on these transactions net of the purchases made by
SmartForce where sufficient evidence to support the fair value of the goods or services
exchanged was not available ." Restatement 8-K/A at Note 1 . The Company was
required to restate its revenue and earnings for these barter transactions .
5_ Defendants Admit To Improperl . Capitalizing, Expenses
117 . Defendants understated expenses by classifying as prepaid assets certain
rundisclosed expenses that already had been fully consumed . Specifically, SmartForce
disclosed in its Restatement 8-KIA that :
SkillSoft PLC also reduced the period over which certain prepaid assetswere heing expensed to reflect facts available at the time of theprepayment .
Restatement R-K/A at Note 1 .
118 . By classifying these expenses as assets, rather than properly charging them
against related revenue recorded during the same period, Defendants fraudulently
understated SmartForce's expenses and overstated its net earnings during the Class
Period in violation of GAAP .
119 . Defendants admit, through the restatement, that there was no adequat e
business justification to support this improper accounting treatment, and that th e
C
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I Company has now expensed all sales-related commissions as costs when they wer e
incurred . Specifically, Defendants admit in the Restatement 8-K/A that :
SkillSoft PLC made other adjustments to correctly record estimates ofliabilities at various balance sheet dates based on evidence of subsequentdisbursements and to expense certain previously capitalized amounts .
Restatement 8-K/A at Note 1 .
120 . Although the Company's disclosures are vague, a review of SmartForce's
cash disbursements revealed that Defendants failed to record certain expenses as a charg e
to income during the Class Period . SmartForce's subsequent payment of those expenses
supports an admission by the Company that the expenses existed and, thus, should have1
been recorded in SmartForce's financial results during the Class Period .
121 . Additionally, SmartForce's failure to record these expenses directl y
1 affected SmartForce's balance sheet by understating total accrued liabilities during th e
Class Pe ri od by $34 .0 million .
6. Defendants Admit To ImproperlyRecording Research And Development Costs
1122 . SmartForce also improperly recorded as a prepaid asset certain cost s
associated with the research and development of its courseware content . Specifically,
Defendants admit in the Restatement 8-K/A that this accounting treatment wa s
"inconsistent with SmartForce's general policy of expensing content development as it is
incurred, " and was also in contravention of GAAP. Thus, Defendants admit that the y
violated SmartForce 's stated accounting policy during the Class Period
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7 . Defendants Admit To Improperly RecordingForward Foreign Currency Transactions As Hedge s
123 . A forward foreign currency exchange contract is one in which a n
agreement is made to exchange different currencies at a future date for a specified rate .
To meet the criteria of a "hedge," the hedged commitment must be a "firm commitmen t
as defined under FASB Statement of Financial Accounting Standards No . 52, "Foreig n
I Currency Translation ." To meet the criteria of a "hedge," the foreign currenc y
transaction : (i) must be designated as a hedge of a foreign currency commitment ; and (ii )
the commitment must be "firm ." If the foreign currency transaction does not meet these
criteria, the gain or loss realized upon settlement of the transaction should be included i n
the determination of net income or loss for that period . Defendants admit that
SmartForce improperly accounted for certain forward contracts as hedges entered into for
the purpose of mitigating the exchange risk associated with future operating expenses
berg ise the commitment was not a "firm commitment ." Thus, any gains or losses related
to the foreign currency transactions should have been deferred and recorded in the period
the contract settled . Specifically, Defendants admit :
During the year ended December 31, 2000, SmartForce had entered intocertain forward foreign currency transactions to hedge future foreigncurrency denominated operating expenses . The forward contracts wereaccounted for as hedges . Because the hedged transactions did not meet thestandard of a firm commitment provided by Statement of financialAccounting Standards (SFAS) 52 "Foreign Currency Translation," the fairvalue and the change in fair value, of the forward contracts have beenrecorded as an asset in 2000 with an offsetting reversal in the period inwhich such contracts settled .
Restatement 8-K/A at Note 1 .
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8. Defendants Admit To ImproperlyReporting Recourse Loans
124 . A recourse loan arises when a company enters into an arrangement to
"factor" or sell its accounts receivable to a third party as a means of obtaining cash
quickly . The most basic accounting principles dictate that in a recourse situation, the
company selling its accounts receivable is still liable to the third party if the custome r
1 ultimately does not pay . Thus, a recourse sale is essentially a loan and should b e
recorded as a liability on the balance sheet, representing an obligation to repay the lende r
if the customer does not .
1 125. FASB Statement of Financial Accounting Standards No . 140, "Accountin g
for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, '
which replaces FASB Statement No . 125, requires the sale of accounts receivable with
recourse be accounted for as a sale only if the following criteria are met :
• the transferred assets have been isolated from the transferor :
• each transferee has the right to pledge or exchange the assets itreceived , and no condition hnth constrains the rancferee (nr
holder) from taking advantage of its right to pledge or
exchange and provides more than a trivial benefit to the
transferor; and
• the transferor does not maintain effective control over the1 transferred assets
126 . Otherwise, the sale of receivables with recourse must be accounted for a s
secured borrowing. FASB No . 140119, 113 .
127 . Here, SmartForce was desperately in need of cash and as a result of its
rapidly deteriorating financial condition, SmartForce sold its accounts receivable with
recourse . Instead of properly recording the factoring arrangement as a loan on th e
42
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balance sheet, SmartForce recorded it as a sale, thereby reducing its accounts receivabl e
and falsely giving investors the impression that customers were satisfied with the produc t
and paying their accounts timely . In the Restatement 8-KIA, Defendants concede that :
During the restatement period, SmartForce entered into a series oftransactions to sell accounts receivable to a financial institution, whichwere accounted for as sales . These financial statements reflect suchtransactions as borrowings, as the criteria with respect to sales of suchaccounts receivable have not been met .
Restatement 8-K/A at Note 1 .
128 . As a result, the Company was required to record a loan payable ,
increasing its liabilities by $4.8 million and $5 .4 million for Fiscal Years 2001 and 2000 ,
respectively . Furthermore, FASB No . 140 (f l7f-g) requires a company to disclose the
details of the factoring arrangement in its financial statements , whether or not there wa s
1 recourse . Here, Defendants failed to disclose any details with respect to these factorin g
arrangements in SmartForce ' s public filings prior to the Restatement 8-K/A, furthe r
evidencing Defendants intention to mislead investors .
1 9. Defendants Admittedly Failed ToWrite Down Assets That Were Permanently Impaired
129. FASB Statement of Financial Accounting Standards No . 115 .
I"Accounting for Certain Investments in Debt and Equity Securities," requires that certai n
investments - e .g ., securities classified as either available-for-sale or held-to-maturity -
that have incurred an impairment that is "other than temporary," below amortized cost to
1 be written down to its fair value, and that an offsetting charge to income be recorded fo r
the impairment . Defendants admit that SmartForce failed to record other than temporar y
losses on its equity investments as a charge to income, in violation of FASB No. 115 .
43
I
FASB No . 115 116, as amended by FASB 130 and FASB 133 . Thus, as part of its
restatement , the Company recorded a total impairment charge of nearly $2 million .
10 . Defendants Admit To Additional Accounting Violations
130 . In addition to the avalanche of improper accounting manipulation s
Defendants employed to inflate SmartForce's revenue and earnings during the Class
Period, Defendants also engaged in a myriad of additional shenanigans that materially
affected SmartForce's financial statements requiring the restatement of nearly every
account . The magnitude of these additional adjustments was particularly astounding
because they involved basic, fundamental accounting concepts and concerned accounts
normally not subject to estimate or interpretation, including cash, fixed assets an d
accounts payable .
131 . For example, it is inconceivable how Defendants could have cumulativel y
overstated SmartForce's cash account by $2 .4 million in total during the Class Perio d
because cash is such an easily verifiable asset that it is virtually impossible, absent fraud,
1 to overstate, i.e ., the money is either in the bank or it is not . Similarly, Defendants
cumulatively overstated SmartForce's property, plant and equipment ("PP&E") account
by $29.8 million during the Class Period, representing approximately one-third of the
originally reported value in each fiscal year . PP&E, too, is an easily verifiable asset, i.e.,
either the company owns the assets and can locate them on the business premises, or it
cannot .' Likewise, accounts payable is not intricate or complex and is easily
determinable - either the Company paid the bill or it did not . Nevertheless, SmartForc
e 2 Notably, the Company made no mention in the Restatement 8-K/A of the reasons why PP&Erequired restatement, leaving investors simply to guess .
44
I
Iunderstated its accounts payable account during the Class Period by a total of $3 .8 3
million .
132 . Moreover, Defendants admit that SmartForce reported amounts in it s
1 shareholder's equity that did not reflect the values contained in SmartForce's detailed
accounting records, which further supports the pervasiveness of Defendant's fraudulen t
accounting practices . It does not get any simpler than that . Specifically, Defendants stat e
Ithat :
A detailed review of equity transactions recorded by SmartForce identifieddiscrepancies between the amounts reflected in the financial statementsrelated to the sale of equity and amounts supported by detailed records.The restatement reflects adjustments to conform the Statement of Changesin Shareholders' Equity and Other Comprehensive Loss to detailed recordsof equity transactions with employees and others .
Restatement 8-K/A at Note I (emphasis added) .
133 . Finally, the Company disclosed that it was required to reduce intangibl e
assets by $32 .8 million during the Class Period to reflect revisions in the value and useful
lives of certain assets and to reduce certain accruals established in connection wit h
Ipurchasing accounting of nine acquisitions .
D. Defendants ' Restatement Had AnEnormous Effect On The Company's Financial Results
134. On September 22, 2003, more than ten months after the Company' s
announcement of improper accounting practices, the Company filed its Restatement 8-
K/A with the SEC, in which the Company reported its restated financial results for Fiscal
Years 1999, 2000, 2001, and for the six months ended June 30, 2002. The restatemen t
was massive and extended far beyond that originally disclosed to investors in the
Company's November 19, 2002 press release ("November 19``' Press Release) . Indeed ,1
45
I
1 as discussed below, Defendants' fraudulent and pervasive accounting schemes spanne d
more than three years, requiring the Company to restate essentially every single incom e
statement and balance sheet account . 3 These facts alone completely undermin e
1 SmartForce's entire financial reporting structure, and give rise to a strong inference o f
fraud . Thus, it is not at all surprising that the Company inconspicuously filed it s
restatement with the SEC, without issuing a corresponding press release to disclose tha t
Ithe restatement was filed .
135 . Specifically, in the Restatement 8-K/A, the Company admits that i t
J
materially overstated its revenues during the Class Period by a total of $113 .6 million, or
16%, and understated its total net losses by $126 .8 million, or 190% for the same period .
Thus, total restated revenue exceeded by nearly four times the $30 million to $32 millio n
/ originally disclosed in the November 19th Press Release. The drastic restatement of ne t
earnings was primarily related to premature revenue recognition and Defendants' failur e
to record material expenses . In addition, the fraudulent conduct alleged herein had a n
1 enormous impact on SmartForce's balance sheet, cumulatively overstating total asset s
and stockholder's equity for the Class Period by a staggering $308.3 nullion and $574 . 2
million, respectively , and understating total liabilities by $265 .9 million . Suc h
I widespread adjustments do not happen by accident and thus, can only be the result of th e
Defendants ' intentional wrongdoing .
136 . The SEC requires that publicly traded companies present their financia l
Istatements in accordance with GAAP . 17 C.F .R. § 210.4-01(a)(l) . GAAP are thos e
3 The only income statement account Defendants did not restate during the Class Period was
"Acquired Research and Development" expense for Fiscal Year 1999, representing a balance of S5 .9million, and only 3 .89% of the Company's operating expenses for that year .
46
I
principles recognized by the accounting profession as the conventions, rules, and
procedures necessary to define accepted accounting practices at a particular time .
137 . SEC Regulation S-X (17 C .F .R. § 210.4-01(a)(1)) provides that financial
statements, that are not prepared in accordance with GAAP, "will be presumed to be
misleading or inaccurate, despite footnote or other disclosures, unless the Commission
has otherwise provided ." Regulation S-X also requires that interim financial statements
must comply with GAAP, with the exception that interim financial statements need not
include disclosures, which would be duplicative of disclosures accompanying annual
financial statements . 17 C.F.R . § 210 .10-01 (a) . The responsibility for preparing
financial statements in conformity with GAAP rests with corporate management as set
forth in Section 110 .02 of the American Institute of Certified Public Accountants
("AICPA") Professional Standards :
The financial statements are management's responsibility . . . .Management is responsible for adopting sound accounting policies and forestablishing and maintaining internal controls that will, among otherthings, record, process, summarize, and report transactions (as well asevents and conditions) consistent with management's assertion embodiedin the financial statements . The entity's transactions and related assets,liabilities, and equity are within the direct knowledge and control ofmanagement . . . . Thus, the fair presentation of financial statements inconformity with [GAAP] is an implicit and integral part of management'sresponsibility.
138 . As set forth in FASB Statement of Concepts No . 1, one of the fundamental
objectives of financial reporting is that it provides accurate and reliable information
concerning an entity's financial performance during the period being presented .
Concepts Statement No . i,142, states :
Financial reporting should provide information about an enterprises'financial performance during a period. Investors and creditors often useinformation about the past to help in assessing the prospects of a n
47
enterprise . Thus, although investment and credit decisions reflectinvestors' and creditors' expectations about future enterprise performance,those expectations are commonly based at least partly on evaluations ofenterprise performance .
139 . SmartForce's financial statements included numerous examples o f
improper accounting practices, ultimately requiring the Company to restate more than
three years of financials . Defendants falsely represented that SmartForce's financial
statements were fairly presented in accordance with GAAP . Specifically, in each of
SmartForce's Forms 10-K filed with the SEC during the Class Period, Defendants
represented that :
The consolidated financial statements are prepared in accordance withgenerally accepted accounting principles in the United States and includethe Company and its subsidiaries in the United States, the UnitedKingdom, Ireland, South Africa, Canada, Germany, Australia, theNetherlands, Sweden, Norway, Denmark, France, Singapore, theCommonwealth of the Bahamas and Grand Cayman after eliminating allmaterial inter-company accounts and transactions .
140 . Similarly, Defendants represented in their quarterly financial statements i n
Forms 10-Q during the Class Period tha t
These interim unaudited consolidated financial statements have beenprepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions to Form 10-Q . . . .We believe that the disclosures are adequate to ensure that the informationpresented is not misleading . . . . In the opinion of management, alladjustments (consisting of normal recurring accruals), considerednecessary for a fair presentation of financial position, results of operationsand cash flows at the dates and for the periods presented have beenincluded .
