1 second consolidated amended class action complaint for violations of federal securities

UNITED STATES DISTRICT COURT DISTRICT OF MARYLAND

IN RE HANGER ORTHOPEDIC GROUP, INC. SECURITIES LITIGATION

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Case No. 8:06-cv-00579-AW ECF Case SECOND CONSOLIDATED AMENDED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS JURY TRIAL DEMANDED

Plaintiffs, by their attorneys, on behalf of themselves and the class they seek to represent,

for their Second Consolidated Amended Class Action Complaint For Violations Of Federal

Securities Laws (the “Complaint”), make the following allegations against defendants Hanger

Orthopedic Group, Inc. (“Hanger” or the “Company”), Thomas F. Kirk, George E. McHenry and

Ivan R. Sabel based upon the thorough investigation conducted by and under the supervision of

plaintiffs’ counsel in order to obtain the information necessary to plead the claims herein with

particularity. Plaintiffs’ investigation included reviewing and analyzing information and

financial data concerning Hanger relating to the “Class Period” (March 13, 2002 through

September 15, 2004, inclusive) and obtained from numerous public and proprietary sources

(such as LEXIS-NEXIS, Dow Jones, and Bloomberg), including, among other things, filings

with the Securities and Exchange Commission (the “SEC”), publicly available annual reports,

press releases, published interviews, news articles, investor conference calls, and other media

reports (whether disseminated in print or by electronic media), and reports of securities analysts

Case 8:06-cv-00579-AW Document 70 Filed 06/12/2006 of 82

and investor advisory services. Plaintiffs’ investigation also included interviewing or consulting

with numerous individuals, including former Hanger employees who worked at the Company

during the Class Period and are knowledgeable about Hanger’s business and operations and/or

the industry and markets in which Hanger operates. Except as alleged herein, the underlying

information relating to defendants’ misconduct and the particulars thereof are not available to

plaintiffs and the public and lie exclusively within the possession and control of defendants and

other insiders, thus preventing plaintiffs from further detailing defendants’ misconduct.

Plaintiffs believe that further substantial evidentiary support will exist for the allegations set

forth below after a reasonable opportunity for discovery.

NATURE OF THE ACTION

1. This is a federal class action on behalf of purchasers of the securities of Hanger

between March 13, 2002 and September 15, 2004, inclusive (the “Class Period”) seeking to

pursue remedies under the Securities Exchange Act of 1934 (the “Exchange Act”).

2. Defendant Hanger describes itself as “the world’s premier provider of orthotic

and prosthetic patient-care services,” which, as of December 31, 2003, operated 585 patient-care

facilities throughout the United States. The Company’s business and stock price are crucially

dependent on maintaining compliance with federal and state rules, and on its reputation in the

health care community.

3. Throughout the Class Period, defendants made statements that represented that

Hanger’s business was being operated in compliance with federal, state and local regulations,

and was free from insurance-related fraud.

4. Unbeknownst to investors, however, as detailed herein, defendants were engaged

in an illegal scheme to bilk the Medicaid and Medicare programs, the Veterans Administration

and private insurers in order to artificially inflate the Company’s financial performance.

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Specifically, during the Class Period, Hanger improperly booked sales by, inter alia, forging

prescriptions and other documents necessary for obtaining reimbursement from insurers

(including Medicare and Medicaid), charging insurers for items or services that were not

prescribed for, or not provided to patients, and misrepresenting to insurers the type of items, or

the scope of the services, provided to patients — all in order to increase bills to Medicare,

Medicaid and private insurers, thereby increasing the insurance payments that Hanger received,

an in turn artificially inflating Hanger’s reported financial results.

5. These undisclosed fraudulent practices jeopardized Hanger’s status as a Medicare

and Medicaid provider and its relationships with private insurers and subjected Hanger to the risk

of incurring criminal and civil penalties. These practices, therefore, were highly material to

investors seeking to evaluate the soundness and effectiveness of the Company’s operations.

6. Throughout the Class Period, Hanger represented that the financial statements that

it disseminated to the market accurately reflected the Company’s financial performance, were

prepared in accordance with Generally Accepted Accounting Principles (“GAAP”) and

applicable SEC regulations, and were free from material misstatement or omission. Defendants

have since restated their financial statements, thereby admitting that the financial statements

were false when issued.

7. As detailed herein, in order to conceal the deteriorating state of Hanger’s business

and to maintain Hanger’s stock price at artificially inflated levels, Hanger engaged in improper

revenue-inflating practices during the Class Period that enabled the Company to artificially

inflate its reported assets, accounts receivable, income and earnings per share (“EPS”) at the end

of the Company’s annual and quarterly reporting periods, and decrease its expenses, rendering

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Hanger’s financial statements and other communications regarding the Company’s financial

performance complained of herein materially false and misleading.

8. As detailed herein, Hanger’s improper accounting included, inter alia:

(a) misrepresenting to investors that the financial statements it issued were accurate and truthful and prepared in accordance with GAAP and the rules and regulations of the SEC;

(b) failing to account properly for accounts receivable and bad debt expense;

(c) failing to properly maintain an adequate system of internal control which rendered Hanger’s financial reporting unreliable and incorrect; and

(d) improperly recognizing the revenue it billed for, and/or received as a result of its fraudulent billing practices, while knowing or recklessly disregarding the fact that this revenue would either not be realized, or if realized, would be subject to recoupment by insurers.

9. The truth began to emerge on June 14, 2004, when WNBC News in New York

aired an investigative report (the “WNBC News Report”) in which a Hanger employee described

the Company’s fraudulent billing practices at one of its patient-care facilities in West

Hempstead, NY (the “West Hempstead Facility”). The WNBC News Report also reported that

the Company had failed an internal audit of its patient files in the summer of 2003, and that in a

follow-up in February 2004 — seven months later — the Company’s auditor warned Hanger

officials that she was “still very concerned about the integrity of the documents I’ve received”

and that “[t]here remain numerous altered documents.”

10. The next day, on June 15, 2004, the Company issued a news release stating that

the Company had been made aware of “alleged billing irregularities” at its West Hempstead

Facility when “an employee” at that facility reported the billing irregularities on the Company's

“Compliance Hot Line.” The Company further disclosed that it had initiated an investigation

into the billing irregularities at the West Hempstead Facility.

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11. As a result of the disclosures on June 14 and 15, 2004, Hanger’s share price

decreased substantially, from an opening price of $15.75 per share on June 14, 2004 to a closing

price of $12.75 per share on June 15, 2004 — a two-day decline of 19%.

12. On June 18, 2004, Hanger announced that it had received a subpoena from the

U.S. Attorney’s Office for the Eastern District of New York relating to the allegations of billing

fraud at the West Hempstead Facility, and seeking information concerning 13 other Hanger

facilities in New York State. At the same time, the Company announced that the SEC also had

requested information from the Company relating to the billing fraud allegations. Although not

announced by the Company, it is Plaintiffs’ understanding from a knowledgeable former Hanger

employee that Medicare also has begun an investigation into Hanger’s billing practices.

13. As a result of the Company’s June 18, 2004 disclosure concerning the

government investigations, the Company’s shares experienced a further sharp decline, falling

from an opening price of $12.00 per share on June 18, 2004 to a closing price of $9.34 on the

following trading day, June 21, 2004 — another two-day drop of 22%.

14. Unfortunately for Hanger’s investors, the bad news did not end there. On August

9, 2004, Hanger issued a press release announcing that it would delay its earnings release for the

second quarter of 2004. The Company claimed that the delay was necessary in order to

“complete certain accounting reviews.”

15. The following day, Hanger filed a Form 12b-25 Notice of Late Filing, announcing

that the Company was delaying the release of its quarterly results because it had been unable to

timely complete the financial review “in large part due to the substantial time and efforts

expended by management to cooperate with the internal investigation of certain alleged billing

discrepancies.”

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16. As the market digested these disclosures in the days following Hanger’s August 9

and August 10, 2004 announcements, Hanger’s already-battered shares dropped even further,

falling from a high of $9.85 per share on August 9, 2004, before the announcements, to a low of

$4.27 per share on August 12, 2004, for a three day decline of over 50%. Thus, by August 12,

2004, Hanger’s share price had fallen over 70% from its opening price on June 14, 2004, before

the WNBC New Report aired, and over 75% from its Class Period high of $19.25 on January 22,

2004.

17. Then, on August 16, 2004, the Company issued a press release announcing that it

was restating its previously issued balance sheet as of December 31, 2003 and the statements of

operations and cash flows for the six months ended June 30, 2003 to reflect “a correction of an

error that led to the overstatement of recorded accounts receivable and an equal understatement

of bad debt expense.” According to the release, the Company’s past financial statements had

understated selling, general and administrative expense by $0.3 million for the quarter ended

March 31, 2004, $1.0 million for the year ended December 31, 2003 and $2.5 million for the two

years prior to 2003.

18. On September 15, 2004, the Company filed an Amendment to its 2003 Form 10-

K and an Amendment to its quarterly report for the first quarter of 2004. These filings restated

the Company’s financial statements as of December 31, 2003, 2002 and 2001 and for the years

then ended, and for the quarter ended March 31, 2004. The restatements materially reduced the

Company’s accounts receivable and increased its selling, general and administrative expenses,

thereby reducing the Company’s assets, income and EPS, as detailed herein.

19. As reported in the Company’s latest 10-Q quarterly report, the Company

expanded the scope of its internal investigation relating to the billing fraud to cover “certain of

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the Company’s other patient-care centers and included consideration of some of the allegations

made in the Amended Complaint” filed in this Action.

20. It is telling that, although the Company has issued several public statements

concerning this lawsuit, including statements concerning the allegations against the Company’s

executive directors and officers, it has never publicly denied the allegations of fraudulent

conduct by the Company itself or disputed that the allegations of billing fraud are true.

JURISDICTION AND VENUE

21. The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a) of

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

the SEC [17 C.F.R. § 240.10b-5].

22. This Court has jurisdiction over the subject matter of this action pursuant to 28

U.S.C. §§ 1331 and 1337, and Section 27 of the Exchange Act.

23. This action was transferred to this venue by Order, dated February, 28, 2006, of

the United States District Court for the Eastern District of New York.

24. In connection with the acts alleged in this complaint, defendants, directly or

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

limited to, the mails, interstate telephone communications and the facilities of the national

securities markets.

PARTIES

25. Court-appointed lead plaintiffs, Les Bronte, Twist Partners, LLP, Ed and Aileen

Stiehle, Thomas Pyles, and Joe Campagnuolo, Jr., as set forth in the certifications previously

filed with the Court and incorporated by reference herein, purchased the common stock of

Hanger at artificially inflated prices during the Class Period and have been damaged thereby.

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26. Defendant Hanger purports to be the largest owner and operator of orthotic and

prosthetic (“O&P”) patient-care centers in the United States.

27. Defendant Ivan R. Sabel (“Sabel”) was, at all relevant times, the Chairman of the

Board of Directors and Chief Executive Officer of Hanger.

28. Defendant George E. McHenry (“McHenry”) was, at all relevant times, the Chief

Financial Officer and an Executive Vice President of Hanger.

29. Defendant Thomas F. Kirk (“Kirk”) was, at all relevant times, Hanger’s President,

Chief Operating Officer and a Director.

30. Defendants Sabel, McHenry and Kirk are referred to herein as the “Individual

Defendants.”

31. During the Class Period, the Individual Defendants, as senior executive officers

and/or directors of Hanger, were privy to confidential and proprietary information concerning

Hanger, its operations, finances, financial condition, present and future business prospects. The

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

Hanger, as discussed in detail below. Because of their positions with Hanger, the Individual

Defendants had access to non-public information about its business, finances, products, markets

and present and future business prospects via access to internal corporate documents,

conversations and connections with other corporate officers and employees, attendance at

management and board of directors meetings and committees thereof and via reports and other

information provided to them in connection therewith. Because of their possession of such

information, the Individual Defendants knew or recklessly disregarded the fact that adverse facts

specified herein had not been disclosed to, and were being concealed from, the investing public.