141 . Defendants' representations that their financial statements were prepare d
in accordance with GAAP were materially false and misleading because SmartForce : (i )
improperly recorded revenue from multiple-element software transactions where n o
vendor specific objective evidence was available ; (ii) improperly recorded revenue fro m
48
0 contracts granting customers "additional rights" before the earnings process was
complete ; (iii) improperly recorded revenue from reseller agreements before its
contractual obligations were fulfilled ; (iv) improperly recorded revenue from barter
transactions ; (v) improperly backdated contracts after quarter end according to the
"Hayes Calendar" discussed herein ; (vi) improperly recorded the transfer of accounts
receivable with recourse as a sale rather than a loan ; (vii) improperly recorded expenses
1as prepaid assets ; (viii) improperly recorded forward foreign currency contracts as
hedges, which did not meet the criteria of a hedge ; (ix) failed to record losses for other
than teitiporary impairment of equity investments ; (x) failed to record legitimate expenses
in its financial records ; (xi) improperly reported SmartForce's revenue backlog, a key
operational metric, to mask its deteriorating financial condition ; and (xii) failed to
properly record and report nearly every single balance sheet and income statemen t
account .
142 . Each of these fraudulent accounting practices, misrepresentations and
omissions , standing alone, was a material breach of GAAP and/or SEC regulations . In
the aggregate, these accounting violations amounted to over a billion dollars of material
misrepresentations that Defendants knowingly or recklessly perpetuated throughout the
1Class Period .
143 . Furthermore, the Company's restatement of its previously reported
financial results during the Class Period constitutes an admission that each of those
statements, as included in SmartForce's press releases and Forms 10-K and IO-Q issued
during the Class Period were materially false and misleading when issued . Under AP B
/
49
0
No . 20, restatements are required for material accounting errors or misstatements .
Section 316 .04 of the AICPA's Codification of Statements on Auditing Standards states :
Misstatements arising from fraudulent financial reporting are intentionalmisstatements or omissions of amounts or disclosures in financialstatements to deceive financial statements users . Fraudulent financialreporting may involve acts such as the following :
• Manipulation, falsification, or alteration of accounting recordsor supporting documents from which financial statements areprepared ;
• Misrepresentation in, or intentional omission from, thefinancial statements of events, transactions, or other significantinformation ;
• Intentional misapplication of accounting principles relating toamounts, classification, manner of presentation, or disclosure .
144 . The Restatement 8-KJA provides a summary of the impact of th e
0 Defendants' fraudulent accounting practices on SmartForce's reported revenue an d
earnings for Fiscal Years 1999 through 2001 and for the first six months of 2002 . The
restatement had an enormous impact on SmartForce' s revenues and earnings .
SmartForcc overstated its revenue by a staggering $63 .2 million, dr ?44%, and by S63 . 9
million, or 32 .3%, for Fiscal Years 2001 and 1999, respectively . In total for the 42-
1
month period ending June 30, 2002, revenue was overstated by over $113 million, or b y
19%. The impact on net loss was even more drastic Specifically, the originally reporte d
$66.7 million net loss for the 42-month period ended June 30, 2002 was understated by a
total of almost $77 million, or by over 115% . Even more astounding is the fact that, but1
for Defendants' fraudulent accounting practices, SmartForce would have reported a ne t
loss for Fiscal Years 2001 and 1999 instead of net income for those periods . Specifically ,
1 for Fiscal Year 2001, SmartForce's originally reported net income of $3 million wa s
50
I
overstated by a whopping $56.6 million, and was actually a net loss of $53 .5 million .
Similarly, for Fiscal Year 1999, SmartForce's originally reported net income of S15.6
million was overstated by almost $70 million and actually was a net loss of $54 .2 million .
145 . The Company also admits in the Restatement 8-K/A that Defendants '
numerous revenue manipulations had the effect of severely overstating account s
1receivable and understating deferred revenue for the corresponding periods . Account s
receivable represents the portion of the Company' s revenue for which the Company ha s
not yet been paid . Deferred revenue represents revenue that has not been earned b y
/ providing goods or se rvices to customers . Specifically, the Company stated that :
With the exception of the adjustments for the reversal of amounts that
were previously provided for uncollectible accounts receivable, all of the
adjustments described above resulted in decreased accounts receivable
(mainly the reversal of amounts previously recorded in accountsreceivable for unbilled revenue) and increased deferred revenue .
Restatement 8-K/A at Note 1 (emphasis added) .
146 . Thus, the Company admits that when revenue was recorded prematurely,
1 as Defendants did here, the corresponding accounts receivable and deferred revenue als o
must be restated .
147 . Defendants overstated accounts receivable by $39 .68 million, or 48 .13% ,
1$52 .93 million, or 51 .70% and $34 .47 million, or 45 .08%, at June 30, 2002, and at
December 31, 2001 and 2000, respectively. Even more alarming was the enormous
impact on deferred revenue, which was understated by $75 .71 million, or 159 .66%, 78 .2 3
million, or 175 .65% and $63.94 million, or 132 .15% at those same dates, respectively.
I
5 1
I
1 148. The balance sheet misstatements were not limited to accounts receivabl e
and deferred revenue . As described herein, all of SmartForce's balance sheet account s
were materially false and misleading.
1 149. In the Restatement 8-K/A, the Company also admits to at least four
specific instances of accounting gimmickry Defendants used to improperly understate
SmartForce's expenses and correspondingly increase earnings, which included : (1 )
1improperly recording expenses as assets ; (2) improperly accounting for forward foreign
currency hedges ; (3) failing to record losses from other than temporary impairments on
equity investments : and (4) intentionally failing to record legitimate expenses in th e1
accounting records . In particular, SmartForce's Prepaid and Other Assets account was
overstated by a shocking $39 .51 million, or 81 .93%, $41 .73 million, or 84 .66%, an d
1 -8.57 million, or 68 .58%, at June 30, 2002, and at December 31, 2001 and 2000 ,
respectively . SmartForce's Intangible Assets account was overstated by $20 .7 million, or
27.76%, $7 .2 million or 9 .67%, and $4 .8 million or 6 .57%, at June 20, 2002, and a t
1 December 31, 2001 and 2000, respectively. SmartForce's Property , Plant and Equipment
account was overstated by $10.9 million or 34 .33%, $12.5 million or 31 .22%, and $6 . 3
million or 21 .4%, at June 20, 2002, and at December 31, 2001 and 2000, respectively .
1 SmartForce's Accounts Payable account was overstated by $1 .26 million or 26 .9%, $1 .3 5
million or 29 .96%, and $1 .22 million or 17 .48%, at June 20, 2002, and at December 31 ,
2001 and 2000, respectively .
1
I
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I
V. THE SCHEME UNRAVELS
A . Defendants ' Improper Accounting Practices Disclosed
150 . Before the opening of trading on November 19, 2002, the Company
shocked investors by issuing a press release announcing that an audit made in connectio n
with SmartForce's closing balance sheet revealed that SmartForce had prematurel y
recognized approximately $30 million to $32 million in revenue during the Class Period .
The Company revealed that , as a result of these "accounting issues ," the Company
intended to restate SmartForce's historical financial statements for Fiscal Years 199 9
through 2001, and for the first two quarters of Fiscal Year 2002 . In addition, th e
Company announced that it would delay the release of its results for the third quarter o f
Fiscal Year 2002 .
151 The November 19th Press Release detailed a multitude of Defendants '
improper accounting practices throughout the Class Period . Specifically, the Compan y
revealed that :
Fir-r, SmartForce recognized approximately $3 .5 million of revenue in thefourth quarter of 2001 under a reseller arrangement . The Company hasnow determined that the proper accounting treatment for that resellerarrangement is to recognize revenue only as payments are received fromthe reseller . The Company expects that this will result in a reversal ofapproximately $3 .5 million of revenue in the fourth quarter of 2001, andthe recording of approximately $1 .4 million of additional revenue during2002, which represents the payments received under that arrangementduring 2002 prior to the merger . This reseller contract remains in effectthrough December 31, 2002, and the Company will recognize up to theremaining $2 .1 million of revenue in the future if such payments continueto be received from the reseller . The Company will also be required toreverse approximately $500,000 in revenue from another customer thathad been recorded in 2000 and instead recognize that revenue in 2001,which will partially offset the $3 .5 million revenue reduction in 2001 .
Second, SmartForce recognized revenue upon shipment of software underseveral customer contracts that involved payment schedules extendin g
53
over several years . Recognition of the revenue upon contract executionwas appropriate, but the amount of revenue recognized immediatelyshould have been discounted to reflect the time value of money inconnection with the payment stream . Accordingly, the Company has
determined to reverse a portion of the $8 million in revenue recognizedunder these agreements and instead recognize that amount as revenue overthe term of the agreements.
Third, SmartForce recognized revenue, upon execution of the customer
contracts, for several transactions to which SOP 97-2 applies . The
Company believes that up to approximately $28 .6 million of revenue from
1999, 2000, and 2001 is subject to uncertainty as a result of this issue .The Company is still in the process of evaluating, in consultation with
SmartForce's auditors, whether it was proper to recognize revenue upon
execution of these contracts . To the extent it was not, the revenue wouldinstead be recognized ratably over the contract period (generally four tofive years) . All of the reversed revenue would likely be recognized as
revenue by [the] Company over the term of the contracts in question ; in
fact, some of the revenue to be reversed would be reflected inSmartForuc's historical financial statements as additional revenue in fiscal
periods subsequent to the execution of the contract . To the extent it is
determined that recognition of revenue upon contract execution wasappropriate, the amount of revenue recognized would have to he
discounted to present value, as described in the preceding paragraph .
Fourth, SmartForce may be required to increase its bad debt reserve as of
December 31, 2001 . Although SmartForce is still examining this issue, it
currently believes the potential adjustment to the reserve may be in therange of $1 million .
Significantly, the Company did not rule out additional material adjustments, reportin g
that its inte rnal investigation may discover additional items on SmartForce's books tha t
need restatement.
152 . Within hours, a myriad of financial news services reported th e
Company 's announcement to a wider audience . On November 19, 2002, Bloomberg
News reported that SmartForce had "recognized revenue too soon . . . when it shipped
software to resellers, or to customers with payment schedules that last several years . "
0 That same day, Dow Jones Newswire reported that the Company intended to restat e
54
SmartForce' s financial statements because SmartForce "improperly accounted fo r
revenue and understated its bad debt reserve . "
153 . In reaction to the November 19th Press Release , the Company's stock
plummeted $1 .57, or 33%, on unusually heavy trading, closing that day at $3 .07 per
share .
154 . Moreover, on November 21, 2002, the Company held a conference cal l
purportedly to "discuss the issues announced on November 19, 2002 ." Nevertheless ,
during the conference call the Company's executives, including Defendant Priest, refused
to discuss the restatement of SmartForce's financial statements . Specifically, the
Company stated that "[w]e do not intend to provide further information about th e
restatement until we, in conjunction with our auditors, reach final closure on the issues . "
The Company also refused to answer any questions related to the SmartForce financia l
statements that were to be restated. Thereafter, information concerning the SmartForce
restatement slowed to a trickle .
1 155. The market reacted negatively to the Company's refusal to provide further
disclosures, causing the Company's stock to lose another 10% of its market value over
the next two months, to close at $2 .73 per share on January 20, 2003 .
B . The SEC Launches An Investiga tion
156. During a conference call on January 21, 2003, the Company announced
for the first time that the SEC had opened an informal probe into SmartForce' accounting
1practices . The Company further revealed that the SEC may launch a formal investigatio n
at some future date .
7
55
7
157 . On February 3, 2003, the Company revealed that the SEC issued a forma l
order of investigation into the Company's accounting practices . Specifically, th e
Company announced that the SEC's investigation centered on "SmartForce's financial
disclosure and accounting during that period, other related matters, compliance with rule s
governing reports required to be filed with the Commission, and the conduct of those
responsible for such matters-" The SEC's investigation is ongoin g
1 158. In response to these revelations, the price of the Company's common stock
steadily declined, falling 15% to close at $2 .44 on February 7, 2003 . By February 18,
2003, the stock price fell an additional 18%, to close at $2 .01 per share .
159 . On September 22, 2003, more than ten months after announcing that th e
Company had improperly recognized revenue in connection with its sottware contracts,
the Company filed with the SEC its Restatement 8-KIA, which included SrnartForce' s
restated consolidated historical financial statements for Fiscal Years 1999, 2000, 2001 ,
and for the six months ended June 30, 2002_ The Company did not .issue a press releas e
1 in connection with its filing. The restatement was massive, and extended far beyond tha t
originally disclosed to investors in the November 19th Press Release, as described in
¶1115-149 herein .
VI . ADDITIONAL SCIENTER ALLEGATIONS
A. The Individual Defendants Had Direc tKnowledge Of And Directly Participated In The Frau d
1 160. Throughout the Class Period, each of the Individual Defendants acte d
intentionally in orchestrating the fraudulent schemes to foster a "culture of aggressive
accounting," and to overstate the Company's revenues and net income . The Individual
Defendants directly participated in, and implemented, a plethora of improper accountin g
56
practices, including : (i) backdating revenue and extending reporting periods through the
"Hayes Calendar" ; (ii) prematurely recognizing revenue from multi-year reselle r
agreements ; (iii) prematurely recognizing revenue from multi-year subscription
agreements ; (iv) improperly accounting for "additional rights" granted to customers,
including contract extensions and discounts ; (v) improperly recognizing revenue from
barter transactions ; and (vi) improperly accounting for expenses as pre-paid assets .
161 . As detailed herein, the Individual Defendants knew of the accounting
manipulations, and knew that they were undertaken to enable SmartForce to meet Wall
Streets' estimates . Specifically, the Individual Defendants reviewed periodic internal
reports, including "Revenue Logs," "Pipeline Reports," "Forecast Reports," "Exception
Reports" and "Contract Information Worksheets ." Moreover, the Individual Defendant s
participated in sales conference calls, and held regular meetings to discuss SmartForce's
sales pipeline, financial outlook and prospects . The Individual Defendants also had
access to the Siebel CRM System, which provided real-time access to deals closed, deal s
in-progress and prospective deals .
162 . The Individual Defendants participated in end-of-quarter revenue
meetings, and directed the manipulation of SmartForce' s revenues and expenses eac h
1 quarter. In pa rt icular, the Individual Defendants directed Trinh and Trudeau t o
prematurely recognize millions of dollars in revenue from multi-year software licensin g
contracts , and to understate SmartForce' s expenses to meet Wall Street's expectations .
163 . The Individual Defendants extended SmartForce's reporting periods
through the "Hayes Calendar," which was designed solely to recognize revenu e
improperly before it was earned . In fact, the Individual Defendants directed th e
57
I backdating of contracts and deposit slips to create the illusion that revenue was earned i n
prior reporting periods .
164 . The Company acknowledges that "the majority of its revenue" comes
1 from software license agreements governed by SOP 97-2 . The Individual Defendant s
were charged with the knowledge of the operative provisions of SOP 97-2, because that
accounting standard applied to the majority of SmartForce's revenue .
1165 . The fact that the Company has restated its financial results for Fisca l
Years 1999, 2000, 2001, and for the six months ending June 30, 2002 constitutes a n
Iadmission that SmartForce reported falsified fi nancial statements throughout the Clas s
Period. Not only does the restatement confirm that SmartForce's reported financia l
results were materially false and misleading, but, based on the magnitude, duration and
pervasiveness of the fraudulent accounting practices detailed above, all of which violated
GAAP and SmartForce's publicly reported accounting policies, the Company's
restatement constitutes strong circumstantial evidence that each of the Individua l
1 Defendants knew or, at a minimum, recklessly disregarded the overwhelming prevalenc e
of improper accounting practices and the falsification of SmartForce's financial results
throughout the Class Period .
1 166. As such , Defendants acted with scienter in that each Defendant knew, o r
recklessly disregarded, that the statements issued or disseminated in the name o f
I
SmartForce were materially false and misleading ; knew, or recklessly disregarded, that
such statements or documents would be issued or disseminated to the investing public ;
and knowingly, or recklessly, participated or acquiesced in the issuance or dissemination
of such statements or documents as primary violations of the federal securities laws .
58
0
B. Insider Tradin g
167 . During the Class Period, the Individual Defendants also were motivated to
engage in the fraudulent practices detailed herein in order to, among other things, reap
illicit insider trading proceeds by selling their holdings of SmartForce common stock at
artificially inflated prices .
168 . As detailed above, the Individual Defendants were privy to non-publi c
information concerning the way SmartForce recorded revenue in violation of GAAP .
Further, the Individual Defendants were intimately involved in directing the fraudulen t
revenue recognition practices discussed herein . In this capacity, each Individual
Defendant had access to material, nonpublic information concerning SmartForce's tru e
financial condition and results of operations .
1 169. Notwithstanding their duty to refrain from trading SmartForce comiiio n
stock under these circumstances, or to disclose the insider information prior to sellin g
Isuch stock, several of the Individual Defendants sold shares of SmartForce commo n
stock at prices that were artificially inflated by Defendants' materially fals e
representations during the Class Period .
' 170. As detailed in the following tables, the Individual Defendants while i n
possession of material, non-public information, sold substantial portions of their holding s
of SmartForce common stock - over 600,000 shares collectively - for proceeds totalin g
0 an astounding $21,591,085 .
171 . As detailed in the following table, during the Class Period Defendan t
Priest exercised options on 240,404 shares at an average exercise price of $7 .00 and
immediately sold at least 167,729, or 69.77%, of those shares at an average market pric e
59
of $28.30, while in possession of material, non-public information . Due to the
Defendants' fraud, these shares traded at an artificially inflated price, allowing Defendant
Priest to reap an immediate windfall of at least $3 .5 million . Additionally, Priest sold
38',,173 shares at an average market price of $41 .00, and realized an additional gain of
over $15 million . According to all of Priest's publicly available Forms 4 and Forms 5
filed with the SEC, it appears from those filings that Priest sold all of the shares he
obtained through the exercise of stock options . In fact, taken together, Priest sold 93 .5%
of his shares and exercised options . As illustrated by the table below, Priest's unusua l
stock trading practices allowed him to personally benefit from the fraudulent scheme b y
over $18 million, establishing a strong inference of scienter .
1
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1
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kyre gory vrlesL tnstaer -)aie s
Date Shares Sold Sale PriceOption Strike
Price Proceeds
10/24/2000 31,360 $52 .8750 $1,658,160 .0 010/2412000 3,800 $51 .2375 $194,702 .5 010/25/2000 16,919 $49 .7663 ~ $842,004 .4 910/26/2000 13,301 $49 .6642 5660,583 .5 210/27/2000 I 11,401 5 51 .8188 $590,786 .1 41oI3n/,)w 760 $48 .8500 $37 .126 .0010/31/2000 759 $47 .9500 $36,394 .051/29/2001 9,105 $44 .7986 5407,891 .2 51/30/2001 15,539 $43 .3247 $673,222 .5 11/31/2001 23,951 $40 .1213 $960,945 .2 6
2/1/2001 45,381 $41 .0781 $1,864,165 . 12 62/2/2001 17,924 $40 .2475 $721,396 .1 9
5/10/2001 10,837 $36 .7933 $398,728 .9 95/11/2001 14,363 $34 .4231
_$494,418 .9 9
5/14/2001 14,450 $33 .8975 $489,818 .8 85/15/2001 17,340 $33 .3938 $5 .2200 5488,533 .69
5/16/2001 26,010 532 .2361 $5 .2200 $702,688 .7 65/17/2001 28,900 $33 .4675 5967,210.757/16/2001 95,377 534 .9020 53,328,905 .2 8
7/17/2001 124,379 $34 .9288 59 .9375 S3,108,392 .9 0
7/18/2001 4.044 $34 .4600 $139 .356.24Total ; 525,900 418,765,431.65
60
172 . As detailed in the following table, during the Class Period Defendan t
1
Drummond exercised options on 90,700 shares at an exercise price of $16 .44 and
immediately sold 100% of those shares, at an average market price of $38 .46, while i n
possession of material, non-public information . Due to the Defendants' fraud thes e
shares traded at an artificially inflated price, allowing Defendant Drummond to reap a n
immediate windfall of nearly $2 million . As identified below, according to all of1
Drummond's publicly available Forms 4 and Forms 5 filed with the SEC, his unusua l
stock trading practices allowed him to personally benefit from the fraudulent scheme b y
1 nearly $2 million , establishing a strong inferciice of scicnter .
1
1
0
David Drummond Insider SalesOption Strit ;e 'Date Shares Sold Sale Price
PriceProfits
10 124 /2000 5 ,407 $52 .8750 5 16 .4375 $197 ,017 .5610124/2000 655 $512375 516 .4375 522 ,794 .0 010/25/2000 2 , 917 349 . 7668 S16 .437-5 $97,221 .5 710/26/2000 2 , 293 549 .6642 $16 . 4375 $76,188 .8 210/27/2000 1 , 966 551 . 8188 S16 .4375 $69,559 .6 410/30/2000 131 548 .8500 $16 . 4375 $4,246 .0 4
10/31/2000 131 $47 . 9500 $16 .4375 54,128 .141 /29/2001 1,570' $44 .7968 $16 .4375 $44 ,524 .1 01/30/2001 2,680 $43 . 3247 $16 . 4375 $72,057 .7 01/31/2001 4,131 540 .1213 $ 16 .4375 $97,837 .7 82/1/2001 7,827 $41 .0781 $16 . 4375 $192.861 .9 82/2/2001 3,092 $40 .2475 $16 . 4375 $73,620.5 2
5/10/2001 1,869 $36.7933 $ 16 .4375 $38,044 .9 95/11/2001 2,477 $34 .4231 $ 16 .4375 ' $44,550.3 35/1412001 2,492 $33 .8975 510 .4375 $43,510.3 25/15/2002 2 , 991 $33 . 3938 $16 . 4375 550,716.2 95/16/2001 4,486 532 . 2361 $16 .4375 $70, 872.525/17/2001 4,9ti5 533 . 4680 $16 .4380 $84 , 894 .5 5
7/16/2001 16 , 450 $34 .9026 $16 .4 375 $303,75 0 .907/17/2001 21,453 $34 .9288 $ 16 .4375 $396,693 .8 67 1 18/2001 697 $34 . 4600 $16 .4375 _12 S 6_1 .6 9
Total : 90,704 $1 , 997,653 .2 8
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1 173. As detailed in the following table, during the Class Period Defendan t
Hayes exercised options on 20,000 shares at an exercise price of $9 .94 and immediately
sold 100% of those shares at an average market price of $51 .34, while in possession of
mate ri al , non-public information . Due to the Defendants' fraud these shares traded at an
artificially inflated price, allowing Defendant Hayes to reap an immediate windfall of
nearly $1 million . As identified below, according to all of Hayes ' publicly available
Forms 4 and Forms 5 fi led with the SEC , his unusual stock trading practices allowed him
to personally benefit from the fraudulent scheme by nearly $1 million, established a
1 strong inference of scienter .
I
John Haves Insider Sale s
Date Shares Sold Sale PriceOption Strike
PriceProfit s
10/24/2000 8,010 $52 .8750 59.9375 I $343,929 .3610/24/2000 971 551 .2375 $9 .9375 $40,102 .3 0
10/25/2000 4,321 .549 .7668 $9 .9375 S 172,102.4 1
10/26/2000 3,397 $49 .6642 $9 .9375 5134,951 .6010/?70-000 2 .912 551 .8188 $9 .9375 $121,958 .3 510/30/2000 194 S48.8500 $9.9375 • $7,549 .0 3
10/31/2000 195 547 .9500 59 .9375 V-4 L2 .44
Total : 20,000 $828,005 .4 9
174. The Individual Defendants' stock sales were unusual and suspicious i n
timing because a great many of them were made in close proximity to SmartForce's
announcements of positive quarterly or year-end results which they knew to be th e
product of, among other improper accounting machinations, fraudulent revenu e
recognition practices . Indeed, all of the Individual Defendants had numerous sales within
the two-week period after SmartForce announced positive third quarter 2000 earning s
results on October 19, 2000 . Defendants Priest, Drummond and Hayes had significant
sales within the two-week period following SmartForce's January 19, 200 0
621
I
1 announcement of positive earnings for the fourth quarter and year-end 2000. Likewise ,
Defendants Priest, Drummond and Hayes had significant sales a mere four days after the
Company's July 12, 2001 announcement of positive financial results for the second
quarter of 2000. In addition, Defendant Priest sold more than 72,000 shares of
SmartForce common stock within five days of SmartForce's issuance of positive results
for the first quarter of 2001 on May 15, 2001 .
175 . The Individual Defendants' stock sales are also unusual and suspicious in
timing because the sales were concentrated, with each of the Individual Defendants
selling stock within the same one-week or two-week period . For example, all of the
Individual Defendants sold a significant number of shares of SmartForce stock during the
one-week period from October 24, 2000-October 31, 2000 . In addition, Defendant s
Priest, Drummond and Hayes sold numerous shares of SmartForce stock during the fivc-
day period from January 29, 2001 to February 2, 2001 and the three-day period from July
16, 2001 to July 18, 2001 .
C. Defendants Falsi fied SmartForce 's Financial
Statements To Meet Analysts' Expectations
176_ Defendants cooked SmartForce's books to meet the expectations of Wai l
Street analysts . As the chart below reflects, with the exception of the fourth quarter of
Fiscal Year 1999, for each quarter during the Class Period SmartForce reported earning s
that either exactly met or barely exceeded analysts' expectations :
1
r
Q1 `99 Q2 '99 Q3 `99 Q4 `99
$0.02 Estimate * 4
$0.03 Reported$0.10 Estimate$0.12 Reported
$0.11 Estimat e$0.11 Reported
$0.16 Estimat e$0.15 Reported
Qi `00 2 '00 Q3 `00 Q4 `00
4 *Re flects the mean estimate as repo rted by FirstCall .
63
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I
($0 .20) Estimate ($0.16) Estimate ($0 .09) Estimate ($0.01) Estimate
($0 .20) Reported ($0.15) Reported ($0 .06) Reported $0.01 Reported
1`01 2'01 3`01 Q4'01
$0.03 Estimate $0.05 Estimate $0.08 Estimate $0.04 Estimate
$0 .04 Reported $0.06 Reported $0.08 Reported $0.04 Reported
Q1 `02 2 `02
($0 .27) Estimate ($0 .17) Estimat e
($0 .26) Reported ($0.15) Reported
Indeed, for thirteen of the fourteen reporting periods during the Class Period ,
SmartForce's earnings were squarely in line with Wall Street's expectations .
D. Defendants' Strategy of "Growth By Acquisition "
177 . The Defendants' explicit strategy of "growth by acquisition" also provide s
a strong inference of scienter . By inflating SmartForce's stock price during the Clas s
Period, Defendants were able to use inflated "currency" to acquire companies at far
cheaper prices than had SmartForce's stock price been fairly valued . Defendants did
little to hide their plan to increase SmartForce's sales and revenue by acquirin g
technologically compatible companies . Indeed, in a March 2, 2000, interview with th e
Wall Street Journal, Defendant Priest clarified SmartForce's corporate strategy of growth
1 by acquisition:
On the side of our making investments in the last five years we've done
six or seven acquisitions . . . . This is a market where the fully vertically
and horizontally integrated business offering every single thing the
customer could possibly want is an utter fantasy . . . . But, this is an
industry where you do have to work with other people in order to be
effective. Whether you do that through partnerships ui acquisitions, you
presumably do it through all of them . This is an important part of our
strategy going forward .
0
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178 . By the end of October 2001, SmartForce had acquired six companie s
during the Class Period, for a total cost of more than $87 million of SmartForce' s
artificially inflated stock .
179 . These acquisitions also were critical in strengthening SmartForce' s
balance sheet so that it would appear more attractive to potential acquirers . As Defendant
Priest noted in his March 2, 2000 interview with the Wall Street Journal, "[iln terms o f
the potential for a strategic investment downstream rather than upstream, I think there are
some potential larger organizations that could deliver us some Leverage and obviousl y
creating an investment structure would give them an incentive and an opportunity to do
that ." In essence, Defendant Priest was using a balance sheet that fraudulently inflated
SmartForce's assets, retained earnings and shareholder equity in order to sell th e
company, and profit from the sale of his inflated shares .
180 . On September 6, 2002, Defendant P riest's statements in his March 2, 2000
Wall Street Journal interview became a reality . On that date, the Defendants parlayed the
1 glowing fi nancial veneer created by their scheme into the Merger with S1illSoft -
consummated using SmartForce's artificially inflated stock as currency .
181 . Additionally, according to the Merger Agreement disclosed in a Form
424(b)(3), dated August 6, 2002, on July 12, 2002 . SmartForce granted to Defendant
Priest and three other SmartForce officers and directors options to purchase an aggregate
of 3,135,000 SmartForce ordinary shares at an exercise price of $3 .30 per share .
182 . The following chart depicts SmartForce's trail of acquisitions,
culminating in the $375 .6 million SkillSoft Merger, as well as the consideration paid i n
each transaction :
65
Transaction Date Target Company Consideratio n
June 18 , 1999 Knowledge Well Approximately 4 .4 millio nordinary shares of CBT Group' sstock valued at $62 .7 millionissued in exchange for al loutstanding Knowledge Wel lstock
March 2, 2000 Advanced Educational Approximately 103,000 ordinar ySystems Limited (AES) shares of SmartForce's stock
valued at $5 .7 million, in additio n
to $1 .6 million in cas hApril 10, 2000 Learning Productions LLC Approximately 225,000 ordinary
shares of SmartForce's stockvalued at $11 .7 million, i naddition to $4 .8 million in cash
-April 2, 2001 IcGlobal Acquisition Corp . $3 million exchangeable into ~j
SmartForce's shares at th eelection of holde r
August 29, 2001 PVIPAXselling .com Approximately 92,000 ordinaryshares of SmartForce's stockvalued at $3 million
October 11, 2001 SkillScape Solutions, Inc . Approximately 17,600 ordinar y
shares of SmartForce's stockvalued at $6 .2 million, in additio nto $600,000 in cas h
September 6, 2002 SkillSoft Corp . $375.6 million worth ofSmartForce's stock based on aconversion ratio of 2 .3674 share s
for every 1 share of SkillSoftstock
In accordance with GAAP, SmartForce recorded a total of $23 .7 in goodwill, and a tota l
of $72.2 million of other identifiable intangible assets, in connection with thes e
acquisitions .