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32. The Individual Defendants are liable as direct participants in, and as co-

conspirators with respect to, the wrongs complained of herein. In addition, the Individual

Defendants, by reason of their status as senior executive officers and/or directors were

“controlling persons” within the meaning of Section 20 of the Exchange Act and had the power

and influence to cause the Company to engage in the unlawful conduct complained of herein.

Because of their positions of control, the Individual Defendants were able to and did, directly or

indirectly, control the conduct of Hanger’s business.

33. The Individual Defendants, because of their positions with the Company,

controlled and/or possessed the authority to control the contents of its SEC filings, reports, press

releases and presentations to securities analysts and through them, to the investing public. The

Individual Defendants were provided with copies of the Company’s SEC filings, reports and

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

ability and opportunity to prevent their issuance or cause them to be corrected. Thus, the

Individual Defendants had the opportunity to commit the fraudulent acts alleged herein.

34. As senior executive officers and/or directors and as controlling persons of a

publicly-traded company whose common stock was, and is, registered with the Securities and

Exchange Commission pursuant to the Exchange Act, traded on the New York Stock Exchange

(“NYSE”) and governed by the federal securities laws, the Individual Defendants had a duty to

disseminate promptly accurate and truthful information with respect to Hanger’s financial

condition and performance, growth, operations, financial statements, business, products, markets,

management, earnings and present and future business prospects, and to correct any previously

issued statements that had become materially misleading or untrue, so that the market price of

Hanger’s common stock would be based upon truthful and accurate information. The Individual

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Defendants’ misrepresentations and omissions during the Class Period violated these specific

requirements and obligations.

35. The Individual Defendants are liable as participants in a fraudulent scheme and

course of conduct that operated as a fraud or deceit on purchasers of Hanger common stock by

disseminating materially false and misleading statements and/or concealing material adverse

facts. The scheme (i) deceived the investing public regarding Hanger’s business, operations and

management and the intrinsic value of Hanger common stock, (ii) enabled Hanger insiders to sell

thousands of shares of Hanger stock for hundreds of thousands of dollars in proceeds; and (iii)

caused plaintiffs and members of the Class to purchase Hanger stock at artificially inflated

prices.

PLAINTIFFS’ CLASS ACTION ALLEGATIONS

36. Plaintiffs brings this action as a class action pursuant to Federal Rule of Civil

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

securities of Hanger between March 13, 2002 and September 15, 2004 inclusive and who were

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

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

representatives, heirs, successors or assigns and any entity in which defendants have or had a

controlling interest.

37. The members of the Class are so numerous that joinder of all members is

impracticable. Throughout the Class Period, Hanger common shares were actively traded on the

NYSE. While the exact number of Class members is unknown to plaintiffs at this time and can

only be ascertained through appropriate discovery, plaintiffs believe that there are hundreds or

thousands of members in the proposed Class. Record owners and other members of the Class

may be identified from records maintained by Hanger or its transfer agent and may be notified of

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the pendency of this action by mail, using the form of notice similar to that customarily used in

securities class actions.

38. Plaintiffs’ claims are typical of the claims of the members of the Class as all

members of the Class are similarly affected by defendants’ wrongful conduct in violation of

federal law that is complained of herein.

39. Plaintiffs will fairly and adequately protect the interests of the members of the

Class and have retained counsel competent and experienced in class and securities litigation.

40. Common questions of law and fact exist as to all members of the Class and

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

questions of law and fact common to the Class are:

(a) whether the federal securities laws were violated by defendants’ acts as alleged herein;

(b) whether statements made by defendants to the investing public during the Class Period misrepresented material facts about the business and operations of Hanger; and

(c) to what extent the members of the Class have sustained damages and the proper measure of damages.

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

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

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

burden of individual litigation make it impossible for members of the Class to individually

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

a class action.

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SUBSTANTIVE ALLEGATIONS

42. Defendant Hanger is an owner and operator of over 580 orthotic and prosthetic

(“O&P”) patient-care centers in the United States. In the Company’s orthotics business, it

designs, fabricates, fits and maintains a wide range of standard and custom-made braces and

other devices. In the Company’s prosthetics business, it designs, fabricates, fits and maintains

custom-made artificial limbs. Hanger derived 44.8%, 43.9%, and 40.5% of its net sales for the

years ended December 31, 2003, 2002 and 2001, respectively, from reimbursements for O&P

services and products from programs administered by Medicare, Medicaid and the U.S. Veterans

Administration.

43. Most of Hanger’s customers are patients who are covered by either private health

insurance or health insurance provided by government programs such as Medicare, Medicaid and

programs run by the Veteran’s administration. Typically, patients in need of Hanger’s O&P

products and services are referred to Hanger by a physician or hospital. The referring physician

provides a prescription listing the type of product or service that the patient needs. A practitioner

(either a prosthetist or orthotist) at one of Hanger’s patient-care facilities — who is typically not

a physician — is then supposed to provide the patient with the prescribed product or service and

the practitioner and administrative staff is supposed to ensure that the documentation necessary

to properly obtain payment from the patient’s insurer is present in the patient’s file.

44. Although the documentation required for payment from insurers differs slightly

depending on the insurer, typically, the necessary documentation includes, inter alia:

(a) a valid prescription, signed and properly dated by the referring physician, which describes the product to be provided to the patient and which is “free of any signs of alteration;”

(b) a Validation of Receipt/Delivery Acknowledgement (“VOR”), signed and properly dated by the patient, which notes the quantity, the type of unit

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and/or description of the item, and in which the patient acknowledges receipt, and date of receipt, of the product;

(c) a HIPAA Notice of Privacy Practices Form, signed and properly dated by the patient, stating that the patient has received a brochure discussing the patient’s privacy rights under the Health Insurance Portability and Accountability Act of 1996;

(d) an Assignment of Benefits/Authorization to Release Information form, signed and properly dated by the patient, in which the patient requests that the patient’s insurer pay insurance benefits directly to Hanger for the service or product provided and authorizes the release of any of the patient’s medical information that is necessary to determine insurance benefits; and

(e) Clinical Notes, sometime referred to as “Progress Notes,” prepared, signed, and properly dated by the attending practitioner, justifying the particular product or service provided to the patient. For prosthetic patients, the Clinical Notes must “include the patient’s current and expected functional levels, explain any differences, and document agreement by the referring physician.”

In addition, some insurers require that a patient’s file include a Certificate of Medical Necessity,

signed and dated by the referring physician, which states why the patient needs the prescribed

product or service.

45. For some insurers, Hanger was not required to submit the necessary

documentation to insurers at the time Hanger billed insurers for the products or services

purportedly provided to patient. However, all insurers required Hanger to have all of the above

documentation — in complete and compliant form — in a patient’s file before billing the

patient’s insurer. Further, all documentation kept in a patient’s file is required to be “free of any

signs of alteration.” Throughout the Class Period, defendants were aware of these requirements.

Defendants were further aware that in the event any patient files were missing any of the

required documentation, or any of the documentation was the product of fraud, Hanger ran the

significant risk of non-payment by the patient’s insurer or recoupment by the insurer of any

payments previously made.

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46. For each patient that Hanger serviced, the attending practitioner was required to

complete a “Patient Data Sheet” or similar form that states the patient’s identifying information,

lists the date of delivery to the patient of the product or service, describes the product or service

provided to the patient (as well as any repairs or replacements to the product), lists the code

number of the product or service provided (the “Billing Code”),1 and states the charges incurred

and balance due from the patient and/or the patient’s insurer. After a patient has been provided

the prescribed product or service, and the necessary documentation is complete and present with

the patient’s file, a Hanger representative submits billing information to the patient’s insurer

requesting payment.

47. Throughout the Class Period, defendants were aware that Hanger’s compliance

with these requirements, and with the federal, state and local government regulations that

governed its operations — and in particular, compliance with Medicare and Medicaid regulations

— was of critical importance to the Company. Defendants knew that non-compliance could

result in significant penalties to the Company, including its exclusion from the Medicare and

Medicaid programs, as well as damage Hanger’s reputation and credibility. In its annual report

on Form 10-K for the year ended December 31, 2003 (“2003 Form 10-K”), the Company stated

that “[f]ailure to comply with applicable governmental regulations may result in significant

penalties, including exclusion from the Medicare and Medicaid programs, which could have a

material adverse effect on our business.” Specifically, the Company stated that any adverse

governmental review, audit or investigation could result in “refunding of amounts we have been

paid pursuant to our government contracts; imposition of fines, penalties and other sanctions on

us; loss of our right to participate in various federal programs; damage to our reputation in 1 The Billing Code entered onto the Patient Data Sheet is a number preceded by a letter of the alphabet (e.g., “L5680”) which corresponds to an O&P item or service that has been approved for billing by insurers.

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various markets; or material and/or adverse effects on the business, financial condition, and

results of operations.”

48. Accordingly, throughout the Class Period, defendants were fully aware of the

fundamental dangers to its business that would result from non-compliance and fraud related to

its insurance billing.

49. Defendants reassured investors, however, that they “make every effort” to

maintain compliance, and that they had the appropriate procedures in place to maintain

compliance. In this regard, the Company’s 2003 Form 10-K and its annual report on Form 10-K

for 2002 (“2002 Form 10-K”) stated as follows:

We are subject to a variety of federal, state and local governmental regulations. We make every effort to comply with all applicable regulations through compliance programs, manuals and personnel training. Despite these efforts, we cannot guarantee that we will be in absolute compliance with all regulations at all times.

Fraud and Abuse. Violations of fraud and abuse laws are punishable by criminal and/or civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal healthcare programs, including Medicare, Medicaid, U.S. Veterans Administration health programs and the Department of Defense’s TRICARE program, formerly known as CHAMPUS. These laws, which include but are not limited to, antikickback laws, false claims laws, physician self-referral laws, and federal criminal healthcare fraud laws, are discussed in further detail below. We believe our billing practices, operations, and compensation and financial arrangements with referral sources and others materially comply with applicable federal and state requirements. However, we cannot assure that such requirements will not be interpreted by a governmental authority in a manner inconsistent with our interpretation and application. The failure to comply, even if inadvertent, with any of these requirements could require us to alter our operations and/or refund payments to the government. Such refunds could be significant and could also lead to the imposition of significant penalties. Even if we successfully defend against any action against us for violation of these laws or regulations, we would likely be forced to incur significant legal expenses and divert our management’s attention from the operation of our business. Any of these actions, individually or in the aggregate, could have a material adverse effect on our business and financial results. [. . .]

False Claims Laws. We are also subject to federal and state laws prohibiting individuals or entities from knowingly presenting, or causing to be

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presented, claims for payment to third-party payors (including Medicare and Medicaid) that are false or fraudulent, are for items or services not provided as claimed, or otherwise contain misleading information. Each of our patient-care centers is responsible for preparation and submission of reimbursement claims to third-party payors for items and services furnished to patients. In addition, our personnel may, in some instances, provide advice on billing and reimbursement to purchasers of our products. While we endeavor to assure that our billing practices comply with applicable laws, if claims submitted to payors are deemed to be false, fraudulent, or for items or services not provided as claimed, we could face liability for presenting or causing to be presented such claims. [Emphasis added.]

50. Hanger’s 2003 Form 10-K and 2002 Form 10-K also represented that the

Company “monitor[s] centrally” each individual patient-care center’s billing and collections of

accounts receivable, and provides each center with “all senior management [and] accounting . . .

services.”

51. Defendants’ statements referenced above in ¶¶ 45, 47 and 48 were each materially

false and misleading when made because they failed to disclose and misrepresented the

following material adverse facts, discussed in detail below at ¶¶ 51-77:

(a) Hanger was systematically engaging in fraudulent billing practices, including falsifying prescriptions and other billing documentation submitted to third party payors, in order to artificially inflate its reported revenues and earnings;

(b) Contrary to its assurances to investors, the Company knew that it was not in compliance with applicable regulations and knew that, far from making “every effort” to comply with such regulations, it was actively engaged in a scheme to evade, and indeed flout those regulations through the billing fraud scheme described in detail herein. Given this scheme, the Company knew that its claim that it believed its billing practices “materially compl[ied]” with applicable regulations was untrue. Although defendants stated that they could not “guarantee” that they would be “in absolute compliance with all regulations at all times,” in truth they knew that this attempted disclaimer was nothing but a smokescreen. Not only did Defendants know that they couldn’t “guarantee” absolute compliance, but they knew that the Company was not even complying materially with regulations, much less complying absolutely.