183. But for Defendants' perpetration of the fraudulent scheme alleged herein ,
SmartForce would not have been able to consummate the foregoing acquisitions at th e
price it Paid . Ultimately, SmartForce's spree of acquisitions using artificially inflated
stock as currency allowed SmartForce to inflate its total assets, as well as its revenues an d
66
profits . In fact, SmartForce's total assets grew more than 108% between January 1, 1999
and January 1, 2002. Almost half of the increase, or $95 .9 million, is attributable to the
1
goodwill and other identifiable intangible as sets directly related to the Company' s
acquisitions .
E. Defendants ' History Of Securities Frau d
184. Prior to October 20, 1999, SmartForce was known as CBT. CBT and itsI
former senior officers, including Defendants Priest, Murphy and Hayes, are named as
defendants in another securities class action for violations of the federal securities laws ,
1 In re CBT Group PLC Securities Litigation , Master File No . C-98-21014 -RMBV (N .D .
Cal .) .
185 . The CBT Complaint charges Defendants Priest, Murphy and Hayes with
engaging in fraudulent accounting practices to falsify CBT's publicly reported financial
results, and is based on events that occurred less than one year before the fraudulen t
accounting practices alleged in this Complaint .
186. The District Court in the CBT action sustained the allegations in that
complaint and denied defendants' motion to dismiss on January 3, 2002 .
VII . FALSE STATEMENTS DISSEMINATED DURING THE CLASS PERIOD
A . First Quarter Fiscal Year 199 9
187. On April 27, 1999, CBT issued a press release announcing its financial
results for the first quarter of Fiscal Year 1999, ended March 31, 1999 ("April 27`h Press
Release") . The April 27`h Press Release announced revenues of $40 .2 million, compared
with revenues of $39 .9 million for the first quarter of 1998. The April 27`t' Press Release
further reported net income for the quarter of $1 .3 million, or $0 .03 per share. Toutin g
671
CBT's financial results for the quarter, Defendant Priest was quoted in the April 27`~
Press Release as stating "[f]or the second consecutive quarter, CBT Group has
comfortably met its objectives, demonstrating that our strategies have produced tangible
results ."
188 . In reaction to the April 27`h Press Release, CBT's stock price soared over
25% from $13.12 per share on April 27, 1999 to a closing price of $16.12 that same day .
189 . On May 13, 1999, CBT filed with the SEC its Quarterly Report on For m
10-Q for the quarter ended March 31, 1999 (the "First Quarter 1999 10-Q") . The First
Quarter 1999 10-Q reported substantially the same financial results that were contained in
the April 27`h Press Release . Defendants represented that :
These interim unaudited condensed and consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions toForm 10-Q . . . . [T]he Company believes that the disclosures are adequateto ensure that the information presented is not misleading . . . . In theopinion of management, all adjustments (consisting' of normal recurring
accruals), considered necessary for a fair presentation` of financialposition, results of operations and cash flows at the dates and for theperiods presented have been included .
Defendant Priest signed the First Quarter 1999 10-Q .
B. Second Quarter Fiscal Year 199 9
190 . On July 21, 1999, CBT issued a press release announcing its financia l
results for the second quarter of Fiscal Year 1999, ending June 30, 1999 ("July 21S` Press
Release" ) . The July 21S` Press Release touted CBT's quarterly revenues as the highest
CBT had achieved to date . Specifically, the July 21" Press Release announced that
revenues for the quarter were $47 .2 million, compared with $44 .9 million for the second
quarter of 1998 . The July 21" Press Release further announced that, on a reported basis ,
68
CBT reported a net loss of $370,000, or $0 .0I per share, in comparison to net income o f
$4.1 million, or $0 .09 per share for the second quarter of 1998 . Praising CBT 's results ,
Defendant Priest stated that :
The results of this quarter are particularly noteworthy because theyrepresent the strongest revenues yet achieved in any quarter in thecompany's history . For the third consecutive quarter, we showed positive
progress against our key metrics . The progress of the business quarter hasbeen extremely encouraging .
Not only did we continue to make progress in rebuilding our corebusiness, we also took significant steps that we believe are key to ourmarket leadership over the next several years . With these steps taken, we
believe that we have built a foundation to support a truly powerfulfranchise in professional education .
191 . In response to the July 2152 Press Release , Merrill Lynch & Co . raised its
long-term rating of CBT from "Accumulate " to "Buy ." In addition , CBT's stock price
gained over 22`70 in reaction to the July 21" Press Release, ri sing from an opening p ri c e
of $24 .88 per share on July 21, 1999 to a closing price of $29 per share on the same date .
192_ On August 13, 1999, CBT filed with the SEC its Quarterly Report o n
Form 10-Q fur the quaiter ended June 30, 1999 (the "Second Quarter 1999 10-Q") . The
Second Quarter 1999 10-Q reported substantially the same financial results that were
contained in the July 21S`• Press Release . Defendants further stated :
These interim unaudited condensed and consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q . . . . [T]he Company believes that the disclosures are adequate
to ensure that the information presented is not misleading . . . . In the
opinion of management, all adjustments (consisting of normal recurringaccruals), considered necessary for a fair presentation of financial
position, results of operations and cash flows at the dates and for the
periods presented have been included .
1 Defendant P riest signed the Second Quarter 1999 10-Q .
69
C. Third Quarter Fiscal Year 199 9
193 . On October 19, 1999, SmartForce issued a press release announcing its
financial results for the third quarter of Fiscal Year 1999, ending September 30, 1999
("October 19`s Press Release") . SmartForce announced record revenue growth for the
second straight quarter . Specifically, the October 19th Press Release claimed that
"[r]evenues for the third quarter were $50 .2 million compared to revenues of $35 .2
million for the third quarter of 1998, an increase of 43 percent ." SmartForce further
touted that, on a reported basis, net income for the quarter was $6 .1 million, or $0 .11 per
share before amortization of acquired intangibles, compared to net income of only $2 .9
million, or $0 .06 per share in 1998 . The October 19`h Press Release quoted Defendant
Priest as follows :
The results of this quarter illustrate that SmartForce has tremendousmomentum as it heads into this new phase - the introduction ofSmartForce e-Learning . Not only did we post record revenues and strongearnings growth, but we showed positive progress against our key metrics
for the fourth consecutive quarter. By simultaneously taking a bold stepthat we believe will help ensure our market leadership, over the nextseveral years, we believe that we have built the foundation for a trulypowerful franchise in professional education .
194 . On November 12, 1999, U13T filed with the SEC its Quarterly Report on
Form 10-Q for the quarter ended September 30, 1999 (the "Third Quarter 1999 10-Q") .
The Third Quarter 1999 10-Q reported substantially the same financial results that were
contained in the October 19`h Press Release . In addition, CBT represented that.
These interim unaudited condensed and consolidated financial statementshave been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions toForm 10-Q . . . . [T)he Company believes that the disclosures are adequateto ensure that the information presented is not misleading . . . . In theopinion of management, all adjustments (consisting of normal recurringaccruals), considered necessary for a fair presentation of financia l
70
position, results of operations and cash flows at the dates and for theperiods presented have been included .
Defendant Priest signed the Third Quarter 1999 10-Q .
D. Fourth Ouarter and Year-End Fiscal Year 199 9
195. On January 18, 2000, SmartForce issued a press release announcing its
financial results for the fourth quarter and year-ending December 31, 1999 ("January 18`"
Press Release") . SmartForce announced record quarterly revenue for the third straight
quarter . Specifically, the January 18`h Press Release stated that "[r]evenues for the fourth
quarter were $60 .1 million compared to revenues of $42 .3 million for the fourth quarter
of 1998, an increase of 42 percent year-over-year . . . ." SmartForce further reported that
revenues for 1999 were a record $197 .8 million, compared to $162 .2 million in 1998 .
Net income was reported to be $10 .3 million, or $0 .18 per share, for the fourth quarter of
1999, representing a 368% increase over the fourth quarter for 1995 . Defendant Pries t
was quoted as stating that "[t]he response to SmartForce e-learning has been even more
positive that we anticipated . "
196 . On word of SmartForce's financial performance, SmartForce's stock price
jumped 17co . from an opening price of $36 per share on January 18, 2000 to a closing
price of $42 per share on January 19, 2000, the very next trading day .
197 . On March 30, 2000, SmartForce filed with the SEC its Annual Report on
Form 10-K for Fiscal Year 1999 (the "1999 10-K") . The 1999 10-K reported
substantially the same financial results that were contained in the January 18`h Press
Release . In addition, Defendants represented that :
The consolidated financial statements are prepared in accordance withgenerally accepted accounting principles in the United States and includethe Company and its subsidiaries in the United States, the Unite d
71
Kingdom, Ireland, South Africa, Canada, Germany, Australia, theNetherlands, Sweden, Norway, Denmark, France, Singapore, theCommonwealth of the Bahamas and Grand Cayman after eliminating al l
material inter-company accounts and transactions .
1The Company has historically derived its revenues primarily pursuant tolicense agreements under which customers license usage of delivered
products for a period of one, two or three years . . . . The first year license
fee is generally recognized as revenue at the time of delivery of allproducts, provided the Company's fees are fixed or determinable and
collections of accounts receivable are probable . Subsequent annual
license fees are recognized on each anniversary date, provided the
Company's fees are fixed or determinable and collections of accountsreceivable are probable . . . . For multi-element agreements Vendor
Specific Objective Evidence exists to allocate the total fee to theundelivered elements of the agreement. In addition, the Company derives
revenues from sales of its products, which is recognized upon shipment,
net of allowances for estimated future returns and for excess quantities indistribution channels, provided the Company's fees are fixed or
determinable and collections of accounts receivable are probable .
Revenues from product development arrangements are generallyrecognized on a percentage of completion basis as milestones arecompleted or products produced under the arrangement .
Revenue from license agreements providing product exchange rights otherthan annually during the term of the agreement are deferred andrecognized ratably over the contract period . Such amounts, together withunearned development and license revenues, arc recorded as deferredrevenues in the consolidated financial statements .
Defendants Priest and Hayes signed the 1999 10-K .
198. Several analysts , including Merrill Lynch & Co ., issued research repo rt s
reiterating long-term "Buy" ratings shortly after SmartForce filed its 1999 10-K . W.R .
Hambrecht & Co . issued a report initiating coverage of SmartForce and ratin g
SmartForce as a "Strong Buy" with a target price of $58.00 per share .
72
E. First Quarter Fiscal Year 200 0
199. On April 12, 2000, SmartForce an nounced its financial results for the firs t
quarter of Fiscal Year 2000, ending March 31, 2000 (the "April 12`h Press Release") .
SmartForce reported a fully committed contract backlog of $222 million as of the end of
the quarter, representing the highest backlog level in SmartForce's history . As a result of
this purported backlog, SmartForce reported revenues for the first quarter of 2000 of
$28 .5 million, and recorded a net loss for the quarter of $10 million, or $0 .20 cents per
share . Defendant Priest stated that :
We are extremely gratified by these results, which dramatically exceeded
what even we believed was possible . These results clearly validate our
Internet strategy . Our customers want e-Learning and they are buying it
now .
Priest further stated that :
Our results demonstrate that we have taken the leadership position in thee-Learning market in an extremely short period of time . With this strongbusiness momentum, the launch of our e-Leaiuing object strategy and oure-Business applications, and our acquisitions of AES and LearningProductions, we believe that we are well poised to maintain and extendour market leadership .
200 . On May 15, 2000, SmartForce filed with the SEC its Quarterly Report o n
Form 10-Q for the qua rter ended March 31, 2000 ( the "First Quarter 2000 10-Q") . The
First Quarter 2000 10-Q reported substantially the same financial results that wer e
contained in the April 12`h Press Release . In addition, Defendants represented that :
These interim unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions to Form 10-Q. . . .
[W]e believe that the disclosures are adequate to ensure that the
information presented is not misleading . . . . In the opinion of
management, all adjustments (consisting of normal recurring accnials),
considered necessary for a fair presentation of financial position, results o f
73
operations and cash flows at the dates and for the periods presented havebeen included.
Defendants Priest and Drummond signed the First Quarter 2000 10-Q .
201 . After filing the First Quarter 2000 10-Q, Merrill Lynch issued a report
reiterating its "Buy" rating and raising its price target for SmartForce stock to $70 pe r
share . W.R. Hambrecht & Co . also issued a report reiterating its "Strong Buy "
0 recommendation .
F. Second Quarter Fiscal Year 2000
202 . On July 12, 2000, SmartForce announced strong financial results for th e
second quarter of Fiscal Year 2000, ending June 30, 2000 (the "July 12`h Press Release") .
In the July 121h Press Release , SmartForcc reported revenue of $36 .4 million,
significantly exceeding analysts' expectations . SmartForce repo rted a net loss of only
$7 .6 million, or $0 .15 per share , which beat the First Call consensus estimate of a loss of
$0 .17 per share. The July 12 `h Press Release attributed SmartForce 's strong results to a
fully committed contract backlog of $256 million, representing the highest backlog i n
SmartForce ' s history, as we ll as a 15% sequential increase over the previous quarter' s
backlog. Defendant Priest trumpeted these purportedly stellar results :
Our results clearly demonstrate our leading position in the e-Learningmarket, a position that prompted DC to recognize us as the world's
largest e-Learning company . . . Customers continue to adopt SmartForce
e-Learning at rates far in excess of our original expectations, allowing usto generate a substantial backlog as the base for future business growth .
At the same time we are capitalizing on opportunities to further extend e-
Leaming around the world : Leadership in a B2B Internet businessrequires scale, resources and market reach . We believe that we have
assembled the ingredients necessary to build a powerful, lasting Internet
education franchise .
74
I
203. On August 9, 2000, SmartForce filed with the SEC its Quarterly Report on
Form l0-Q for the quarter ending June 30, 2000 (the "Second Quarter 2000 10-Q") . The
Second Quarter 2000 10-Q reported substantially the same financial results that wer e
0 contained in the July 12th Press Release . In addition, Defendants represented that :
These interim unaudited condensed and consolidated financial statementshave been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to
Form 10-Q . . . . [T]he Company believes that the disclosures are adequateto ensure that the information presented is not misleading . . . . In theopinion of management, all adjustments (consisting of normal recurringaccruals), considered necessary for a fair presentation of financialposition, results of operations and cash flows at the dates and for theperiods presented have been included .
Defendants Priest and Drummond signed the Second Quarter 2000 10-Q .
204 . In reaction to the Second Quarter 2000 10-Q, several analysts, includin g
Merrill Lynch, Chase Hanibrecht & Quist and U .S . Bancorp Piper Jaffray Inc ., issue d
reports publicizing their "Buy" recommendations . In addition, Goldman, Sachs & Co .
issued a report raising its rating of SmartForce from "Recommend" to "Market
Outpcrfo m .°"
205 . In an interview with the Wall Street Journal on September 20, 2000 ,
Defendant Priest reaffirmed SmartForce's financial results, stating that :
I[i]n 1999 we fundamentally recreated the business around using the
Internet to deliver integrated learning to companies . Content, the
education piece, continues to be a key component, but we've added alearning management platform and tools for the creation of learning and
testing. This adds the capability of developing full learning systems that
are tied directly to a company's business goals . We did about $200
million in revenue last year .
75
G. Third Quarter Fiscal Year 200 0
On October 26, 2000, SmartForce announced strong financial
results for the third quarter of Fiscal Year 2000, ending September 30,
2000 (the "October 26`s Press Release") . The October 26th Press release
touted revenues of 545 .6 million, up 25% sequentially from the second
quarter and exceeding analysts' consensus estimates . Net loss for the
quarter minus amortization of intangible assets was 33 million, or $0 .06
per share, which measured 33% better than analysts' expectations of a
$0.09 loss per share . Speaking optimistically of these reported results,
Defendant Priest declared that :
In only three quarters since our general commercial release of SmartForcee-Learning, we have completed the migration of our business from acomputer-based training company to an e-learning solutions company, andwe did so a quarter earlier than even we had hoped . . . . We believe that
this is nothing less than an extraordinary achievement, and we areparticularly gratified that we have met and exceeded the cominiuneuts wemade a year ago concerning the roll-out of our e-Learning solutions . The
transitional period is now behind us, and we are poised to take maximumadvantage of our position as the world's largest e-Learning cuu,pa«y .
206 . Analysts reacted positively to SmartForce's third quarter financial results .
Credit Suisse First Boston issued a report rating SmartForce a "Strong Buy," while
Merrill Lynch issued two reports rating SmartForce a "Buy" at a target price of $70 per
share . In addition, SmartForce's stock price spiked markedly upward, ri sing from an
opening price of $42 .88 per share on October 19, 2000 to a close of $56 .5 per share the
next trading day, representing a two-day increase of more than 31 % .
207 . On November 14, 2000, SmartForce filed with the SEC its Quarterly
Report on Form 10-Q for the quarter ended September 30, 2000 (the "Third Quarter 200 0
76
10-Q") . The Third Quarter 2000 10-Q reported substantially the same financial result s
that were contained in the October 19`s Press Release . In addition, SmartForc e
represented that:
These interim unaudited condensed and consolidated financial statementshave been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions toForm 10-Q. . . . [T]he Company believes that the disclosures are adequateto ensure that the information presented is not misleading . . . . In theopinion of management, all adjustments (consisting of normal recurringaccruals), considered necessary for a fair presentation of financialposition, results of operations and cash flows at the dates and for theperiods presented have been included.
Defendants Priest and Drummond signed the Third Quarter 2000 10-Q .
208. Commenting on SmartForce's positive financial results, on December 24 ,
2000, Defendant Priest was quoted in the Sunday Business Post and stated that "[e]ac h
1 quarter [Smartrbree has] gone and shown what we have dune and every quarter we hav e
exceeded the operational targets we set for Wall Street . "
H . Fourth Quarter And Year-End Fiscal Year 2000
1209. On January 18, 2001, Sman :Force issued a press release announcing it s
I
financial results for the fourth quarter and year-ended December 31, 2000 (the "Januar y
18th Press Release") . Specifically, SmartForce announced that fourth quarter revenue s
were $57 .7 million, up 27% sequentially fruin the third quarter, which exceeded analysts '
expectations by $4 .6 million . Net income for the quarter excluding amortization o f
intangible assets was $648,000, or $0 .01 per share. For Fiscal Year 2000, SmartForc e
announced revenues of $168 .2 million . The net loss for the year, before amortization of
intangibles, was $20 .1 million, or $0 .39 per share . The January 18`a Press Release quote d
I Defendant Priest as stating that :
77
SmartForce had a terrific quarter. . . . We reported profitability a quarterahead of schedule, making us one of the few Internet companies - and theonly e-Learning company - that has reached this milestone . At the sametime, we signed a record number of million dollar-plus agreements,customers are embracing our new e3 platform, and we ended the year witha strong backlog of business for 2001 . The fourth quarter results reflectthe benefits of the strategy we've undertaken of providing mission-criticale-Learning solutions that serve our customers' strategic businessinitiatives . We intend to continue this focus in 2001 as we seek to extendour leadership position in the e-Learning market space .
210. On March 21, 2001, an article in the Wall Street Journal quoted Defendan t
Drummond as stating:
We are the only e-learning company that is profitable. We were, as CBT
Systems, always a profitable company . When we moved to SmartForce,
because we've changed the offering, we had to account for our revenues
differently, and that had the account of moving out some revenues from2000, that we otherwise would have had, into future periods . Because of
that, we actually had a loss for the first three quarters of 2000 . We
returned to profitability in the fourth quarter of 2000, and that was aquarter ahead of schedule . We expected that that wouldn't happen until
the first quarter of 2001 . So we have returned to profitability, we did that
a quarter early, and we are the only profitable company in the space .
Defendant Drummond further commented on SmartForce's financial condition a s
1follows :
We have the leading position in that market . We are the largest companyin the industry by a significant factvi, more than twice the size of our
nearest competitor. We've got a complete solution to address the market
that's not matched by anybody else in the space . We've got a financialmodel that is extremely attractive . Because of the way we recognize the
revenues, we have a high degree of visibility in our revenues . For
instance, in the $265-270 million that we expect to recognize this year,$135 million was already done when Nye came into the year because of our
backlog of committed business . Similarly, about 5190 million of the
$370-$380 million, we expect to do in 2002 will come out of backlog thatwe already have going into the year. So it's an extremely visible business
model and already a profitable one . So there's not a worry that this will
turn a profit .
781
211 . On April 12, 2001, SmartForce filed with the SEC its Annual Report o n
Form 10-K for the fiscal year ended December 31, 2000 (the "2000 10-K") . The 200 0
10-K reported substantially the same financial results that were contained in the Januar y
19`h Press Release.
212. In addition, Defendants represented in the 2000 10-K that :
The consolidated financial statements are prepared in accordance with
generally accepted accounting pri nciples in the United States (US GAAP)
and include the Company and its subsidiaries in the United States, the
United Kingdom, Ireland, South Africa , Canada, Germany, Australia, the
Netherlands, Sweden, Norway, Denmark, France , Singapore, theCommonwealth of the Bahamas and Grand Cayman after eliminating allmaterial inter-company accounts and transactions .
*xx*
The Company recognizes revenues primarily from software licenses . The
Company recognizes a majo rity of its business pursuant to e-Learning
rental agreements under which customers rent access to the Company's
lea rn ing environment for a period of time, such as one, two or three years .
Revenue from e-Lea rning rental agreements is generally deferred and
recognized ratably over the term of the agreement provided a signedcontract or other persuasive evidence of an arrangement exists, the
Company's fees are fixed or determinable and collections of accounts
receivable are probable .
The Company also recognizes revenue pursuant to legacy software license
agreements under which customers license usage of delivered products for
a period of time, such as one, two or three years . . . . The first year license
fee is generally recognized as revenue at the time of delive ry of all
products , provided a signed contract or other persuasive evidence of anarrangement exists, the Company's fees are fixed of detetminahle and
collections of accounts receivable are probable . Subsequent annual
license fees are recognized on each anniversa ry date, provided a signed
contract or other persuasive evidence of an arrangement exists, the
Company's fees are fixed or determinable and collections of accounts
receivable are probable . Revenue from license agreements providingproduct exchange rights other than annually du ring the term of the
agreement are deferred and recognized ratably over the contract pe ri od .
The Company has entered into agreements with customers to rent access
to the Company 's learn ing environment and to provide certain
professional serv ices, management fees and or the resale of third parties '
79
instructor-led training to the customer. Revenues from the non-rentalcomponent of these agreements will generally be recognized as servicesare performed provided a signed contract or other persuasive evidence ofan arrangement exists, the Company's fees are fixed or determinable andcollections of accounts receivable are probable .
In addition, the Company derives revenues from sales of its products,which are recognized upon shipment, net of allowances for estimatedfuture returns and for excess quantities in distribution channels, providedpersuasive evidence of an arrangement exists, the Company's fees arefixed or determinable and collections of accounts receivable are probable .Where no such vendor specific objective evidence exists revenue isrecognized ratably over the life of the agreement .
Defendants Priest and Drummond signed the 2000 10-K .
213. In reaction to SmartForce's 2000 10-K, UBS Warburg reiterated its "Bu y
recommendation for SmartForce and raised its target price from S42 to $53 per share .
First Quarter Fiscal Year 200 1
214. On April 18, 2001, SmartForce issued a press release announcing it s
financial results for the first quarter of Fiscal Year 2001, ending March 31, 2001 (the
"April 181 h Press Release") . SmartForce posted record revenues of $61 .3 million, a
figure that was 115% higher than the first quarter of 2000 . SmartForce further reported
net income of $2 .3 million, or 50 .04 pci share, prior to amortization of intangible assets,
representing a 300% increase over income per share for the fourth quarter of 2000 .
Defendant Priest expressed his confidence in the reported financial results and stated :
Our first quarter results are yet another validation of our dual strategy of
leveraging our global customer base and using our e-Learning solutions to
forge new market opportunities . We executed strongly against ourobjectives for the first quarter, we achieved record revenues, earnings over
performance and strong performance on all of our key operating metrics .We remain confident in our ability to extend our leadership position in2001 and beyond.
80
w 215, During a conference call with Wall Street analysts on April 18, 2001 ,
Defendants Priest and Drummond commented on SmartForce's first quarter Fiscal Yea r
2001 results, reporting substantially the same financial results that were contained in th e
April 18`h Press Release .
216. On May 1 5 , 2001, SmartForce filed with the SEC its Quarterly Report o n
1Form 10-Q for the quarter ended March 31, 2001 (the "First Quarter 2001 10-Q") . The
First Quarter 2001 10-Q reported substantially the same financial information that wa s
contained in the April 18`x' Press Release . In addition, Defendants represented that :
These interim unaudited condensed and consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions toForm 10-Q . . . . [T]he Company believes that the disclosures arc adequate
to ensure that the information presented is not misleading . . . . In the
opinion of management, all adjustments (consisting of normal recurringaccruals), considered necessary for a fair presentation of financial
position, results of operations and cash flows at the dates and for the
periods presented have been included .
Defendants P riest and Drummond signed the First Quarter 2001 10-Q .
I
i
217. Analysts reacted positively to SnitutForce's first quarter Fiscal Year 200 1
results . Several analysts, including W.R. Hambrecht & Co., issued reports reiterating
their "Strong Buy" rating of SmartForce . Others, including US Bancorp Piper Jaffra y
Inc ., reiterated a "Buy" recommendation . In addition, SmartForce's stock price rose 22 %
in direct reaction to its financial results for the first quarter of Fiscal Year 2001, movin g
1 from a close of $26 .85 per share on April 17, 2001 to a close of $32 .91 per share o n
April 19, 2001 .
1
81i
I J. Second Quarter Fiscal Year 2001
218. On July 12, 2001, SmartForce issued a press release announcing it s
financial results for the second quarter of Fiscal Year 2001, ending June 30, 2001 (the
"July 12`t' Press Release") . SmartForce reported record revenues of $66 .1 million in th e
second quarter of 2001, exceeding the previous year 's second quarter revenues by S2% .
SmartForce also posted net income of $3 .6 million, or $0.06 per share, before1
acquisition-related amortization, in excess of the First Call consensus by 20%. For the
six-month pe riod, SmartForce recorded revenues of $127 .4 million , representing a n
1 increase of 96% over the mid-year revenues for 2000 . In addition, Defendant Priest
heralded the results and stated that :
We are very pleased with our second quarter results . We deliveredanother quarter of strong financial performance, exceeding our previousguidance for revenues and earnings and significantly increasing our
operating cash flow. That we were able to achieve these results in thecurrent difficult market environment is particularly gratifying . Wecontinue to be confident in the market opportunity available to [theCompany] and in our ability to execute against that opportunity .
219 . On August 14, 2001, SmartForee filed with the SEC its Quarterly Report
on Form 10-Q for the quarter ended June 30, 2001 (the "Second Quarter 2001 10-Q") .
The Second Quarter 2001 10-Q reported substantially the same financial results that were1
contained in the July 12th Press Release . In addition, SmartFurce represented that :
These interim unaudited condensed and consolidated financial statementshave been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions to
Form 10-Q . . . . [T)he Company believes that the disclosures are adequateto ensure that the information presented is not misleading . . . . In the
opinion of management, all adjustments (consisting of normal recurring
accruals), considered necessary for a fair presentation of financialposition, results of operations and cash flows at the dates and for the
periods presented have been included .
82
1 Defendants Priest and Drummond signed the Second Quarter 2001 10-Q .
220. Following SmartForce's Second Quarter 2001 10-Q, several analysts ,
1
including W.R. Hambrecht & Co ., Deutche Banc Alex Brown and Thomas Weise l
Partners, reiterated their "Strong Buy" recommendations . Other analysts, includin g
Merrill Lynch and Credit Suisse First Boston, reiterated their "Buy" ratings . In addition ,
the market reacted positively to the news, driving SmartForce's stock price from a close1
of $29 .72 per share on July 11, 2000 to a closing price of $36 .5 per share on July 13 ,
2000, an increase of nearly 23%.
1 K. Third Quarter Fiscal Year 200 1
221. On October 17, 2001, SmartForce issued a press release announcing it s
financial results for the third quarter of Fiscal Year 2001, ending September 30, 2001 (the
0 "October 17`h Press Release") . The October 17`h Press Release announced tha t
SmartForce met its revenues and earning expectations for the third quarter, postin g
revenues of $68 .1 million, up 49% from the same period a year earlier. Net income wa s
Ireported to have increased to $4.7 million, or $0 .08 pci sharc, representing a year-over-
1U
year earnings increase of $7 .7 million . Moreover, the October 17a' Press Release toute d
record nine-month earnings of $195.5 million, compared to $110 .5 million for the first
nine months of 2000, representing a 77% increasc . Defendant Priest was quoted a s
follows :
We believe that our ability to meet third quarter revenue and earningstargets notwithstanding the events of September 11 and their aftermath
reflects the predictability and leverage of [the Company's] businessmodel . Going forward, [the Company] is in the fortunate position to be
able to continue investing in the growth of the business, which we believewill not only help us weather the current economic environment, but also
position us to extend our leadership position .
C83
0 222. Du ring a conference call with Wall Street analysts on October 17, 2001 ,
Defendants Priest and Drummond reported on SmartForce's third quarter results fo r
Fiscal Year 2001, providing substantially the same information contained in the Octobe r
0 17`h Press Release.
223 . On November 14, 2001, SmartForce filed with the SEC its Quarterl y
Report on Form 10-Q for the quarter ended September 30, 2001 (the "Third Quarter 200 1
10-Q"). The Third Quarter 2001 10-Q reported substantially the same financial result s
that were contained in the October 17`t' Press Release . In addition , SmartForce
1 represented that :
These interim unaudited condensed and consolidated financial statementshave been prepared in accordance with generally accepted accounting
principles for interim financial information and with the instructions toForm 10-Q . . . . [T]he Company believes that the disclosures are adequateto ensure that the information presented is not misleading . . . . In the
opinion of management, all adjustments (consisting of normal recurringaccruals), considered necessary for a fair presentation of financial
position, results of operations and cash flows at the dates and for the
periods presented have been included .