(c) the Company’s purported risk warnings failed to disclose that the Company had falsified billing records and defrauded federal and state

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governments and private insurers thereby placing its accreditation at serious risk; and

(d) the Company suffered from material deficiencies in its internal compliance controls, including inadequate auditing and supervision of its patient care facilities to ensure compliance with federal, state, and local regulation and the requirements of private insurers.

52. Further, defendants caused the Company to file reports with the SEC during the

period June 2003 through June 2004, including quarterly reports on Form 10-Q for each quarter

during this period, that were materially false and misleading in that they failed to disclose the

material adverse facts affecting the Company alleged in ¶ 49 above and discussed in detail in

¶¶51-77 below.

HANGER’S FRAUDULENT BILLING SCHEME

53. In furtherance of its scheme to inflate revenue and earnings, Hanger engaged in

systematic and flagrant billing fraud at its patient care facilities, as witnessed by several

knowledgeable former employees of the Company.

54. Hanger’s brazen billing fraud was witnessed by, inter alia, a former Office

Administrator who worked at Hanger’s West Hempstead Facility from June 2003 to June 2004

(the “Office Administrator”). The Office Administrator’s daily job responsibilities included,

inter alia, processing patients’ bills, billing insurers for items and services provided to patients,

requesting authorization from insurers to bill for payment, verifying patients’ insurance

eligibility, and coordinating with practitioners working out of the West Hempstead Facility and

certain other Hanger facilities in New York concerning insurance billing documentation — job

responsibilities that put the Office Administrator in a position to have first-hand knowledge of

the fraudulent billing practices that Hanger engaged in at the West Hempstead Facility.

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55. Among the fraudulent practices that the Office Administrator witnessed at the

West Hempstead facility during the period from June 2003 to June 2004 were the following:

(a) Practitioners forged prescriptions, Certificates of Medical Necessity and other insurance-related documentation that were necessary to support the patient bills that Hanger submitted to insurers. For example, in May 2004, the Office Administrator witnessed Gennaro Ritieni (“Ritieni”), the Facility Manager and head practitioner of the West Hempstead Facility, forge the signature of Dr. Carl Richie, the referring physician for a patient named Geraldine McKoy, on a Prescription and a Certificate of Medical Necessity. Copies of this forged Prescription and Certificate are attached hereto as Exhibit A. In another instance, in May 2004, the Office Administrator witnessed Ritieni cut the signatures of patients and physicians from existing documents and pasted them onto billing-related documents, such as VORs and prescriptions, that needed, but did not have those signatures. A copy of a VOR that Ritieni forged in this manner is attached hereto as Exhibit B. To enable these forgeries, Ritieni photocopied blank prescription pads that had been obtained (presumably, illicitly) from Elmhurst Hospital.

(b) Practitioners, and other employees in the facility acting at the practitioners’ behest, improperly submitted Billing Codes to insurers for products that were more expensive than the products actually provided to patients, thereby resulting in higher payments to Hanger by insurers.

(c) Practitioners improperly back-dated insurance billing documents, including VORs, listed phony dates on billing documents, and dated documents that were required to be dated only by the patient. For example, in one case, the Office Administrator was instructed by practitioners, including Lisa Constantine (“Constantine”), to submit a stack of patient bills to insurers on May 1, 2004 even though the dates of service listed on the supporting documentation in the patients’ files were in mid-May 2004 — a clear indication to the Office Administrator that the supporting documentation had been falsified.

(d) Practitioners and other employees improperly billed insurers for add-on items that were never prescribed by the referring physician. For example, throughout the Class Period, patients whose prescriptions called for the patient to be provided a pair of shoes routinely would be provided, and Hanger would subsequently bill their insurers for, orthotics and padding in addition to the shoes. In each instance of this type of fraud, the addition to the bill of the padding alone could result in an additional cost to the insurer, and payment to Hanger, of approximately $125, whereas the shoes alone cost only approximately $25 — a 500% mark-up. This fraudulent practice was so pervasive that some insurers eventually refused to pay Hanger for such add-on items.

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(e) Practitioners and other employees improperly billed insurers for each component part of a product purportedly provided to a patient, rather than billing for the item as a whole, in order to reap the higher price of the component parts.

(f) Hanger improperly billed insurers for items and services that were not actually provided to patients. For example, in March 2004, Ritieni provided a prosthetic leg to a patient named Johnnie Cole, who was a single amputee, but listed Cole as a double amputee and billed Cole’s insurer for two prosthetic legs rather than one.

(g) Practitioners improperly signed and/or dated VORs themselves, and often did so before the patient had even received the product or service for which Hanger billed insurers, despite the fact that VORs were supposed to be signed and dated only by patients, and only after the patient had received the product or service.

(h) Practitioners instructed Hanger employees responsible for billing, such as the Office Administrator, to use the Billing Codes that corresponded to the most expensive product within a product category, regardless of whether the patient actually received that product. For example, throughout the Class Period, the Office Administrator routinely was instructed by practitioners to bill for custom-made items (e.g., custom-molded shoes) rather than off-the-shelf items, even though the patient had been prescribed, and had received, the off-the-shelf item.

(i) Hanger employees improperly fabricated false diagnoses for patients, and recorded such fabricated diagnoses in the patient’s file, in order to justify the provision of products or services that Hanger billed to insurers. For example, the Office Administrator was often instructed to list a patient as suffering from a severe type of diabetes, despite the fact that that diagnosis was not accurate, solely for the purpose of “justifying” to insurers the product that Hanger billed with respect to that patient.

56. Based on her first-hand knowledge, the Office Administrator estimates that,

taking into account the fraudulent activities of only two practitioners at the Facility (Ritieni and

Constantine) — and not even counting all the other practitioners at the Facility and at other

Hanger facilities who engaged in similar fraudulent activities — Hanger forged or otherwise

improperly tampered with billing documentation in connection with approximately 4000 patient

files for the period from June 2003 to June 2004. According to the Office Administrator, the

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vast majority of the revenue obtained by the West Hempstead Facility during this period —

which Hanger has stated was $1.9 for 2003 and $0.9 million for the first half of 2004 — was

obtained through fraudulent billing practices. Although the total amount of revenue that Hanger

fraudulently billed for, or received, is exclusively within the knowledge of the Company, and has

not been disclosed, the fraudulent revenue relating to only the West Hempstead Facility — and

not counting the other Hanger facilities that participated in similar fraud, as alleged herein — is

reasonably believed to be over $1 million.

57. Hanger’s bonus compensation policies encouraged these fraudulent billing

practices. Every six months, Hanger dispensed a bonus sum to each Regional Manager, which

the Regional Manager was authorized to distribute to the managers and practitioners within his

or her region based on the amount of money that each facility within that region billed for and

collected. This policy of tying bonuses to money billed for and collected encouraged Regional

Managers, and the Facility Managers, practitioners and other employees that reported to them, to

inflate bills and seek to collect as much money from insurers as possible, without regard to

compliance with federal, state and local regulations and the requirements of insurers.

58. Hanger further encouraged the billing fraud by pressuring its practitioners and

staff to meet unrealistic revenue targets. For example, Regional Managers held “revenue

meetings” attended by, inter alia, Facility Managers, practitioners, office administrators and

other employees of Hanger’s facilities, in which the revenue targets and revenue billed for, and

collected to date, were discussed. According to the Office Administrator, one such “revenue

meeting” was held in April 2004, which was led by David Zwicker (“Zwicker”), the Regional

Manager for Hanger’s New York region, and attended by the Office Administrator, Ritieni and

other employees of the facilities in the New York region. At this meeting, Hanger employees

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were shown slides comparing the amount of revenue that each Hanger region, and each facility

within each of those regions, had billed for and collected for 2003, and displaying whether, based

on revenue generated during the first quarter of 2004, each facility was in line to meet pre-

established revenue projections for the full year 2004. Further, Hanger employees were shown

slides displaying each region’s, and each facility’s, revenue ranking compared to other regions

and facilities. Unsurprisingly, given the massive fraud occurring at the West Hempstead facility,

the West Hempstead facility and the New York Region consistently ranked among the top 5

facilities and regions in the country. Hanger held similar “revenue meetings” every six months,

including one such meeting in October 2003.

59. Zwicker, the Regional Manager for Hanger’s New York region, was fully aware

of, and indeed encouraged, the fraudulent and illegal activity that was rampant at the West

Hempstead facility. For example, according to the Office Administrator:

(a) At a May 2004 meeting at the West Hempstead Facility attended by several Hanger employees, including the Office Administrator and Ritieni, Zwicker stated that the Facility was committing “illegal acts” and that if anyone outside the Company were to enter the Facility and see what was occurring there, “the office would be padlocked.” Despite these statements, Zwicker took no action to stop the illegal activity occurring at the Facility, and indeed the activity continued thereafter. For example, according to the Office Administrator, in May 2004, after the above-mentioned meeting, Ritieni requested that the Office Administrator take home a stack of patient files and have her son sign the forms that needed signatures.

(b) In June 2004, Zwicker attempted to eliminate a $30,000 revenue shortfall at other facilities in the New York Region by instructing the West Hempstead Facility to bill $30,000 for a prosthetic leg for a patient (Geraldine McKoy) whose documentation was incomplete and non-compliant. Zwicker told the Office Administrator that, despite the patient’s incomplete and non-compliant documentation, he wanted the patient’s insurer to be billed for the product. Ritieni complied with Zwicker’s instructions by forging the missing documentation for the patient (including the prescription). Copies of the forged documentation are attached hereto as Exhibit A. According to the Office Administrator, in demanding that the patient’s insurer be billed despite the absence of proper supporting documentation, Zwicker’s sole interest was that the

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price of the billed-for product was sufficiently high to cover the $30,000 revenue shortfall.

60. According to the Office Administrator, given the lax oversight by Hanger, and the

encouragement and participation of Zwicker, Ritieni and other practitioners at the Facility were

more afraid of falling short of the revenue targets that Hanger had set for them — and thus

jeopardizing their bonuses — than of being caught and fired for fraud.

61. Hanger’s fraudulent billing practices were not the product of rogue employees

operating exclusively at one facility or one region without Hanger’s knowledge, but were

pervasive at various Hanger facilities across the country. Several former employees of the

Company witnessed similar fraud during the Class Period at Hanger’s facilities in Bethesda, MD,

Baltimore, MD, Towson, MD, Lynchburg, VA, Wilmington, DE, Trenton, NJ, Charlotte, NC,

Aurora, CO, Denver, CO, Brooklyn, NY, Pittsburgh, PA, and Rancho Mirage, CA. For example:

(a) A former Hanger Senior Office Administrator (“SOA”) who was employed in Hanger’s offices in Baltimore, MD, Towson, MD and Wilmington, DE offices before and during the Class Period witnessed a pattern of non-compliance dating back to at least 1999, of which Hanger’s headquarters were aware. For example, in 1999 the Baltimore office was not compliant with HIPAA regulations. The SOA called Hanger’s corporate headquarters and alerted them to the non-compliance. In response, Hanger had an auditor and the Baltimore office’s Regional Manager, John Schulte, audit the Baltimore office. They gave the office a passing grade, even though, according to the SOA, the office should have failed the audit. During 2003 to 2004, the SOA also witnessed billing fraud at Hanger’s Wilmington, DE office, which included the office’s Branch Manager, and of which Hanger’s headquarters was aware. For example, the Branch Manager improperly gave a patient a prosthetic leg costing $50,000 in order to make his numbers for the month. The SOA reported this incident of billing fraud to Hanger’s corporate headquarters. The Branch Manager was terminated from the Delaware office but was re-assigned to a Hanger office in the Pennsylvania region. The Wilmington office also maintained pre-signed prescriptions in blank in the name of a Dr. Axe, an orthopedic surgeon. The SOA also found prescriptions where the original patient’s name had been deleted and copies of the prescriptions were made and used over and over with respect to other patients, by inserting the new patient’s name and the date. Further, in one of Hanger’s Baltimore offices, the SOA discovered documentation showing that Hanger had fraudulently billed Medicaid for two prosthetic legs (right and left)

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issued to the same patient one month apart, even though the patient was not a double amputee. The SOA reported this fraud in emails and other communications to Hanger’s Vice President of Accounting, Chuck Jordan, a Branch Manager, Ed Herman, and an area administrator, Linda Fowler. Jordan was located in Hanger’s headquarters and reported to defendant Ivan Sabel.