Defendants P riest and Drummond signed the Third Quarter 2001 IO-Q _
224. In reaction to the Third Quarter 2001 10-Q, SmartForce's stock pric e
I
increased nearly 19%, opening at $18 .90 per share on November 14, 2001 and closing a t
$22.43 per share on November 16, 2001 .
L . Fourth Quarter And Year-End Fiscal Year 200 1
1 225. On January 16, 2002, SmartForce issued a press release announcing it s
financial results for the fourth quarter and year ending December 31, 2001 (the "Januar y
16`h Press Release") . SmartForce reported that revenues for the fourth quarter were u p
1 13% from the fourth quarter of 2000, totaling $65 .3 million . Net income was in line wit h
84
n
1 analysts ' estimates of $2 .6 million, or $0 .04 per share . Defendant Priest noted that
SmartForce was "encouraged by the strength we saw in the quarter and are particularlti
pleased with the success our sales force is having in selling solutions that are critical t o
1 our customers' business initiatives . "
226. During a conference call with Wall Street analysts on January 16, 2002 ,
Defendants Priest and Drummond reported on SmartForce's fourth quarter and year-end1
results for Fiscal Year 2001, providing substantially the same financial results that wer e
contained in the January 16`s Press Release . Defendant Priest stated :
We met our Q4 revenue target, delivering a record $65 .3 million ofrevenue against a consensus estimate of $65 million . This represents thehighest quarterly revenues in SmartForce's history - the fourthconsecutive quarter that we've achieved that milestone . We also met ourQ4 earnings target, coming in at 4 cents a share, in line with our target .For the year, we recorded revenues of $261 million, a 55 percent increaseover revenues of $168 million in 2000 . . . . To achieve that target during,what was the most challenging year for enterprise software in recentmemory is, I think, an accomplishment.
(Emphasis added) . Moreover, Defendant Priest further stated that :
SmariForce booked more business in December than in any previousmonth this year. We again exceeded our target of $5 million plus
contracts for the quarter - our average contract size for the quarter, again,was up sequentially for the 13`h consecutive quarter, dollar renewal rates
for the quarter continued (indiscernible) at over 150 percent. We had, in
short, a very solid quarter that met our expectations in a time of significanteconomic dislocation .
227. Defendant Drummond assessed SmartForce's purported performance o n
the January 16, 2002 conference call by noting that "in an . . . overall economic1
environment that continues to be cliallcuging, we were able to achieve solid performanc e
against our key operating metrics ."
85
228 . During this same conference call on January 16, 2002, Howard Block, an
analyst with Banc of America Securities, asked Defendants Priest and Drummond t o
explain SmartForce 's reported drop in deferred revenues in light of the fact that it als o
reported increased booking for the quarter . Specifically, W. Block asked :
I'm really sort of startled to reconcile the sequential decline in deferredrevenue, particularly with comments about December being the bestbookings month, and considering that 3Q's numbers were so challengedby September 11th, anyway, if you could just elaborate on that .
Defendant Priest responded as follows :
Sure . . . . (W]hat we said on that October 1 conference call, and what wethen subsequently said later in October, is that our view was that the
impact on September 11`h was, first and foremost, and most immediately,
a disruption in the practicalities of sales cycles, but what, we also expectedto see and what we did in fact see, was just there's still lots of activity, but
an increased level of nervousness on the part of companies generally about
signing deals . And therefore, we expected October and November to belight_ October and November were light . December was quite strong, aswe mentioned, but the overall effect - that was not a onetime episodic
event, that only had a momentary impact, that was an event that was goingto have a going forward impact . We thought it was going to have a going
forward impact, we planned for it, we guided on the basis of it, and when
you look at what actually happened, we were pretty much spot - on inwhat we predicted. So, we said at that time that we thought this was theway it was going to play out - a variety of metric standpoints, including
where deferred revenue was going to go, and it happened the way ithappened .
229 . On March 12, 2002, SmartForce filed with the SEC its Annual Report on
Form 10-K for the fiscal year ended December 31, 2001 (the "2001 10-K") . The 200 1
10-K reported substantially the same financial information contained in the January 16t h
Press Release .
230. In addition, Defendants represented in the 2001 10-K that :
The Company recognizes the majority of its revenues pursuant to softwarelicense agreements . The Company recognizes revenue from softwarelicense agreements in accordance with the provisions of the America n
86
Institute of Certi fied Public Accountan ts ("AICPA") Statement of Position("SOP") 97-2, Software Revenue Recognition , as amended by SOP 98-4
and SOP 98-9 ("SOP 97-2, as amended") . Revenue is recognized fromsoftware license agreements when persuasive evidence of an arrangement
exists, delivery has occurred , the fee is fixed or determinable andcollectibility is probable .
The Company's software license agreements generally include multiple
elements, which may include such elements as access on an ASP basis to
hosted content or platform services for a specified number of years, up-
front software licenses, software rentals for a specified number of years,professional services, maintenance and resale of third parties' products
and services . Where possible, the Company allocates revenue to each
element based on vendor-specific objective evidence ("VSOE") inaccordance with the provisions of SOP 97-2, as amended, and recognizes
the revenue associated with each element in accordance with relevantrevenue recognition requirements for that element . Where VSO1 dots not
exist, the Company aggregates the elements and recognizes the revenues
with respect to all elements on delivery of the last-delivered elements, as
provided in SOP 97-2, as amended .
Revenue associated with customer access to hosted content or platformservices is generally deferred and recognized ratably over the term of the
agreement . . . , Revenue associated with software rentals providingproduct exchange rights other than annually during the term of theagreement are generally deferred and recognized iatably over the term ofthe agreement.
. . *
Revenue associated with the resale of third parties' products and servicesare generally recognized as above, depending on the character of theproduct or service resold .
Defendants Priest and Drummond signed the 2001 10-K .
M. First Quarter Fiscal Year 2002
231 . On April 18, 2002, SmartForce issued a press release announcing it s
financial results for the first quarter of Fiscal Year 2002, ending March 31, 2002 (th e
"April 18`h Press Release") . SmartForce posted revenues of $43 million . Net losse s
87
before amortization of acquired intangibles and one-time charges in connection with a n
aborted merger were reported at $14 .9 million, or $0 .26 per share .
232. On May 15, 2002, SmartForce filed with the SEC its Quarterly Report on
Form 10-Q for the quarter ended March 31, 2002 (the "First Quarter 2002 10-Q"). The
First Quarter 2002 10-Q reported substantially the same financial results that wer e
contained in the April 18`h Press Release . In addition, SmartForce represented tha t
These interim unaudited condensed and consolidated financial statementshave been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions toForm 10-Q . . . . [T]he Company believes that the disclosures are adequateto ensure that the information presented is not misleading . . . . In theopinion of management, all adjustments (consisting of normal recurringaccruals), considered necessary for a fair presentation of financialposition, results of operations and cash flows at the dates and for theperiods presented have been included .
1 Defendants Priest and Murphy signed the First Quarter 2002 10-Q .
N. Second Quarter Fiscal Year 200 2
233 . On July 18, 2002, SmartForce issued a press release announcing its
1financial results for the second quaver of Fiscal Year 2002, ending June 30, 2002 ("July
181h Press Release") . SmartForce reported revenues of $44 .4 million and net losses o f
$0.15 per share before acquisition and restructuring related charges . Commenting o n
SmartForce' s financial status, Defendant Piicst stated :
We are, on the whole, encouraged by our second quarter performance with
respect to our revenue, bookings and balance sheet objectives . We
continued to experience a very challenging market environment . And theenvironment was made all the more challenging for [the Company] by theissues that we faced this quarter surrounding missing our first quarter
revenue and earnings targets, planning and making a major reduction in
our staff and planning the execution of a major merger . Notwithstandingall of these challenges, we kept our eyes on the ball, and our performance
stabilized, and even improved modestly . We see this as a positive sign .
88
234. During a conference call with Wall Street analysts on July 18, 2002 ,
Defendant Priest reported on SmartForce's second quarter results for Fiscal Year 2002 ,
providing substantially the same financial results described in the July 18`t' Press Release .
In addition, Defendant Priest added that :
In short, customers are getting value from their investments in eLearning
and from their contracts with SmartForce . This means that they're
evaluating new opportunities to work with us and engaging in sales cycles .
To be sure, the sales cycles are longer and harder but deals are still getting
done because customers are seeing value from their investments in
el-earning. They are signing more deals and signing more significant
deals with SmartForce than with any other company, bar none. Though
the operating environment is making every deal more challenging to get,the deals arc there - and they are getting done .
235 . On August 14, 2002, SmartForce filed with the SEC its Quarterly Report
on Form 10-Q for the quarter ended June 30, 2002 (the "Second Quarter 2002 10-Q") .
The Second Quarter 2002 10-Q reported substantially the same financial results that wer e
contained in the July 18`' Press Release . In addition, SmartForce represented that :
These interim unaudited condensed and consolidated financial statements
have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to
Form 10-Q. . . . [T]he Company believes that the disclosures are adequate
to ensure that the information presented is not misleading . . . . In theopinion of management, all adjustments (consisting of normal recurring
accruals), considered necessary for a fair presentation of financial
position, results of operations and cash flows at the dates and for the
periods presented have been included .
Defendants Priest and Murphy signed the Second Quarter 2002 10-Q .
0. Revenue Recognition Policie s
236 . Defendants also violated SmartForce's stated revenue recognition pcilicie c
throughout the Class Period for Fiscal Years 1999, 2000 and 2001, each quarte r
contained therein, and for the six month period ended June 30, 2002 .
89
237 . In the 1999 10-K, Defendants provided assurances that SmartForce
recognized revenue from individual elements of multiple-element software contract s
separately, only where vendor specific objective evidence of fair value was available .
Specifically, the 1999 10- K states that :
For multi-element agreements Vendor Specific Objective Evidence existsto allocate the total fee to the undelivered elements of the agreement .
1 238. SmartForce's 2000 10-K provides similar assurances and states, i n
relevant part :
For multi-element agreements Vendor Specific Objective Evidence exists toallocate the total fee to the various elements of the agreement . . . . Where no such
vendor specific objective evidence exists revenue is recognized ratable over the
life of the agreement .
239 . SmartForce's 2001 10-K provides similar assurances with respect t o
vendor specific objective evidence :
Where possible, [the Company] allocate[s] revenue to each element basedon vendor specific objective evidence ("VSOE") in accordance with the
provisions of SOP 97-2, as amended, and recognize[] the revenue
associated with each element in accordance with the relevant revenuerecognition requirements for that clement . Whcic VSOE dots not exist,
[the Company] aga egate[s] the elements and recognizes the revenues
with respect to all elements on delivery of the last-delivered elements, asprovided in SOP 97-2, as amended .
240 . As disclosed in the Second Quarter 2002 10-Q, Defendants falsely assure d
investors that :
Where possible, we allocate revenue to each clement based on vendor
specific objective evidence ("WSOE")in accordance with the provisions of
SOP 97-2, as amended, and recognize the revenue associated with eachelement in accordance with the relevant revenue recognition requirementsfor that element . Where VSOE does not exist, we aggregate the elements
and recognize the revenues with respect to all elements on delivery of thelast delivered elements . . . .
90
i241 . In reality, however, Defendants admit that they did not have vendo r
specific objective evidence to support revenue recognition separately for each element i n
these multi-element software transactions . Defendants concede in the Restatement 8-K/ A
that they prematurely recognized millions of dollars of revenue in direct contravention o f
SmartForce's internal policies :
Smartforce did not have vendor specific objective evidence of the fair value of its
products and se rv ices as de fined in Ame rican Institute of Ce rtified PublicAccountants ("AICPA") Statement of Posi tion ("SOP") 97-2, "Software RevenueRecognition ," as amended by SOP 98-4 and SOP 98-9 ("SOP 97 -2, as amended"),to permit separate revenue recognition for individual elements included inmultiple-element transactions .
242. Defendants also violated SmartForce's revenue recognition policies wit h
respect to reseller agreements . Specifically, Defendants provided false assurances that
SmartForce recognized revenue associated with resellci agreements in accordance wit h
GAAP. As disclosed in the 1999 10-K, Defendants represented, in relevant part :
In addition, the Company derives revenues from sales of its products, which is
recognized upon shipment, net of allowances for estimated future return and forexcess quantities in distribution channels, ptovidcd the Company's fees are fixed
or determinable and collections of accounts receivable are probable .
243 . Similarly, in the 2000 10-K, Defendants repeated essentially the sam e
I false representation, stating that :
Revenue from e-Learning rental agreements is generally deferred andrecognized ratably over the term of the agreement provided a signed
contract or other persuasive evidence of an arrangement exists, theCompany's fees are fixed or determinable and collections of accounts
receivable are probable .
244. Likewise, Defendants disclosed in the 2001 10-K :
Revenue is recognized from software license agreements when persuasive
evidence of an arrangement exists, delivery has occurred, the fee is fixed
or determinable and collectibility is probable .
91
245 . In the Restatement 8-K/A, Defendants admit that they did not recognize
revenue from reseller agreements in accordance with SmartForce's revenue recognition
policies but, rather, Defendants recognized revenue immediately upon delivery and
before their contractual obligations were satisfied and collectibility was probable .
Specifically, Defendants concede "for certain reseller arrangements, recognition o f
1 revenue should be deferred until the contractual obligation to the end user had bee n
fulfilled and payment had been received . "
246 . Defendants also violated a myri ad of inte rnal accounting policies related to
SmartForce 's balance sheet accounts for Fiscals Year 2000 and 2001 and each quarte r
therein .
247 . In SmartForce's 2001 10-K and 2000 10-K, Defendants disclose that :
"[r]esearch and development expenditures are generally charged to operations as
incurred ." Notwithstanding SmartForce's stated policy, Defendants did not record
research and development expenses as a charge to income when incurred but rather as an
asset on the balance sheet . Specifically, Defendants admit in the Restatement S-K/A that
in contravention of company policy, "SmartForce had capitalized or established a s
prepaid assets certain costs associated with the development of content . This accounting
treatment was inconsistent with SmartForce's general policy of expensing content
development as it is incurred . Such amounts were restated to conform to SmartForce's
policy ."
248 . Similarly, in SmartForce's 2001 10-K and 2000 10-K, Dcfcndants disclos e
that "[d]eferred sales commissions are charged to expense when the related revenue is
recognized ." Defendants now admit in the Restatement 8-K/A that rather than properl y
92
I
recording the sales commissions as an expense when SmartForce recognized the
corresponding revenues in accordance with SmartForce' s internal policy, Defendants
recorded these sales commissions as prepaid assets . Furthermore, in the Restatement 8-
KIA, Defendants also concede that "there was not adequate business justification an d
detailed accounting records were not maintained to support this accounting treatment . "
IThe Company has thus "expensed all sales related commissions as period costs whe n
they were incurred . "
249. Lastly, Defendants violated SmartForce's internal policy relating to
foreign currency exchange contracts for Fiscal Year 2000 . Specifically, in the 2000 10-
K, Defendants state that "[i]n 1999 and 2000 a gain or loss on a forward contract that is
intended to hedge an identifiable foreign currency firm commitment was deferred and
/ included in the measurement of the related foreign currency transaction ." Defendant s
now admit in the Restatement 8-KJA that they improperly accounted for these foreign
currency transactions as hedges, because the corresponding commitment "did not mee t
1the criteria of a firm commitment" and thus should not have been included in die
measurement of SmartForce's operating expenses .
P. Joint Proxv Statement/Prospectus
250 . On June 20, 2002, SmartForce and SkillSoft filed with the SEC an d
disseminated to the public the Registration Statement on Form S-4 . Subsequently, on
1 July 30, 2002, SmartForce and SkillSoft filed with the SEC and disseminated to th e
public the Amended Registration Statement on Form S-4/A ("Registration Statement"),
which included the Joint Proxy Statement/Prospectus for SmartForce PLC/Skillsoft
1
931
' Corporation containing detailed information concerning both companies and th e
prospective merger ( the "Joint Proxy") .
251 . The Forms S-4 and S -4/A were both signed by, among others , Defendant
Priest, as President and Chief Executive Officer of SmartForce PLC, and Defendant
Murphy, as Vice President of Finance and Acting Principal Accounting Officer .
252. The Joint Proxy, which was signed by, among others , Defendants Priest
and Murphy , was sent to the shareholders of both companies on or about August 8, 2002 ,
253. The Registration Statement and Joint Proxy includes Merger Agreement ,
which was attached as Annex A to the Registration Statement and Joint Proxy. In the
Merger Agreement, SmartForce and Skilisoft represented as follows :
4.5 SEC Filings; Financial Statements; Information Provided.
(a) SmartForce has filed all registration statements , forms, repo rts and
other documents required to be filed by SmartForce with the SEC
since January 1, 2000 and has made available to SkillSoft copies of allregistration statements , forms , reports and other documents filed by
SmartForce with the SEC since such date, all of which are available on
the SEC's EDGAR system . All such required registration statements,
forms, reports and other documents (including those that SmurtForce
may file after the date hereof until the Closing) are referred to herein
as the "SmartForce SEC Repo rts ." The SmartForce SEC Reports (i)
were or will be filed on a timely basis, ( ii) at the time fled, were or
will be prepared in compliance in all material respects with the
applicable requirements of the Securities Act and the Exchange Act,
as the case may be, and the rules and regulations of the SEC
thereunder applicable to such SntartForee SEC Reports , and (iii) did
not or will not at the time they were or are filed contain any untrue
statement of a material fact or unit to state a material fact required
to be stated in such SmartForce SEC Reports or necessary in order
to make the statements in such SmartForce SEC Reports, in the lightof the circumstances under which they were made, not misleading ---
(b) Each of the consolidated financial statements (including, in each case,any related notes and schedules) contained or to be contained in
SmartForce SEC Reports at the time filed (i) complied or will comply
as to form in all material respects with applicable accountin g
94
► requi rements and the published rules and regulations of the SEC withrespect thereto, ( ii) we re or will be prepared in accordance with GAAP
applied on a consistent basis throughout the pe riods involved (exceptas may be indicated in the notes to such financial statements or, in thecase of unaudited inte rim fi nancial statements , as permitted by th e
► SEC on Form 10-Q under the Exchange Act) and ( iii) fairly presentedor will fairly present in all material respects the consolidated financialposition of SmartForce and its Subsidiaries as of the dates indicatedand the consolidated results of SmartForce and its Subsidiaries'operations and cash flows for the pe riods indicated , consistent with thebooks and records of SmartForce and its Subsidiaries , except that theunaudited inte rim financial statements were or are subject to normaland recur ring year-end adjustments which were not or are not expectedto be mate rial in amount .
(Emphasis added .)
1254. The Joint Proxy included the following message to shareholders : -[T]h e
boards of directors of SmariForce and SkiliSoft have unanimously approved a merge r
between SmartForce and Skil]Soft . . . The attached joint proxy statement/prospectus1
provides detailed information conce rn ing SmartForce, SkillSoft, the merger and th e
proposals related to the merger . . . . "
255 . The Joint Proxy further stated :
In order to complete the merger, both companies must obtain the approval
of their shareholders . . . . Please give all of the information contained in
the joint proxy statetueut/prospectus your careful attention .
After careful consideration, the boards of directors of both SmartForceand SkiliSoft have unanimuu3ely determined the merger to be fair to, and
in the best interests of the respective shareholders of their companies .
The boards of directors of both companies have approved the mergeragreement and unanimously recommend that the shareholders of their
respective companies vote FOR the proposals related to the merger.
(Emphasis in original . )
256. The Joint Proxy explained that the record date for eligibility to vote on the
Merger was August 2, 2002, and that the Special Stockholders Meetings for SmartForc e
95
I
and SkillSoft shareholders would both take place on September 6, 2002 .
257 . The Merger required and received the affirmative vote of the SmartForce
and SkiliSoft shareholders at the respective Special Stockholders Meetings .
258 . The Registration Statement and Joint Proxy included selected financial
data of SmartForce, including the audited financial statements of SmartForce for Fisca l
Years 1999, 2000 and 2001, and unaudited historical interim condensed consolidate d
financial statements for the three-month periods ending March 31, 2001 and March 31 ,
2002 .
259. The Registration Statement also incorporated by reference, inter alia, the
documents set forth below, each of which included some or all of the materially untru e
and misleading financial statements and information referred to herein :
(a) SmartForce's annual report on Form 10-K, as amended, for the fiscal
year ended December 31, 2001 (filing date April 30 . 2002) ; and
(b) SmartForce's quarterly report on Form 10-Q for the quarter endedMarch 31, 2002 (filing date May 14, 2002) .
260 . The statements identified above for Fiscal Years 1999, 2000, 2001, and fo r
the first and second quarters of Fiscal Year 2002 are admittedly false and misleading . On
September 22, 2003, the Company filed the Restatement 8-KJA with the SEC restatin g
1SmartForce's consolidated financial statements for Fiscal Years 1999, 2000, 2001, an d
for the six months ended June 30, 2002 . As a result, in addition to the reasons set forth i n
IJ42-149 above, the statements contained in 9[9[187, 189, 190, 192-95, 197, 199, 200,
202-03, 205-06, 208-13, 215-17, 219-20, 222-24, and 226-260 were materially false an d
misleading when made because :
96
(a) Defendants knowingly or recklessly overstated SmartForce's total
revenues by at least $113 .6 million and understated net losses by at leas t
$126.8 million during the Class Period ;
(b) Defendants knowingly or recklessly overstated revenue by improperl y
recording revenue from bundled software sales transactions up front where
vendor specific objective evidence was not available to support revenu e
recognition, instead of ratably over the term of the agreements ;
(c) Defendants knowingly or recklessly overstated revenue from contract s
granting "additional rights" such as contract extensions, credits an d
discounts by improperly recording the full amount of revenue up front ,
rather than ratably over the term of the agreement ;
r (d) Defendants knowingly or recklessly overstated revenue by prematurel y
recording revenue from agreements with resellers before SmartForc e
fulfilled its contractual obligations and received payment :
(e) Defendants knowingly or recklessly overstated revenue by recordin g
revenue from agreements with resellers where collectability was no t
probable ;
(f) Defendants knowingly or recklessly recorded revenue from barter
transactions, which amounted to nothing more than a mere swap o f
SmartForce's goods and services for that of another company . Such
swaps, according to GAAP, do not culminate the earnings process an d
thus revenue should not have been recognized ;
97
I (g) Defendants knowingly or recklessly overstated both accounts receivabl e
and understated current liabilities by $4 .8 million and $5 .4 million for the
years ended December 31, 2001 and 2000, respectively, by failing to
properly record the transfer of SmartForce's accounts receivable, wit h
recourse, as a liability . Instead, Defendants improperly recorded th e
transfer as a sale of accounts receivable . Moreover, Defendants failed to1
disclose any details of this factoring arrangement, as required by GAAP ;
(h) Defendants knowingly or recklessly understated expenses by improperl y
recording bona fide expenses as prepaid assets . Specifically, Defendants
recorded commissions, research and development costs and other
undisclosed expenses as prepaid assets, resulting in the understatement of
expenses and net losses . In addition, Defendants also cumulativel y
overstated total prepaid and other assets by $109 .8 million during the
Class Period ;
_(i) Defendants knowingly or recklessly understated losses by improperly
recording forward foreign currency transactions as hedges when the
hedged foreign currency commitment was not a "firm" commitment . As a
result, SmartForce was not permitted to offset related gains and losse s
against measurement of the commitment ;
1 (j) Defendants knowingly or recklessly understated losses by failing to recor d
other than temporary impairment losses on equity investments as a charg e
to income ;
981
(k) Defendants knowingly or recklessly understated net losses by failing to
record bona fide expenses as a charge to income ;
(1) Defendants knowingly or recklessly failed to disclose significant events or
trends having a material impact on SmartForce's financial statements ,
such as changing trends in sales ;
(m) Defendants knowingly or recklessly manipulated virtually every balance1
sheet account which had the effect of cumulatively overstating cash by
$2.4 million, cumulatively overstating intangible assets by $32 .8 million,
cumulatively overstating property, plant and equipment by $29 .8 million,
cumulatively understating accounts payable by $3 .8 million, cumulatively,
understating accrued liabilities by $34 .0 million, cumulativel y
understating deferred revenue by $217 .8 million and cumulativel y
overstating stockholder's equity by $574 .2 million ;
(n) Contrary to Defendants' representations , SmartForce's financia l
I statements were not prepared in accordance with the instructions to Form
10-Q and Article 2 of Regulation S-X that requires that the statements be
prepared in accordance with GAAP ;
r(u) Contrary to Defendants' representations, SmartForce's financial
statements did not reflect all adjustments of normal recurring nature
necessary for a fair statement of results for the interim periods presented ;
(p) Defendants knowingly or recklessly caused SmartForce to engage in the
accounting irregularities identified above ; and
r
99b
(q) Defendants knowingly or recklessly disregarded the fact that SmartForce' s
reported financial results were materially inflated by the imprope r
accounting activities identified above .
X . CLASS ALLEGATIONS
261 . Lead Plaintiffs bring this action as a class action under Rules 23(a) and
23(b)(3) of the Federal Rules of Civil Procedure on behalf of a class consisting of Lead
Plaintiffs and all persons or entities who : i) purchased SmartForce ADSs trading on the
NASDAQ under the ticker symbol "SMTF" from April 27, 1999 through September 6,
2002; ii) acquired SmartForee's ADSs as pan of the Merger between SkillSoft Corp . and
SmartForce on or about September 6, 2002 ; or iii) purchased the Company's ADSs
trading on NASDAQ under the ticker symbol "SKIL" from September 6, 2002 through
and including November 18, 2002 . Excluded from the Class are the Defendants herein ,
and the officers and directors of SmartForce, SkillSoft Corp. and/or the Company and the
members of their immediate families, any entity in which any of the Defendants has a
controlling interest or is a parent or subsidiuuy of or is controlled by^the Company and the
officers, directors, affiliates, legal representatives, heirs, predecessors, successors and
assigns of any of the excluded persons or entities (the "Class") .
262 . The Class is so numerous that joinder of all members is impracticahl e
The Company had in excess of 99 .615 million shares of its common stock outstanding as
of May 30, 2003 . There are believed to be thousands of persons who purchased the
Company's securities during the Class Period . From April 27, 1999 through September
6, 2002, the Company's ADSs were traded on NASDAQ under the ticker symbo l
r
100
"SMTF." The Company's ADSs are currently trade on NASDAQ under the symbol
"SKIL."
263 . Lead Plaintiffs' claims are typical of the claims of the other members of
the Class, as Lead Plaintiffs and all members of the Class sustained damages arising out
of Defendants' conduct in violation of federal law, as complained of herein .
264 . Lead Plaintiffs will fairly and adequately protect the interests of the
members of the Class and have retained counsel competent and experienced in class
actions and securities litigation .
1 263. A class action is superior to other available methods for the fair and
efficient adjudication of this controversy since joinder of all members is impracticable .
Furthermore, as the damages suffered by individual members of the Class may b e
1 relatively small, the expense and burden of individual litigation make it impossible for
the members of the Class individually to redress the wrongs visited upon them . There
will be no difficulty in the management of this action as a class action .
1 266. Common questions of law and fact exist as to all members of the Class and
predominate over any questions affecting solely individual members of the Class .
Among the questions of law and fact common to the Class are :
1 v(a) whether the federal securities laws were violated by Defendants' acts as
alleged herein ;
(b) whether statements disseminated by Defendants to the investing public
and to Class members du ring the Class Period omitted andlor
misrepresented mate ri al facts about the business , operations, prospects and
financial condition of the Company ;
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(c) whether Defendants acted willfully, knowingly, or in a severely reckless
manner in omitting and/or misrepresenting such material facts ;
(d) whether Defendants' non-disclosures and/or misrepresentations constituted
a fraud on the market by artificially inflating the market price of
SmartForce (SMTF) and/or Company (SKIL) securities during relevant
times of the Class Period ; and
(e) whether the members of the Class have sustained damages and, if so, what
is the proper measure of such damages .
XI. LEAD PLAINTIFFS' INVESTIGATION
267 . Lead Plaintiffs' allegations as set forth herein are based on a thorough
investigation, conducted by and through their attorneys, of all reasonably availabl e
1 sources of information so as to permit them to plead the claims alleged herein with
particularity . The nature and scope of Lead Plaintiffs' efforts to obtain the information
needed to plead with particularity included :
(a) Reviewing SmartForce's, SkillSoft Corp .'s, and the Cwrnpaily's filings
with the SEC during the relevant time period, including but not limited to
SmartForce's :
i• Annual Reports on Form 10-K for Fiscal Years 1999, 2000 and 2001 ;
• Quarterly Reports on Form 10-Q for the first, second and third fiscal
quarters of 1999, 2000 and 2001 ;
• Quarterly Reports on Form 10-Q for the first and second quarters of 2002 ;
• Forms 8-K ;
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0 • Registration Statement on Forms S-4 and S-4/A, which were filed wit h
the SEC on June 20, 2002 and July 30, 2002, respectively ;
• Definitive Joint Proxy Statement/Prospectus on Schedule 14A ;
0 • Acquisition Statement on Form 13D filed with the SEC on June 10, 2002 ;
• Individual Defendants' Forms 144, Forms 4 and Forms 5 ; and
• Restatement 8-KIA filed with the SEC on September 22, 2003 .
(b) Reviewing SmartForce's press releases, analyst conference call
transcripts, and other publicly-disseminated statements made by
Defendants during the relevant time period ;
(c) Reviewing reports, articles, and discussions concerning SmartForce.