(b) A former Hanger Area Administrative Manager (“AAM”) of Hanger’s mid-Atlantic region during the Class Period also witnessed, and reported to Hanger’s corporate headquarters, rampant billing fraud in several offices in the mid-Atlantic region, including the offices in Bethesda, MD, Baltimore, MD, Delaware and Lynchburg, VA. In the Lynchburg, VA office, the AAM discovered documentation demonstrating that the Practice Manager, Michael Voight, had forged patients’ signatures on validation receipts and fraudulently billed Medicare for products that Hanger had not provided to patients. When the AAM reported this information to the Regional Manager, John Schulte, Schulte refused to believe her. The AAM then reported this information to Hanger’s Compliance Hotline. Further, according to the AAM, it was common knowledge that Voight “played with the numbers.” Although Voight was a solo practitioner, he billed for more revenue that a three-practitioner operation in Baltimore. The AAM was also aware of billing fraud in the Delaware office, where the Practice Manager, Dennis Rafferty, would backdate documentation and bill for products that patients did not receive. Similar fraud occurred in Hanger’s Alexandria, VA office. There, Practice Manager Johnny Baskins submitted claims prior to the patient’s receipt of the product. Baskins also billed Medicare twice for the same products by altering balances on Hanger’s computer system to make it appear that Hanger had not received payment from Medicare. The AAM reported Baskin’s fraud to the Schulte, the Regional Manager, and the Director of Operations, Chuck Jordan, on three occasions. As Regional Manager, Schulte reported to Hanger’s President Rick Taylor. The AAM also witnessed the use of the same Medicare provider number at various offices, a practice which is contrary to Medicare policy which requires each office to bill under its own provider number. Hanger’s Director of Regulatory Affairs, Joe McTernan, among others at Hanger, was alerted to this violation.

(c) A former Hanger employee who worked as an orthotist in Hanger’s Charlotte, NC facility during the Class Period witnessed several instances of “upcoding,” i.e., billing for a product or service that was more expensive than the product or service actually provided to the patient. According to this orthotist, Michael Jenks (“Jenks”), the Branch Manager of the Charlotte facility, often would add additional products to a patient’s bill (e.g., special padding, special closure kits, or special strapping) that the patient had not received. This orthotist also witnessed Jenks change the Billing Code on patients’ records in order to increase the charge to the patient’s insurer, often increasing the bill by thousands of dollars. For example, Jenks fraudulently changed the Billing Code recorded for one patient from a “pelite liner” to a “gel locking liner,” which improperly added approximately $2000 to that patient’s bill. Further, according

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to this orthotist, Jenks received blank prescription pads from a physician at a clinic with which Hanger did business. In violation of compliance requirements, Jenks would fill out prescriptions for patients prescribing whatever products Jenks wanted to bill for and then fax the prescription to the patients’ physicians for their signatures.

(d) A former Hanger employee who worked as a Fitter/Office Administrator at Hanger’s Aurora, CO facility from September 2003 to July 2004 witnessed improper “upcoding” at that facility, including, for example, billing insurers for a more expensive custom-made product rather than for the off-the-shelf product that was actually provided to the patient.

(e) According to a former Hanger employee who worked in the Accounts Payable department of Hanger’s Denver, CO facility from January 2003 to April 2004, often when Medicare, Medicaid and private insurers would return billing forms to the facility that were not completed correctly, this former employee’s manager instructed him to input certain Billing Codes on the forms regardless of whether the patient actually received the product or service that corresponded to the Billing Code that had been inputted. In a further indication that this facility was billing insurers for products or services not provided to patients, this former employee often heard directly from patients that they had not received all the items listed on their “Explanation of Benefit” forms provided by their insurers. According to this former employee, the manager of the Denver facility often submitted bills to insurers for services to patients that had not been completed — a practice that the Regional Manager in charge of this facility was aware of, and knew to be fraudulent.

(f) According to the Office Administrator, in December 2003 or January 2004, Michelle Hickman (“Hickman”), an office administrator in Hanger’s Brooklyn facility met with Ritieni in the West Hempstead Facility and told Ritieni that, in order to “fix” patient files that did not have the proper billing documentation, she routinely would “cut and paste” the signatures of patients and physicians from others documents onto the documents that needed signatures. Tellingly, in a company-wide newsletter issued to all Hanger facilities throughout the country after this incident (in approximately January or February 2004), the Brooklyn office was named “Most Improved Office” with respect to compliance, and specifically praised Hickman in this respect.

(g) One former Hanger employee responsible for patient billing in Hanger’s Pittsburgh facility during the Class Period was privy to numerous instances where Hanger billed insurers for products that were different than the product that the patient at issue had actually received.

(h) According to a former Hanger employee who worked as a Facility Manager and practitioner in the Rancho Mirage, CA facility from February 1996

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to April 2003, her supervisor instructed her to input Billing Codes for additional services or products that were not provided to patients, and routinely instructed her to input the most expensive Billing Codes for patients, regardless of whether the Billing Code accurately reflected the item provided to the patient.

(i) Another former Hanger employee who worked as an Office Administrator in the Rancho Mirage, CA facility from May 1997 to June 2003 was aware that the facility was inputting Billing Codes that did not reflect the actual services provided to patients.

(j) A former Hanger orthotist and practice manager who was employed in Hanger’s Trenton, NJ office during the Class Period was frequently directed by his District Manager, Brad Duedne, to pre-bill for products not yet delivered to patients in order to fulfill sales quotas, even though this practice was against regulations. This former employee repeatedly complained about this office’s improper billing procedures to Duedne, but to no avail.

62. As at the West Hempstead Facility, Hanger’s managers at these other facilities

created an environment that fostered fraudulent billing in order to meet ever-increasing revenue

targets. For example:

(a) According to a former Hanger employee who worked an orthotist in Hanger’s Charlotte, NC facility during the Class Period, practitioners were under tremendous pressure to meet unrealistic revenue quotas. In one staff meeting attended by this orthotist, Mike Jenks, the Branch Manager of the Charlotte facility, stated that he did not care how the revenue quotas were met but that he wanted the quotas met on paper, and that he wanted the staff to do “anything and everything” to meet the quotas. At this meeting, Jenks further told the staff that their bonuses would suffer if the quotas were not met.

(b) According to a former Hanger employee who worked as a Fitter/Office Administrator at Hanger’s Aurora, CO facility from September 2003 to July 2004, Hanger expected the facility to meet unrealistically high revenue goals.

(c) According to a Hanger employee responsible for patient billing in Hanger’s Pittsburgh facility throughout the Class Period, Fran Volker, the Regional Manager in charge of the Pittsburgh facility, imposed on practitioners unrealistically high expectations as to the amount of revenue that that facility should have been generating.

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63. Defendants were aware of, or recklessly disregarded, these billing practices since

at least July 2003, when the Company conducted an audit of the West Hempstead Facility. On

July 21, 2003, Donna Crouse (“Crouse”), Hanger’s Compliance Auditor, conducted an audit of

that facility, consisting in part of a review of the documentation contained in 15 patient files,

including the files of 12 Medicare patients (the “July Audit”). The facility failed the audit

miserably — out of a maximum possible score of 100%, with 80% being the minimum score that

Hanger considers “compliant,” the facility scored only 50.93%.

64. The July Audit revealed a host of deficiencies in the 15 patient files that were

audited, including deficiencies with respect to prescriptions and Clinical Notes in 14 of 15 files

and deficiencies with respect to VORs in all 15 files. According to the Company’s Audit

Summary of the July Audit, the July audit revealed, inter alia, that:

(a) certain patient files contained non-compliant prescriptions (including prescriptions that did not describe the patient’s diagnosis or the Billing Codes to be billed);

(b) certain patient files were completely lacking any Clinical Notes or contained Clinical Notes that did “not provide justification for our services,” or that stated simply “Seen by Jerry” or “Seen by Maxwell,” without further explanation;

(c) certain Patient files were completely lacking any VOR or contained a VOR that was not signed or dated by the patient;

(d) certain Patient files were completely lacking any Assignment of Benefits form and/or HIPAA Acknowledgement form;

(e) Hanger had submitted bills to insurers for multiple products even though the supporting documentation in the patient’s file either did not suggest that any product was actually provided to the patient, confirmed that only one product was actually provided, or suggested that the billed-for product was never even fabricated, much less provided. For example, with respect to several patients, the Audit Summary noted that Hanger had “billed for 2 test sockets, however there are no notes to verify that any test sockets were provided,” or that

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Hanger had “billed for 2 test sockets, however the notes indicate that only 1 test socket was provided;” and

(f) Hanger had submitted bills to insurers on dates that preceded the date of delivery of the product to the patient. For example, the Audit Summary found with respect to one patient that: “There is no VOR, but indicates that pt [i.e., patient] got an aircast and shoes. However, notes for aircast show it was delivered 6/19, shoes were delivered 7/ /03 [sic]. HCFA shows all were billed with DOS [i.e., “Date of Service”] 6/19. This should have been two different dates of service, one for the aircast, one for the shoes.”

65. Crouse noted her suspicion that documents in patients’ files were being

improperly altered by Hanger employees. In an email that Crouse sent to the West Hempstead

Facility, Crouse stated: “Remember that you cannot alter a document after it has been signed

by a patient or physician. The only changes you are permitted to make is to add the patient’s

address, the physician’s address and/or UPIN to the prescription. Any other changes affect

the integrity of a document.” [Original emphasis.]

66. With respect to many patient files audited in the July Audit, Crouse noted that

because of the lack of supporting documentation the facility would need to “refund Medicare and

any other payer” for products that were “billed for but not fabricated.” Ultimately, Hanger

determined that $160,000 needed to be refunded to insurers with respect to the limited number of

patient files audited in the July Audits, and without even counting the thousands of other patient

files that had not been audited. However, despite Crouse’s acknowledgment that the payments

relating to certain patients would need to be refunded to insurers, according to the Office

Administrator, Hanger did not do so during the Class Period. Instead, according to the Office

Administrator, rather than refund the payments relating these patients — which would have

reduced the Facility’s revenue and thereby jeopardized the Facility’s, and the Facility’s

practitioners’ bonuses — Ritieni and other practitioners at the West Hempstead Facility forged,

altered and otherwise improperly completed the necessary documentation for these patients.

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67. Hanger’s routine audit procedures required that, in response to the July Audit, the

West Hempstead facility had to “take corrective action” and provide the Compliance Auditor a

“Management Response” within 10 days of the audit. The facility also was required to obtain

and forward to the Compliance Auditor all missing documentation for the audited patient files

within 90 days, including an explanation of “how each of the specific deficiencies will be

corrected, as well as an action plan outlining how similar errors will be avoided in the future.”

68. Despite these requirements, however, according to the Office Administrator, the

West Hempstead Facility never provided the Management Response, never provided the “action

plan,” and as of December 2003, had not provided the corrected documentation. According to an

internal Hanger email from Crouse to the West Facility dated December 9, 2003, Crouse had still

not received “any of the corrected documentation from the July audit” by December 9, 2003 — 5

months after the audit, and over 6 weeks after the corrected documentation was due. According

to an email from Crouse to the West Hempstead Facility dated May 7, 2004, the facility had still

not submitted all the corrected documentation for the July Audit by May 7, 2004 — over 9

months after the audit and over 6 months after the corrected documentation was due. However,

according to the Office Administrator, apart from sending emails to the facility reminding it to

submit the documentation, Hanger took no action to obtain the corrected documentation, to

further investigate the billing discrepancies revealed by the July Audit, or otherwise to prevent

the fraud that was occurring at the West Hempstead Facility.

69. Instead, in November 2003, Hanger purported to conduct a second audit of the

West Hempstead Facility (the “November Audit”). In reality, the November Audit was a sham

designed to give the appearance that the problems identified in the July Audit had been

addressed and that the West Hempstead Facility was now “compliant.” Of the thousands of

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patient files maintained at the West Hempstead Facility, Hanger audited only ten. This number

of files was inadequate to measure compliance, especially given the Facility’s failure of the July

Audit, which suggested that a more thorough, rather than less thorough follow-up audit needed to

be conducted. Further, with respect to those ten patient files, Hanger thwarted one of the main

purposes of a random audit by providing the facility two weeks advance notice of which ten

patient files would be audited, allowing the Facility ample time to alter, forge and otherwise

“correct” any non-compliant files among those ten patient files. Further, Hanger did not even

bother to re-audit the non-compliant files reviewed in the July Audit, for which the West

Hempstead Facility had failed to submit the corrected documentation as requested by Crouse and

required by Hanger’s audit policy.

70. In conducting the November Audit, Hanger found several patient files that were

missing documentation or that had other indicia of fraud. Despite this, Hanger gave the West

Hempstead Facility a score of 80% — the minimum passing score.

71. Internal Hanger documents prepared after the November Audit, however,

demonstrate that the West Hempstead Facility remained far from compliant, to say the least. On

February 13, 2004, Crouse sent an email to the West Hempstead Facility and Ritieni, on which

Zwicker and Jerry Johnson, Hanger’s Senior Compliance Auditor, were copied, concerning the

corrected documentation that she had received from the facility in response to the July Audit. In

the email, Crouse again noted her suspicion that fraud was occurring at the West Hempstead

Facility: “I am still very concerned about the integrity of the documents I have received for

the July Audit. There remain numerous altered documents, which cannot be accepted

because they are not compliant.” Crouse’s email continues by listing the examples of altered

documents that she found, such as: “Documents that were signed but not dated by the patient at

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the time of the audit, but are now dated (not dual dated). Or VOR’s that were missing the

description of all codes billed, but now have all the descriptions on them, again not dual dated.

Also, of concern is the large number of outstanding documents.” Crouse’s email goes on to list

the deficiencies in specific patient files that had failed the audit, noting that “it is not legal to add

a date after the patient has signed the document.” With respect to the documents in another

patient file, Crouse noted, “Were they backdated?”

72. Although Crouse claimed to be “very concerned” about the integrity of the

facility’s documents, both she and Hanger recklessly failed to take any follow-up action. For

example, according to the Office Administrator, Hanger never conducted a follow-up visit to the

facility for the purpose of reviewing the originals, rather than the copies, of the audited patient

files — which were available for review at the West Hempstead facility. According to the Office

Administrator, had Hanger done so, it would have been readily apparent that much of the

“corrected” documentation in the audited patient files were obvious forgeries. For example, the

original documents contained in certain patients’ files clearly showed the paper fragments

containing patient signatures that Ritieni had cut from other documents in the patient’s file and

pasted onto the necessary documentation. An example of the patient documentation that was

forged in this “cut-and-paste” manner is attached hereto as Exhibit B.

73. Crouse’s February 13, 2004 email is direct evidence that the Company’s auditors

and senior managers — including the Senior Compliance Auditor and the Regional Manager for

the New York region — were either aware of fraudulent and illegal conduct occurring at the

West Hempstead facility, or at a minimum, recklessly disregarded the evidence of such conduct.

Despite the numerous indications of fraudulent and illegal conduct noted in the email, including

Crouse’s doubts about the “integrity of documents,” “altered documents,” and the “illegal”

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dating of documents, according to the Office Administrator, the Company took no action to

prevent the fraud at the West Hempstead facility, which continued unabated at least until the

WNBC News Report aired on June 14, 2004.

74. Nor was Defendants’ knowledge of the billing fraud limited to the West

Hempstead facility. The accounts of former employees of Hanger also establish that Hanger’s

corporate headquarters was aware that similar billing fraud was occurring at other Hanger offices

as well. For example, the SOA reported fraud occurring at the Wilmington, DE office to

Hanger’s corporate headquarters. In addition, the AAM reported the fraud she witnessed in the

Lynchburg, VA office to Hanger’s Compliance Hotline.

75. Hanger was also aware of the fraud occurring at facilities outside West

Hempstead through compliance audits that it conducted. According to the AAM, Hanger

conducted four audits of the Baltimore and Bethesda offices in 2002 and 2003. The audits

revealed numerous violations and each audit resulted in a failing grade.

76. Further, the West Hempstead Facility’s high revenue rankings combined with the

indicia of fraud uncovered by the July Audit provided defendants with unmistakable signs of

fraudulent billing activity which Hanger knowingly or recklessly disregarded. Hanger was

aware of the unusually large amount of revenue generated by the West Hempstead Facility

compared to other facilities in New York and around the country. For example, according to the

figures in the slides displayed at the April 2004 “revenue meeting,” and witnessed by the Office

Administrator, the West Hempstead Facility generated approximately twice as much revenue as

Hanger’s facility in Westbury, NY, even though the West Hempstead Facility employed

approximately half as many practitioners as the Westbury facility.

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77. Moreover, Hanger’s centralized computerized billing system — known as “OPS”

— further suggests that Hanger was aware of, or recklessly disregarded, the billing fraud

occurring at its various facilities throughout the country. By virtue of OPS, in 2003 and 2004

Hanger’s corporate headquarters had the ability to view in real-time the billing information that

was being inputted into the OPS system for particular patients by Hanger employees at facilities

throughout the United States. The fraud that was being committed at Hanger’s facilities would

have been readily apparent to anyone at Hanger’s corporate headquarters who made use of this

capability. For example, the West Hempstead Facility inputted the exact same Billing Code for

every diabetic patient treated at that facility — a circumstance that is inherently implausible and

highly suspicious, given that not all diabetic patients have the same level or type of disability or

need the same O&P products or services.

78. Hanger also signaled its approval of artificial revenue inflation practices by

routinely instructing its facilities to keep their books open beyond the end of the month or the

end of the quarter in order to inflate the revenue generated during the period at issue. For

example:

(a) According to a former Hanger employee who worked as a Facility Manager and practitioner in the Rancho Mirage, CA facility from February 1996 to April 2003, Hanger closed the books after the end of the month, usually in months at the end of quarters, when Hanger filed its quarterly reports with the SEC.

(b) Another former Hanger employee who worked as an Office Administrator in the Rancho Mirage, CA facility from May 1997 to June 2003 received calls from her area administrator, and even emails from Hanger’s corporate headquarters, advising her to keep the facility’s books open beyond the end of the month, especially at the end of the year, in order to be able to report greater revenue.

79. Further, Hanger was explicitly informed of the billing fraud occurring at the West

Hempstead Facility, including the involvement of the Regional Manager for the New York

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region (Zwicker) and the Facility Manager for the West Hempstead Facility (Ritieni) by the

Office Administrator via a call to the Company’s Compliance Hotline on June 7, 2004 — one

week before the WNBC News Report aired — in which the Office Administrator alerted Hanger

to the billing fraud and the participation of Zwicker and Ritieni in that fraud.

80. Defendants were well aware throughout the Class Period that the billing practices

discussed above constituted insurance fraud and subjected Hanger to the risk of claims for

recoupment from insurers. For example, Hanger’s own compliance auditor recognized the

impropriety of the pervasive practice of “upcoding” and charging for additional products

components that were not provided to patients and/or not prescribed by the patient’s physician.

As stated in an internal Hanger Audit Summary, “if components or add ons are not listed on the

Rx [i.e., prescription], payment received will be considered an overpayment.” Hanger was also

aware that forging or otherwise improperly altering prescriptions and other necessary billing

documentation was improper. An internal Hanger document states that prescription “must . . . be

signed and properly dated by the physician” and that no one other than the referring physician

may add information to a prescription, other than the patient’s address, the physician’s address,

and the physician’s “UPIN” number.

81. Further, as demonstrated by Hanger’s public statements warning of the grave

jeopardy to the Company’s business of non-compliance and fraud (alleged above in paragraphs

¶¶ 47 and 48 above) defendants knew that these fraudulent practices put the Company at the risk

of suffering fundamentally debilitating consequences. These consequences included, but were

not limited to (i) “criminal and/or civil sanctions, including, in some instances, imprisonment”

(ii) exclusion from participation in federal healthcare programs, including Medicare, Medicaid,

U.S. Veterans Administration health programs,” (iii) “liability for presenting or causing to be

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presented such claims.” Defendants further were aware that these consequences could have a

“material adverse effect on [the Company’s] business and financial results.”

HANGER’S MATERIALLY FALSE AND MISLEADING FINANCIAL STATEMENTS

82. Throughout the Class Period, defendants consistently represented to investors that

its financial statements accurately reflected the financial results of the Company, that its financial

statements were prepared in accordance with GAAP, that it recognized revenue in accordance

with GAAP and that its financial statements were devoid of material misstatements and

omissions.

83. The Class Period begins on March 13, 2002, when Hanger announced its financial

results for the fourth quarter of 2001 and the full year 2001. In a press release that day, Hanger

announced “record sales and income from operations” for the fourth quarter of 2001 and the

year ended December 31, 2001. The Company stated that net sales for 2001 reached a “record”

$508.1 million, an increase of $22.1 million or 4.5%, over the prior year’s net sales of $486.0

million. The Company attributed the increase primarily to an “increase in same center sales in

the Company's O&P practices.” The release further stated that “the Company reported income

before income taxes of $16.5 million in 2001 compared to a pretax loss of $13.1 million in the

prior year, an improvement of $29.6 million.” The Company reported results for 2001, in

relevant part, as follows:

Net sales for the year ended December 31, 2001, reached a record $508.1 million, an increase of $22.1 million or 4.5%, over the prior year's net sales of $486.0 million. This sales growth was primarily due to a 6.8% increase in same center sales in the Company's O&P practices, offset by a reduction in sales due to the sale of SOGI. Gross profit for the year ended December 31, 2001 improved by $32.5 million, or 4.3% as a percentage of sales, to $267.2 million, or 52.6% of net sales, compared to $234.7 million, or 48.3% of net sales, in the prior year. The gross margin was favorably impacted by the increase in net sales along with a reduction in the costs of

- 34 -


materials and labor resulting from various performance improvement initiatives implemented during 2001. [Emphasis added.]

Commenting on these results, defendant Sabel stated in the release: “We have improved our

operations [and] increased our cash flow . . . .”

84. On April 1, 2002, Hanger filed with the SEC its Annual Report on Form 10-K for

the year ended December 31, 2001, which was signed, inter alia, by defendants Sabel and

McHenry (“2001 Form 10-K”). The 2001 Form 10-K reported accounts receivable for 2001 in

the amount of $104,040,000 and selling, general and administrative expenses in the amount of

$182,972,000. The Company’s reported results, in relevant part, were as follows:

$’000 Year Ended

December 31, 2001 Net Sales $508,053 Gross profit $267,185 Income from Operations $35,089 Net Loss $(8,883) Basic EPS $(0.73) Diluted EPS $(0.73) Accounts Receivable $104,040 Allowance $17,625 Total Current Assets $195,887 Total Assets $699,907

85. In the 2001 Form 10-K, the Company stated that “[o]ur analysis and discussion of

our financial condition and results of operations are based upon our Consolidated Financial

Statements that have been prepared in accordance with generally accepted accounting principles

in the United States (‘U.S. GAAP’).”