SkiliSoft Corp . and the Company and the subject matter of this Complaint
contained in the print and electronic media and computer databases ;
(d) Reviewing reports of securities analysts and investor advisory service s
concerning SmartForce and the e-learning industry ;
(o) Reviewing pleadings filed with the United States District Court for the
Northern District of California in the action captioned In re CBT Group
PLC Securities Litigation , Master File No . C-98-21014-RMW (N .D. Cal .) ;
pleadings filed with California Superior Court in the action captioned
KPMG International Investments B .V. v . Sm artForce, et al . , Civil Case
No. 422722 (San Mateo County) ; pleadings filed with the United States
District Court for the District of Minnesota in the actions captioned
Hussey v . SmartForce PLC n/k/a SkillSo ft, Civil File No. 03-172 8
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ADMVUAJB and Dunham v. SmartForce PLC n/k/a Skil]Soft, Civil File No .
03-1729 RHK/AJB ;
(f) Interviewing former employees of SmartForce with first-hand knowledge
of SmartForce's business, corporate reporting structure, financial dealings
and accounting practices .
(g) Consultating with experts .
268 . Except as alleged in this Complaint, the underlying information relating to
Defendants' misconduct and the particulars thereof is not currently available to Lead
Plaintiffs and the public, and lies exclusively within the possession and control of
Defendants and other insiders at the Company, thus preventing Lead Plaintiffs from
further detailing Defendants' misconduct at this time .
XII . FRAUD ON THE MARKET PRESUMPTIO N
269. Lead Plaintiffs will rely, in part, upon the presumption of reliance
established by the fraud-on-the-market doctrine, in that :
(a) Defendants made public misrepresentations or failed to disclose material
facts regarding SmartForce's and the Company's financial results and
operations during the Class Period ;
(b) The omissions and misrepresentations were material ;
(c) SmartForce's and the Company's ADSs trade on NASDAQ, an efficient
and open market ;1
(d) The misrepresentations and omissions alleged would tend to induce a
reasonable investor to misjudge the value of SmartForce and/or the
Company's ADSs ;
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► (e) Lead Plaintiffs and the members of the Class purchased or obtained thei r
SmartForce's and/or the Company's ADSs between the time Defendant s
failed to disclose or misrepresented material facts and the time the true
facts were disclosed, without knowledge of the misrepresented facts ; and
(f) SmartForce's and/or the Company's ADSs traded on NASDAQ and were
followed by numerous financial analysts, including, inter alia, Merrill
Lynch, Credit Suisse First Boston, William Blair & Co ., Brean Murra y
Securities, Legg Mason Wood Walker Inc ., Banc of America, Thoma s
Weisel Partners, ]U.S . Bancorp Piper Jaffray, Inc ., UDS Warburg, W .R .
Hambrecht & Co ., Deutche Banc Alex Brown and Chase Hambrecht & .
Quist . Thus, the price of SmariForce's and/or the Company's securitie s
1 reflected the effect of news disseminated in the market .
270. Based on the foregoing, Lead Plaintiffs and the members of the Class are
entitled to the presumption of reliance upon the integrity of the market .
XIII . THE SAFE HARBOR PROVISION IS INAPPLICABL E
271. The statutory safe harbor under the Private Securities Litigation Reform
Act of 1995, which applies to forward-looking statements under certain circumstances ,
does not apply to any of the allegedly false statements pleaded in this Complaint . The
statements alleged to be false and misleading herein all relate to then-existing facts and
conditions . In addition, to the extent certain of the statements alleged to be false may be
characterized as forward-looking, they were not adequately identified as "forward-
looking statements" when made, and there were no meaningful cautionary statements
identifying important factors that could cause actual results to differ materially fro m
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those in the purportedly forward-looking statements . Alternatively, to the extent that the
statutory safe harbor is intended to apply to any forward-looking statements pleaded
herein, Defendants are liable for those false forward-looking statements because, at the
time each of those forward-looking statements was made, the particular speaker ha d
actual knowledge that the particular forward-looking statement was materially false or
misleading, and/or the forward-looking statement was authorized and/or approved by an
executive officer of SmartForce who knew that those statements were false when the y
were made .
COUNT I
Against All Defendants For ViolationsOf Section 10(b) Of The Exchange Ac t
And Rule 10b-5 Promulgated Thereunde r
272. Lead Plaintiffs repeat and reallege the allegations contained in th e
preceding paragraphs .
273. During the Class Period, Defendants carried out a plan, scheme and course
="of conduct, which was intended to, and did : (a) deceive the investing public, includin g
Lead Plaintiffs and other Class members as alleged herein, by making various false
statements of material fact and omitting to state material facts to make the statement s
made not misleading to Lead Plaintiffs and the other members of the Class ; (b) artificiall y
inflate and maintain the market price of SmartForce's and/or the Company's ADSs ; and
(c) cause Lead Plaintiffs and other members of the Class to purchase and/or obtai n
SmartForce's or the Company's ADSs at inflated prices by employing rnanipulutive 01
deceptive devices and contrivances .
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1 274. In furtherance of this unlawful scheme, plan and course of conduct ,
SmartForce, the Company and the Individual Defendants took the actions set forth herein .
275 . By engaging in the conduct in connection with the sale of SmartForce's
andJor the Company's securities, as set forth in this Complaint, 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 statements made
not misleading; and (c ) engaged in acts , practices , and a course of business which
operated as a fraud and deceit upon the purchasers of SmartForce ' s and/or the
Company' s secu ri ties in an effort to inflate and maintain the artificially high marke t
prices for SmartForce's and/or the Company's securities in violation of Section 10(b) of
the Exchange Act and Rule lOb-5 promulgated thereunder by the SEC . Each Defendant
is sued as a primary participant in the wrongful and illegal conduct charged herein .
276. In addition to the duties of full disclosure imposed on Defendants as a
result of their making of affirmative statements and reports to the investing public,
Defendants had a duty promptly to disseminate truthful information that would be
material to investors in compliance with the integrated disclosure provision for the SEC
as embodied in SEC Regulation S-X (17 C .F.R. Sections 210 .10 et se q .), Regulation S-K
I(17 C.F .R . Sections 229 .10 et sec l .) and other SEC regulations, including accurate and
truthful information with respect to SmartForce's and/or the Company's business,
operations and financial condition and performance, so that the market price of
SmartForce's and/or the Company's eoirunon stock would be based upon truthful ,
complete and accurate information .
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1 277. The Individual Defendants , as officers and directors of SmartForce and/o r
the Company, either had actual knowledge of. or recklessly disregarded, the materia l
omissions and/or the falsity of the material statements set forth above and intended t o
deceive the Lead Plaintiffs and the other members of the Class, or acted with reckles s
disregard for the truth when they failed to ascertain and disclose the true facts in the
statements they or other SmartForce or Company personnel made to the SEC, Lead
Plaintiffs and other members of the Class . Defendants also had the motive an d
opportunity to commit securities fraud, as set forth more fully above .
278 . The facts alleged herein provide a strong inference that Defendants made
material false and misleading statements to the investing public with scienter, in that
Defendants : (a) knew or recklessly disregarded that the public statements issued or
disseminated in the name of SmartForce and/or the Company were materially false an d
misleading ; (b) knew or recklessly disregarded that such statements would be issued or
disseminated to the investing public ; and (c) knowingly and substantially participated or
acquiesced in the issuance or dissemination of such statements as primary violators of th e
federal securities laws .
279 . Insider selling is highly probative of Defendants' scienter in their scheme ,
artifice to defraud, or acts, practices of course of conduct in violation of Section 10(b)
and SEC Rule lOb-5. While Defendants were issuing false favorable statements abou t
1 SmartForce's business and concealing or obscuring negative information, the Individua l
Defendants, with access to confidential information and awareness of the truth abou t
SmartForce and its financial condition, were benefiting from the illegal course o f
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► business or course of conduct described herein by selling their own holdings o f
SmartForce 's securities at artificially inflated prices .
280 . As a result of the dissemination of the materially false and misleadin g
information and failure to disclose material facts, as set forth above, the market prices o f
SmartForce and the Company's securities were artificially inflated during the Clas s
Period. In ignorance of this fact, and relying directly or indirectly on : (a) the false an d
misleading statements made by Defendants ; (b) the integrity of the market in which th e
securities trade ; and/or (c) the absence of material adverse information that was known to
1 or recklessly disregarded by Detendants but not disclosed by Defendants during the Clas s
Period, Lead Plaintiffs and members of the Class acquired SmarcForce's and/or th e
Company's securities during the Class Period at artificially high prices and wer e
1 damaged thereby. Lead Plaintiffs and other members of the Class were ignorant of th e
misrepresentations, omissions and deceptions and reasonably believed that Defendants '
misrepresentations were true . Had Lead Plaintiffs and other members of the Class an d
the marketplace known of the true financial condition, operativu5, performance an d
business prospects of SmartForce and/or the Company, which were concealed by th e
Defendants, Lead Plaintiffs and other members of the Class would not have purchase d
Smartrorce's and/or the Company's securities during the Class Period, or, if they had ,
they would not have done so at the artificially inflated prices that they paid .
1 281. As a result of Defendants' conduct, Lead Plaintiffs and the other member s
of the Class purchased and/or obtained Swar-Torce' s and/or the Company 's secu ri tie s
du ring the Class Period and were damaged thereby .
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COUNT I I
Against All Defendants For Violations Of Section 14(a )
Of The Exchange Act And Rule 14a-9 Promulgated Thereunder
282. Lead Plaintiffs repeat and reallege the allegations contained in th e
preceding paragraphs .
283. This claim, brought pursuant to Section 14(a) of the Exchange Act an d
1 SEC Rule 14a-9 promulgated thereunder, is alleged directly against each Defendant i n
this action .
284. Defendants caused to be issued the Joint Proxy which was distributed t o
1 SkillSoft's and SmartForce's shareholders .
285 . The Joint Proxy described herein was a "proxy solicitation" within the
meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder .
286 . The Joint Proxy was materially false and misleading in that it containe d
false and misleading statements and failed to disclose material information, as set fort h
above .
287 . Defendants sought to secure SkillSoft and SmartForce shareholde r
approval of the Merger by means of the materially false and misleading Joint Proxy .
288 . Defendants, at the time they issued the Joint Proxy, acted negligently an d
without due care in distributing or causing to be distributed the Joint Proxy containing th e
false and misleading statements and omissions .
289 . The Merger required and received the affirmative vote of the SmartForce
and SkillSoft shareholders at the respective Special Stockholder Meetings held on
September 6, 2002 . Accordingly, the material and misleading Joint Proxy was an
essential link in the accomplishment of the Merger .
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COUNT II I
Against The Individual Defendants For ViolationsUnder Section 20(a) of The Exchange Ac t
290 . Lead Plaintiffs repeat and reallege the allegations contained in the
preceding paragraphs .
291 . This claim is asserted against the Individual Defendants who each acted as
controlling persons of SmartForce and/or the Company and each other within the
meaning of Section 20(a) of the Exchange Act, as alleged herein . By virtue of their high -Z7 -
level positions , their substantial stock ownership, their participation in and/or awareness
of SmartForce's and the Company's operations and/or their intimate knowledge of th e
SmartForce's and the Company's financial condition, products and the actual progress of
its development efforts, the Individual Defendants had the power to influence an d
1 control, and did influence and control , directly or indirectly, the decision-making of
SmartForce and the Company and each other, including the content and dissemination of
the various statements that Lead Plaintiffs contend are false and misleading . The
Individual Defendants had, or were provided with, unlimited access to copies of
SmartForce's and the Company's internal reports, press releases, puhlic Filings and other
statements alleged by Lead Plaintiffs to be misleading prior to, and/or shortly after ,1
SmartForce and the Company issued these statements and thus had the ability to preven t
the issuance of the statements or cause them to be corrected .
1 292. The Individual Defendants, as a result of their positions with SrnartForc e
and/or the Company, had direct and supervisory involvement in the day-to-day operation s
of SmartForce and/or the Company, as well as the power to control or influence the
1 public statements being made by, or on behalf of, SmartForce and/or the Company, th e
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fact that their signatures were required on SmartForce's and the Company's SEC filings,
and the course of their individual holdings of SmartForce's and the Company's securities .
These facts se rve as further indicia of the Individual Defendants' control over SmartForc e
and the Company and each other within the meaning of Section 20(a) of the Exchange
Act .
293. As set forth above, all of Defendants violated Section 10(b) and SEC Rul e
10b-5 by their acts and omissions as alleged in this Complaint . By virtue of their position
as controlling persons of SmartForce and the Company and each other, the Individual
Defendants ate alsu liable pursuant to Section 20(a) of the Exchange Act . As a direct and
proximate result of the Individual Defendants' wrongful conduct, Lead Plaintiffs an d
other members of the Class suffered damages in connection with their purchases o f
SaiaitForce's and/or the Company's common stock during the Class Period .
PRAYER FOR RELIE F
WHEREFORE, Lead Plaintiffs, on their behalf and on behalf'of the Class, pray
fur judgment as follows :
A. Declaring this action to be a proper class action and ce rtifying Lead
Plaintiffs as the class representatives under Rule 23 of the Federal Rules of Civi l
1Piucedurc ;
B . Awarding compensatory damages in favor of Lead Plaintiffs and the other
members of the Class against all Defendants, jointly and severally, for the damages
sustained as a result of the wrongdoings of Defendants, together with interest thereon ;
C. Awarding Lead Plaintiffs the fees and expenses incurred in this action,
including reasonable allowance of fees for Lead Plaintiffs' attorneys and experts ;
112
D . Granting extraordinary equitable and/or injunctive relief as permitted b y
law, equity and federal and state statutory provisions sued on hereunder , including
attaching, impounding , imposing a construc tive trust upon or otherwise rest ricting the
proceeds of Defendants ' trading activities or their other assets so as to assure that Lead
Plaintiffs and other members of the Class have an effective remedy; and
E. Granting such other and further relief as the Court may deem just an d
proper.
JURY TRIAL DEMANDED
Lead Plaintiffs demand a trial by jury of all issues so triable .
Dated: October 31, 2003 Respectfully submitted ,
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Joh,, B . Garvey (-'907)John R . Harrington (#4820)SULLOWAY & HOLLIS, P.L.L.C .9 Capitol Stree tConcord, NH 03302(603) 224-234 1
Liaison Counsel for Lead Plaintiffs
BERMAN DEVALERIO PEASETARACC O BlTRT & PUCILLO
LfG,
!fi tGlen DeValerioKathleen M . Donovan-MaherBryan A. Woo dN. Nancy GhabaiOne Liberty SquareBoston, Ma S sachusctts 02109
(617 ) 542 -8300
~. V r
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Ski IISofL P/I933ActComptaint_Fina]
BERNSTEIN LITOWITZ BERGER &GROSSNUNN LL P
Joh . Coffey `Jeffrey N . Leibel lJoseph A. Fonti1285 Avenue of the AmericasNew York, New York 1001 9(212) 554-1400
Lead Counsel for Lead Plaintiffs
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CERTIFICATE OF SERVICE
I hereby certify that copies of the foregoing Consolidated Class Action Complaint forViolations of the Securities Exchange Act of 1934 were served this 31" day of October, 2003 as
follows :
Via hand delivery to Edward A. Haffer, Esquire and via federal express overnight to
William H. Paine, Esq . attorneys for defendants SmartForce and Gregory M . Priest .
Via Mail to defendants David C . Drummond and Patrick Eric Murphy.
A
John Harrington