86. The 2001 Form 10-K included a letter from Hanger’s outside auditor,

PricewaterhouseCoopers LLP, which represented that the financial statements contained therein

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were prepared and presented in accordance with GAAP and fairly presented the Company’s

results, stating, in relevant part, as follows:

In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 40 present fairly, in all material respects, the financial position of Hanger Orthopedic Group, Inc. and its subsidiaries at December 31, 2000 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America.

87. On February 26, 2003, Hanger issued a press release announcing “record sales,

net income and earnings per share” for the year ended December 31, 2002. The release

reported the Company’s results for 2002, in relevant part, as follows:

Net sales for the year ended December 31, 2002, reached a record $525.5 million, an increase of $17.5 million, or 3.4%, over the prior year's net sales of $508.1 million. The sales growth was primarily due to a 4.6% increase in same center sales in the Company's O&P practices and a 0.7% increase in outside sales by the Company's distribution business, offset by a 0.9% reduction in sales due to the sale of SOGI, the Company's manufacturing operations, in October of 2001. Gross profit for the year ended December 31, 2002 improved by $17.0 million, or 6.4%, to $284.2 million, or 54.1% of net sales, compared to $267.2 million, or 52.6% of net sales, in the prior year. The gross margin was favorably impacted by the increase in net sales along with a reduction in the costs of materials and labor due to increased productivity in the operation of the O&P practices. The Company recorded net income of $23.6 million for the year ended December 31, 2002, compared to a net loss of $8.9 million in the prior year, an improvement of $32.5 million. Net income applicable to common stock before extraordinary item for the year ended December 31, 2002 was $26.4 million, or $0.99 per share diluted share, a $32.3 million improvement over the $8.9 million loss recorded in the prior year. Hanger reported net income applicable to common stock of $18.4 million, or $0.86 per share diluted for the year ended December 31, 2002, compared to a net loss of $13.7 million, or $0.73 per share diluted for the prior year. [Emphasis added.]

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Commenting on the Company’s year-end results for 2002, defendant Sabel stated that the

Company “continued to improve [its] operations and generated strong cash flow” and that 2002

“was definitely a win-win year for all of our stakeholders.” [Emphasis added.]

88. On March 28, 2003, Hanger filed its Annual Report on Form 10-K for the year

ended December 31, 2002, which was signed, inter alia, by defendants Sabel, McHenry and Kirk

(“2002 Form 10-K”). The 2002 Form 10-K reported accounts receivable for 2002 in the amount

of $107,604,000 and selling, general and administrative expenses in the amount of $189,768,000.

The Company’s reported results, in relevant part, were as follows:

$’000 Year Ended

December 31, 2002 Net Sales $525,534 Gross profit $284,162 Income from Operations $82,642 Net Income $23,570 Basic EPS (before extraordinary item)

$1.08

Diluted EPS (before extraordinary item)

$0.99

Accounts Receivable $107,604 Allowance $8,649 Total Current Assets $192,642 Total Assets $712,226




in the United States (‘U.S. GAAP’).” Further, defendants Sabel and McHenry issued separate

statements, incorporated into the 2002 Form 10-K, stating that the information contained therein

“fairly presents, in all material respects, the financial condition and results of operations of the

Company.” In addition, defendants Sabel and McHenry stated that the 2002 Form 10-K “does

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not contain any untrue statement of a material fact or omit to state a material fact necessary to

make the statements made, in light of the circumstances under which such statements were made,

not misleading with respect to the period covered by this annual report.”




results, stating as follows in relevant part:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) on page 43 present fairly, in all material respects, the financial position of Hanger Orthopedic Group, Inc. and its subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

91. The statements referenced in ¶¶ 79-86 above were each materially false and

misleading when made, and were known or recklessly disregarded as such by defendants for the

following reasons:

(a) the Company had improperly recognized and reported revenue for the years 2001 and 2002, thereby artificially inflating its revenue and net income;

(b) the Company had materially overstated its accounts receivable and materially understated its bad debt expenses and its selling, general and administrative expenses for the years 2001 and 2002, thereby artificially inflating assets and net income;

(c) the Company’s reported results for the years 2001 and 2002 were not prepared in accordance with GAAP and did not fairly present the financial condition of the Company;

(d) the Company’s reported “record” results were attributable in material part to improper accounting rather than increased demand for its products and operational improvements;

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(e) the Company suffered from material deficiencies in its internal accounting controls to properly record accounts receivable, bad debt expense and revenue, which rendered Hanger’s financial reporting unreliable and incorrect; and

(f) defendants failed to disclose the material adverse factors alleged in subparagraphs (a) through (e) above.

92. On July 29, 2003, Hanger issued a press release announcing its results for the

second quarter of 2003, in which it touted “record sales and earnings,” including a 21%

increase in net income and increases in net sales and in income from operations for the quarter,

and increases in net sales, gross profit and income from operations for the first six months of

2003. The release reported the Company’s results for the second quarter of 2003, and the first

six months of 2003, in relevant part, as follows:

Net sales for the quarter ended June 30, 2003 increased by $5.8 million, or 4.4%, to $138.9 million from $133.1 million in the prior year's comparable quarter. The sales growth was primarily the result of a $2.3 million, or 1.9%, increase in same-center sales in the Company's O&P practices and a $1.9 million, or 27.6%, increase in sales of the Company's distribution segment. Gross profit for the second quarter of 2003 was $73.5 million, or 52.9%, of net sales, compared to $69.9 million, or 52.5%, of net sales, in the second quarter of the prior year. The improvement in gross profit, in both dollars and as a percentage of net sales, was due to a reduction in labor costs. Income from operations increased by $2.3 million in the second quarter of 2003 to $25.2 million from $22.9 million in the same period of the prior year. The increase in income from operations is the result of increased net sales and gross profit.

Net income for the second quarter of 2003 was $9.4 million, or approximately $0.35 per diluted share, on 26.8 million weighted average diluted shares outstanding. During the quarter it became more dilutive to earnings per share to convert the Company's outstanding preferred stock to common stock, therefore the preferred stock dividends declared and accretion of $1.4 million were not included in the computation, as required by accounting principles generally accepted in the United States. In the corresponding period of the prior year, Hanger had net income of

- 39 -


$7.7 million, or approximately $0.29 per diluted share, on 22.0 million weighted average diluted shares outstanding.

Net sales for the six months ended June 30, 2003 increased by $8.5 million, or 3.3%, to $265.1 million from $256.6 million in the prior year's comparable period. The sales growth was primarily the result of a $2.6 million or 1.1% increase in same-center sales in the Company's O&P practices and a $3.4 million, or 24.9%, increase in the sales of the Company's distribution segment. Gross profit for the first six months of 2003 was $139.0 million, or 52.4% of net sales, compared to $133.8 million, or 52.1%, of net sales, in the prior year. The improvement in gross profit, in both dollars and as a percentage of net sales, was due to a reduction in labor and material costs. Income from operations increased by $4.1 million in the first half of 2003 to $43.4 million from $39.3 million in the same period of the prior year. The increase in income from operations is the result of increased net sales and gross profit. [Emphasis added.]

Commenting on these results, defendant Sabel stated: “Sales continued to improve at our

patient-care centers during the quarter. We were able to achieve our profitability goals through a

combination of the sales increase, continued control of our costs and the continued exceptional

overall performance by our distribution segment. This quarter's results represent record sales

and earnings.”

93. On August 12, 2003, Hanger filed its quarterly report on Form 10-Q for the

second quarter of 2003, which was signed, inter alia, by defendants Sabel and McHenry. The

Company stated that the financial statements accompanying the Form 10-Q were “prepared in

accordance with Rule 10-01 of Regulation S-X” and that “all adjustments considered necessary

(consisting solely of normal recurring adjustments) for a fair presentation of the consolidated

financial statements have been included.” Further, defendants Sabel and McHenry made the

following representations: “Based on my knowledge, this quarterly report does not contain any

untrue statement of a material fact or omit to state a material fact necessary to make the

statements made, in light of the circumstances under which such statements were made, not

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misleading with respect to the period covered by this quarterly report.” These defendants further

represented in the Form 10-Q that: “Based on my knowledge, the financial statements, and other

financial information included in this quarterly report, fairly present in all material respects the

financial condition, results of operations and cash flows of the registrant as of, and for, the

periods presented in this quarterly report.” The Company’s reported results, in relevant part,

were as follows:

$’000 Quarter Ended June 30, 2003

Net Sales $138,936 Gross profit $73,520 Income from Operations $25,188 Net Income $9,353 Basic EPS $0.39 Diluted EPS $0.35 Accounts Receivable $111,060 Allowance $8,456 Total Current Assets $186,850 Total Assets $716,805

94. On October 30, 2003, Hanger issued a press release announcing its results for the

third quarter of 2003 and touting growth in EPS of 10%. The release also announced increases

in net sales, net income, and income from operations, and reported the Company’s results for the

third quarter of 2003, in relevant part, as follows:

Net sales for the quarter ended September 30, 2003 increased by $6.0 million, or 4.5%, to $140.0 million from $134.0 million in the prior year's comparable quarter. The sales growth was primarily the result of a $2.1 million, or 1.7%, increase in same-center sales in the Company's O&P practices, a $1.6 million, or 19.8%, increase in sales of the Company's distribution segment, with the net balance coming principally from acquired practices. Gross profit for the third quarter of 2003 was $75.2 million, or 53.7%, of net sales, compared to $72.1 million, or 53.8%, of net sales, in the third quarter of the prior year. The improvement in gross profit dollars was due to increased net sales. Income from operations

- 41 -


increased by $1.5 million in the third quarter of 2003, to $24.6 million from $23.1 million in the same period of the prior year. The increase in income from operations is the result of increased net sales slightly offset by a $1.2 million increase in selling, general and administrative expenses associated primarily with the operating expenses of acquired practices, costs associated with the roll-out of our new billing system, and an increase in our marketing and corporate development activities.

Based on the above improvements, net income for the third quarter of 2003 increased to $8.8 million, or approximately $0.33 per diluted share. In the corresponding period of the prior year, Hanger had net income of $7.8 million, or approximately $0.30 per diluted share. [Emphasis added.]

Commenting on these results, defendant Sabel stated:

During the third quarter we were able to generate 10% growth in earnings per share despite continued challenges in our efforts to improve sales growth. Same-center sales growth was approximately 2% for the quarter, but we were able to leverage our efficient platform and improve our EBITDA margins from 19.0% last year to 19.6% in 2003. We increased EPS by 10% over the prior year by maintaining our gross profit margins and reducing our SG&A to 34.2% of sales this year compared to 34.8% in 2002. At the same time, we have been making significant investments in marketing, systems and corporate development that will benefit future periods. While we expect fourth quarter to produce the same or slightly improved sales growth as the third quarter, once we put the reimbursement and economic issues of 2003 behind us and the investments we are making begin to take hold we are optimistic that sales growth will improve in 2004.

95. On November 12, 2003, Hanger filed its quarterly report on Form 10-Q for the

third quarter of 2003, which was signed, inter alia, by defendants Sabel and McHenry. The

Company stated that the financial statements accompanying the Form 10-Q were “prepared in

accordance with Rule 10-01 of Regulation S-X” and that “all adjustments considered necessary

(consisting solely of normal recurring adjustments) for a fair presentation of the consolidated

financial statements have been included.” Further, the Form 10-Q contained the following

representation from defendants Sabel and McHenry made the following representations: “Based

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on my knowledge, this quarterly report does not contain any untrue statement of a material fact

or omit to state a material fact necessary to make the statements made, in light of the

circumstances under which such statements were made, not misleading with respect to the period

covered by this quarterly report.” These defendants further represented in the Form 10-Q that:

“Based on my knowledge, the financial statements, and other financial information included in

this quarterly report, fairly present in all material respects the financial condition, results of

operations and cash flows of the registrant as of, and for, the periods presented in this quarterly

report.” The Company’s reported results, in relevant part, were as follows:

$’000 Quarter Ended September 30, 2003

Net Sales $140,045 Gross profit $75,246 Income from Operations $24,592 Net Income $8,829 Basic EPS $0.36 Diluted EPS $0.33 Accounts Receivable $110,920 Allowance $6,832 Total Current Assets $194,040

Total Assets $721,255

96. In a press release, dated February 25, 2004, Hanger announced a $22.4 million

increase in its net sales for the year ended December 31, 2003. The Company reported its results

for 2003 as follows:

Net sales for the year ended December 31, 2003 increased by $22.4 million, or 4.3%, to $547.9 million from $525.5 million in the prior year. The sales growth was primarily the result of an $8.0 million, or 1.6%, increase in same- center sales in the Company's O&P practices, and a $5.8 million, or 19.6%, increase in external sales by the Company's distribution segment, with the net balance coming principally from recently acquired practices. Gross profit for the year was $289.5 million, or 52.8%

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of net sales, compared to $278.5 million, or 53.0% of net sales, in the prior year. The $11.0 million improvement in gross profit was due to increased net sales. Income from operations increased $1.9 million during the year to $84.6 million from $82.6 million in the prior year. Selling, general and administrative expenses increased as the result of the following: (i) a $5.7 million increase in salaries, travel, and selling expense primarily associated with staffing the Company's marketing initiative, corporate governance costs, and staffing related to recently acquired practices; (ii) a $1.7 million increase in bad debt expense due to the increase in net sales which was virtually unchanged as a percentage of sales; and (iii) $2.7 million in increased rent and occupancy costs associated principally with acquired facilities. Income from operations was further affected by a $0.8 million increase in depreciation and amortization due to the roll-out of OPS. [Emphasis added.]

97. The 2003 Form 10-K reported accounts receivable for 2003 in the amount of

$116, 479,000 and selling, general and administrative expenses in the amount of $194,473,000.

The Company’s Consolidated Balance Sheet for the year was reported as follows:

$’000 Year Ended December 31, 2003

Net Sales $547,903 Gross profit $289,520 Income from Operations $84,570 Net Income $16,239 Basic EPS $0.42 Diluted EPS $0.39 Accounts Receivable $116,479 Allowance $3,875 Total Current Assets $211,393 Total Assets $740,364




in the United States.” Further, defendants Sabel and McHenry issued separate statements,

incorporated into the 2003 Form K, stating that the information contained in the 2003 Form 10-K

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“fairly presents, in all material respects, the financial condition and results of operations of the

Company.” Defendants Sabel and McHenry further represented that the Form 10-K “does not

contain any untrue statement of a material fact or omit to state a material fact necessary to make

the statements made, in light of the circumstances under which such statements were made, not

misleading with respect to the period covered by this annual report.”




results, stating, in relevant part, as follows:

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Hanger Orthopedic Group, Inc. and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

100. On April 28, 2004, Hanger issued a press release announcing its results for the

first quarter of 2004 as follows:

Net sales for the three months ended March 31, 2004 increased by $5.5 million, or 4.4%, to $131.6 million from $126.1 million in the prior year's first quarter. The net sales growth was primarily due to net sales of acquired O&P practices and a 12.9% increase in the external sales of the Company's distribution segment, reduced by a 0.8% decrease in same center sales. Gross profit for the first quarter of 2004 was $66.2 million, or 50.3% of net sales, compared to $65.4 million, or 51.9% of net sales, in the prior year. The improvement in gross profit dollars was the result of the 4.4% increase in net sales and the decrease, as a percentage of net sales, was due to an increase in labor and material costs. Labor costs increased as a percentage of net sales due to a combination of the impact of annual salary increases effective January 1, 2004 and a 0.8% decrease in same center sales. Selling, general and administrative expense increased by $2.4 million due to increased expenditures quarter-over-quarter on corporate governance, the

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billing system (OPS) rollout, our sales growth initiatives, expenses of acquired entities and the effect of the annual salary increases, effective January 1, 2004, on salary expense and the related benefits. Depreciation and amortization increased by $0.8 million because the new billing system was placed in service and due to the rollout of Insignia. Interest expense decreased by $1.0 million due to interest savings generated by the refinance of the Subordinated Notes with the new "Term Loan B" in the fourth quarter.

Net income applicable to common stock and per diluted share for the first quarter of 2004 was $3.6 million, or approximately $0.16 per diluted share, a decrease of $0.5 million and $0.03, respectively, from the comparable period last year. [Emphasis added.]

Commenting on these results, defendant Sabel stated in the release: “We believe that our efforts

and investments that have been made thus far will provide for long-term gain in the future.”

[Emphasis added.]

101. On May 10, 2004 Hanger filed its quarterly report on Form 10-Q for the first

quarter of 2004, which was signed, inter alia, by defendants Sabel and McHenry. The Company

stated that the financial statements accompanying the Form 10-Q were “prepared in accordance

with Rule 10-01 of Regulation S-X” and that “all adjustments considered necessary (consisting

solely of normal recurring adjustments) for a fair presentation of the consolidated financial

statements have been included.” Further, defendants Sabel and McHenry made the following

representations: “Based on my knowledge, this quarterly report does not contain any untrue

statement of a material fact or omit to state a material fact necessary to make the statements

made, in light of the circumstances under which such statements were made, not misleading with

respect to the period covered by this quarterly report.” These defendants further represented

that: “Based on my knowledge, the financial statements, and other financial information included

in this quarterly report, fairly present in all material respects the financial condition, results of

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operations and cash flows of the registrant as of, and for, the periods presented in this quarterly

report.” The Form 10-Q stated the Company’s results, in relevant part, as follows:

$’000 Quarter Ended

March 31, 2004 Net Sales $131,609 Gross profit $66,209 Income from Operations $15,761 Net Income $4,536 Basic EPS $0.17 Diluted EPS $0.16 Accounts Receivable $116,114 Allowance $4,900 Total Current Assets $201,026 Total Assets $747,761

102. The statements referenced above in ¶¶ 88-97 were each materially false and

misleading when made, and were known or recklessly disregarded as such by defendants for all

the reasons alleged in ¶ 87 above, and for the following additional reasons:

(a) defendants failed to disclose the material adverse fact that it had engaged, and continued to engage in the insurance billing fraud alleged above in ¶¶ 51-77;

(b) the Company had materially overstated its accounts receivable and materially understated it bad debt expense and selling, general and administrative expenses, and had improperly recognized and reported revenue that was the product of the fraudulent billing practices alleged above in ¶¶ 51-77, thereby artificially inflating its assets;

(c) the Company’s reported increases in sales, income, gross profit and EPS were in substantial part the result of the fraudulent billing practices alleged above in ¶¶ 51-77;

(d) the Company suffered from material deficiencies in its internal accounting and financial controls, which rendered Hanger’s financial reporting unreliable and incorrect;

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(e) the Company suffered from material deficiencies in its internal compliance controls, including inadequate auditing and inadequate supervision of its patient care facilities to ensure compliance with federal, state, and local regulations and the requirements of private insurers; and

(f) defendants failed to disclose material adverse facts alleged in subparagraphs (b) through (e) above.

THE TRUTH CONCERNING HANGER’S BILLING FRAUD BEGINS TO EMERGE

103. In the 11 p.m. news on June 14, 2004, WNBC aired a story that began as follows:

SUE SIMMONS, co-anchor:

Prescription for fraud. A whistleblower says her company is stealing hundreds of thousands of dollars of taxpayer dollars. A Newschannel 4 investigation [. . .]

104. Simmons, with her co-anchor Chuck Scarborough, and investigative reporter Tim

Minton, went on to report that Kendall McDaniel, a Hanger employee who was in charge of

processing patients’ bills, alleged that “thousands of patient files are forged or non-existent, none

of which she claims stops the company from billing taxpayers for medical devices that may or

may not have been delivered.” The news segment continued as follows:

Ms. KENDALL McDANIEL (Hanger Employee): They will come in, with say, a prescription for shoes and they will either get the shoes, but then the insurance company will be billed for shoes and additional items. And then I'm saying that there may be no patient at all, just a fake name.

MINTON: The rules for reimbursement by Medicare, Medicaid, and insurance companies are strict and specific. A prescription signed by a doctor is required, and so are notes that justify why particular equipment is necessary, given the patient's diagnosis and condition. McDaniel says blank Elmhurst Hospital prescription pads and official insurance company documents are kept at the Hanger office where she says she has seen a manager fill them out.

Ms. McDANIEL: Not only prescriptions, letters of medical necessities, Medicare supplier standards. Things that need to be in the chart in order to bill out to Medicare are just signed as if a doctor was signing them on a day-to-day basis.

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MINTON: In a statement, the New York City Health and Hospital's Corporation says, "this matter appears to involve the theft and fraudulent use of hospital prescription pads without any knowledge of Elmhurst Hospital or the physicians whose names were used."

The whistleblower has hired an attorney. She says to make sure she can keep her job and follow the law. Kenneth Mollins sent a letter to federal and state prosecutors, requesting they review Hanger's files.

MINTON: Hanger's response, "the company is adamant about compliance. We're conducting an internal audit. If there is something that is done inappropriately, there will be strong and immediate action."

But the results of an internal audit conducted last summer and obtained by Newschannel 4, show that all 15 files checked at that time had problems complying with the law ranged from no prescriptions to no justifying notes.

Overall, the company's own auditor gave a failing grade, 50 out of 100 with 80 considered compliance. In a follow-up this February, seven months later, the auditor sent an e-mail to company officials warning, "I am still very concerned about the integrity of the documents I've receive. There remain numerous altered documents."

Ms. McDANIEL: I worked for Worldcom. I got fired or laid off due to fraud. The biggest fraud in the history of the country. I've been through this, and I don't want to have it happen again. Maybe I can stop it and tell people, and maybe somebody else will come forward.

MINTON: Kendall McDaniel has been placed on administrative leave with pay until Hanger completes its internal audit. The company says it has reassigned a manager implicated in forged prescriptions and other alleged fraud to a job where he can be more closely supervised. Sue, Chuck, more to come on this.

105. In a press release issued the following day, the Company attempted to downplay

the billing fraud. In the release, the Company referred only to “allegations of billing

irregularities” (emphasis added), and did not describe the nature or extent of the fraud. Nor did

defendants admit that they knew — by virtue of the results of the July and November Audits,

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Hanger’s failure to resolve the deficiencies identified in those audits, the expressed concern of

Hanger’s Compliance Auditor that illegal activity was being committed by Hanger employees,

and the Office Administrator’s whistleblower call to the Company’s Compliance Hotline — that

the facts presented in the WNBC News Report were more than mere “allegations” and that

Hanger was aware of the truth of the facts in that report. The release stated as follows:

Hanger Orthopedic Group has been made aware of alleged billing irregularities by one clinician in one of the company’s 608 patient care centers. An employee in the office reported the alleged irregularities on the Company’s Compliance Hot Line — a confidential communications vehicle that encourages individuals to come forward with any concerns or suspicions regarding potential violations of the Company’s processes or policies. The Company, in conjunction with its outside counsel, has initiated a prompt and thorough investigation of these allegations.

Ivan R. Sabel, Chairman and CEO of Hanger Orthopedic Group said ‘Hanger Orthopedic Group has an active internal audit team that reports to the Audit Committee of its Board of Directors and is committed to maintaining the highest standards of integrity and compliance. We take this matter very seriously. We are expending all necessary resources to bring this matter to an accurate and swift conclusion.’

Hanger, however, did not, and to this day has not, denied any of the allegations of billing fraud at

the West Hempstead Facility.

106. As a result of the disclosures on June 14 and 15, 2004, the price of Hanger shares

declined substantially. The Company’s shares had opened on June 14, 2004 at $15.75 per share.

The following day, after trading in the Company's shares was halted by the NYSE due to

unusually heavy volume, Hanger shares fell to a closing price of $12.75 per share on heavy

volume of 2.4 million shares. Thus, in the two days following the initial revelations about the

Company’s billing fraud, the Company’s stock price decreased by 19 percent.

107. On June 18, 2004 the Company announced that it had received a subpoena from

the U.S. Attorney’s Office for the Eastern District of New York on June 17, 2004 requesting that

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the Company produce documents relating to the allegations of billing fraud, and seeking

information concerning 14 of the Company’s facilities located in New York State. At the same

time, the Company also announced that the SEC also had requested information from the

Company relating to the billing fraud allegations.

108. The June 18, 2004 announcement further weakened Hanger’s reputation and

further eroded confidence in Hanger’s integrity. The announcement suggested to the market

that, far from being an isolated incident at only one of Hanger’s facilities, the billing fraud was

occurring at several other Hanger facilities, which further jeopardized Hanger’s status as an

approved O&P provider under Medicare, Medicaid and private insurance programs and further

exposed Hanger to penalties and liability. For example, a Lehman Brothers analyst report issued

on June 21, 2004 — after the Company’s disclosure of the government investigations — stated

that:

The investigation appears to be more broad based than originally assumed, with the US Attorney’s Office requesting documents regarding these issues from 14 facilities across downstate New York (vs. the one facility originally cited). In addition, the scope of the investigation may be wider than originally thought. The SEC also has requested information from HGR relating to the allegations. [Emphasis added.]

109. As a result of the Company’s June 18, 2004 disclosure concerning the

government investigations, the Company’s shares experienced a further sharp decline. Hanger’s

stock price fell from an opening price of $12.00 on Friday, June 18, 2004 to a closing price of

$9.34 on the next trading day, Monday June 21, 2004 — a two-day drop of more than 22 %.

THE TRUTH CONCERNING HANGER’S MATERIALLY FALSE FINANCIAL STATEMENTS BEGINS TO EMERGE

110. On August 9, 2004, Hanger issued a press release announcing that it would delay

its earnings release for the second quarter of 2004 scheduled for August 9, 2004, until August 16,

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2004. The Company claimed that the delay was necessary in order to “complete certain

accounting reviews.” The press release, in relevant part, stated:

Hanger Orthopedic Group, Inc. Announces Delay of Its Earnings Release and Investor's Conference Call

BETHESDA, Md., Aug. 9 /PRNewswire-FirstCall/ -- Hanger Orthopedic Group, Inc. (NYSE: HGR) today announced the delay of its earnings release scheduled for after the close of the market on August 9, 2004, until after the close of the market on August 16, 2004, and the investor's conference call scheduled for August 10, 2004, until August 17, 2004 in order to complete certain accounting reviews.

111. On August 10, 2004, Hanger filed a Form 12b-25 Notice of Late Filing, signed by

defendant McHenry, stating that it was delaying the filing of its Form 10-Q for the second

quarter of 2004. The Company stated that it was unable to complete the financial review of its

quarterly results in a timely fashion “in large part due to the substantial time and efforts

expended by management to cooperate with the internal investigation of certain alleged billing

discrepancies.”

112. As reported by TheStreet.com on August 11, 2004, “[s]hares in Hanger

Orthopedic Group (NYSE:HGR - News) plunged in heavy trading Wednesday in the wake of the

company’s decision to postpone its earnings report to ‘complete certain accounting reviews.’”

As a result of Hanger’s August 9 and August 10, 2004 announcements, Hanger’s shares fell from

a high of $9.85 per share on August 9, 2004 to a low of $4.27 per share on August 12, 2004, for

a three day decline of over 50%. Thus, by August 12, 2004, Hanger’s share price had fallen over

72% from its opening price on June 14, 2004, before the WNBC New Report, and over 77%

from its Class Period high of $19.25 on January 22, 2004.

113. On August 16, 2004, the Company issued a press release announcing that it was

restating its previously issued balance sheet as of December 31, 2003 and the statements of

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http://finance.yahoo.com/q?s=hgr

http://finance.yahoo.com/q/h?s=hgr

operations and cash flows for the six months ended June 30, 2003 to reflect “a correction of an

error that led to the overstatement of recorded accounts receivable and an equal understatement

of bad debt expense.” According to the release, the Company’s past financial statements had

understated selling, general and administrative expense by $0.3 million for the quarter ended

March 31, 2004, $1.0 million for the year ended December 31, 2003 and $2.5 million for the

years prior to 2003. In the same release, Hanger claimed that the “discrepancy” in its financial

statements was discovered during the completion of the roll-out of its new billing and cash

collection system, OPS. According to the Company’s release, the new OPS system gave the

Company “better visibility over its accounts receivable and improved controls over its inter-

branch cash collection activity,” and led the Company to determine that “certain receivables

were uncollectible.” The August 16, 2004 press release, in relevant part, stated:

Restatement of Accounts Receivable

The previously issued balance sheet as of December 31, 2003 and the statements of operations and cash flows for the six months ended June 30, 2003 have been restated to reflect a correction of an error that led to the overstatement of recorded accounts receivable and an equal understatement of bad debt expense. The error resulted in an understatement of selling, general and administrative expense of $0.3 million for the quarter ended March 31, 2004, $1.0 million for the year ended December 31, 2003 and $2.5 million for the years prior to 2003. In the year ended December 31, 2003, selling general and administrative expense for the three months ended June 30, 2003 and March 31, 2003 was restated and increased by $0.2 million and $0.3 million, respectively.

The discrepancy was discovered during the preparation of our June 30, 2004 financial statements. By June, we had substantially completed the roll-out of our new billing and cash collection system (OPS), which aided in the discovery of the discrepancy. The OPS system replaced more than 15 different billing and cash collection platforms previously utilized in our over 600 practices to bill and collect for our products and services. The new system provides the Company better visibility over its accounts receivable and improved controls over its inter-branch cash collection activity. After a successful pilot test, the Company commenced the

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installation of this system in September 2003 and by the end of June 2004 had installed the system in all practices except the patient care centers of two recent acquisitions and three central billing offices, which require an enhanced multi-user version of the system that has not yet completed testing.

The conversion to the OPS single billing and cash collection platform permitted reconciliation of inter-branch cash collection activity and we determined that certain receivables were uncollectible. The Company, with the concurrence of its independent registered public accounting firm, concluded that this adjustment should be reported as a correction of an error to previously issued financial statements. The release of our second quarter results and the filing of form 10-Q for the quarter and six months ended June 30, 2004 was delayed while we completed an analysis of the periods affected by the error. The Company also was delayed in filing because it was unable to complete the financial review of its quarterly results in a timely fashion due to the substantial time and efforts expended by management to cooperate with the independent investigation of the allegations concerning improper billing activities at our West Hempstead branch, discussed in our press release dated August 9, 2004. We intend to file within a reasonable period of time an amendment to our 2003 Form 10-K report.

114. On September 15, 2004, the Company filed an Amendment to its 2003 Form 10-

K (“Restated 2003 Form 10-K”), which restated the Company’s financial statements as of

December 31, 2003, 2002 and 2001 and for the years then ended. Specifically, the Company

restated its consolidated balance sheets as of December 31, 2003 and 2002 and its consolidated

statements of operations and cash flows for the years ended December 31, 2003, 2002 and 2001,

as follows:

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$’000 SG&A

Net Income /

(Loss) Before Taxes

Basic EPS

Diluted EPS

Accounts Receivable

Total Current Assets

2003 Previously Reported 194,473 28,210 0.42 $0.39 116,479 211,393 Adjustment 1,043 (1,043) (0.03) $(0.02) (3,543) (2,016) Restated 195,516 27,167 0.39 $0.37 112,936 209,377 2002 Previously Reported 184,072 39,642 0.94 $0.86 107,604 192,642 Adjustment 1,015 (1,015) (0.03) $(0.03) (2,500) (1,423) Restated 185,087 38,627 0.91 $0.83 105,104 191,219

2001 Previously Reported 178,571 (7,976) (0.73) $(0.73) - - Adjustment 1,485 (1,485) (0.04) $(0.04) - - Restated 180,056 (9,461) (0.77) $(0.77) - -

115. The Restated 2003 Form 10-K also disclosed for the first time the deficiencies in

the Company’s internal controls, stating:

During the preparation of our June 2004 financial statements, it became apparent that, with the enhanced visibility provided by our new billing and cash collection system (O/P/S) that our previously reported accounts receivable balance at March 31, 2004 was overstated by $3.8 million. The error has been corrected and financial statements have been restated as appropriate.

The Company is continuing its evaluation of its internal controls in light of the standards adopted by the PCAOB. In the course of its ongoing evaluation, management has identified certain deficiencies which the Company is addressing. Areas requiring improvement include documentation of controls and recording of transfers between patient-care centers. Management will consider these matters when assessing the effectiveness of the Company’s internal control over financial reporting at December 31, 2004. [Emphasis added.]

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116. Also on September 15, 2004, the Company filed an Amendment to its quarterly

report for the first quarter of 2004, signed by defendant McHenry, which restated the Company’s

financial statements as of March 31, 2004, and for the quarters ended March 31, 2004 and 2003.

The reported effects of the restatement on the Company’s previously issued financial results

were as follows:

$’000

Quarter Ended March 31, 2004 (as

previously reported) Adjustments

Quarter Ended March 31, 2004

(Restated)

SGA $47,134 $257 $47,391

Net Income Before Taxes

$7,688 $(257) $7,431

Basic EPS $0.17 $(0.01) $0.16

Diluted EPS $0.16 $(0.01) $0.15

Accounts Receivable

$116,114 $(3,800) $112,314

Total Current Assets

$201,026 $(2,162) $198,864

Total Assets $747,761 $(2,162) $745,599

117. By the time the Company issued its August 16, 2004 announcement that it would

restate its financial results, and its September 15, 2004 restated financial statements, the market

had already anticipated the effect of this news on the value of Hanger shares by virtue of

Hanger’s August 9 and 10, 2004 disclosures, causing a 50% decline in Hanger’s shares by

August 12, 2004. Given that by August 12, 2004, the market had already factored into Hanger’s

share price the effect of an anticipated restatement of Hanger’s financial results, Hanger’s share

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price remained relatively unchanged in the days following the Company’s August 16, 2004

announcement and its September 15, 2004 restatements.

HANGER’S MATERIALLY FALSE FINANCIAL STATEMENTS VIOLATED GAAP AND SEC REGULATIONS

118. Defendants represented that Hanger’s Class Period financial statements were

prepared in accordance with GAAP. As set forth herein, these representations were materially

false and misleading because defendants caused Hanger to issue financial statements that

misrepresented and/or artificially and improperly inflated the Company’s operating results

during the Class Period.

119. As investors came to learn on August 16, 2004, Hanger had been artificially

inflating its financial results and condition throughout the Class Period by overstating its

accounts receivable, revenue and net income and understating its bad debt expense and selling,

general and administrative expenses. Because of these accounting improprieties, Hanger’s

financial statements were, contrary to its express representations contained in its quarterly and

annual reports, not prepared in accordance with GAAP or applicable SEC regulations.

120. GAAP are those principles recognized by the accounting profession as the

conventions, rules, and procedures necessary to define accepted accounting practices at a

particular time. As set forth in Financial Accounting Standards Board (“FASB”) Statements of

Concepts (“Concepts Statement”) No. 1, one of the fundamental objectives of financial reporting

is that it provide accurate and reliable information concerning an entity’s financial performance

during the period being presented. Concepts Statement No. 1, paragraph 42, states:

Financial reporting should provide information about an enterprise’s financial performance during a period. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors’ and creditors’ expectations about

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future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance.

Management is responsible for preparing financial statements that conform with GAAP. As

noted by the AICPA professional standards:

financial statements are management’s responsibility . . . . [M]anagement is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, record, process, summarize, and report transactions (as well as events and conditions) consistent with management’s assertions embodied in the financial statements. The entity’s transactions and the related assets, liabilities and equity are within the direct knowledge and control of management . . . . Thus, the fair presentation of financial statements in conformity with Generally Accepted Accounting Principles is an important and integral part of management’s responsibility.

121. As set forth in Financial Accounting Standards Board (“FASB”) Statement of

Concepts (“Concepts Statement”) No.1 (“CON1), Objectives of Financial Reporting by Business

Enterprises (November 1978), 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. CON1 provides, in pertinent part,

Financial reporting should provide information about an enterprise’s financial performance during a period. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors’ and creditors’ expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance.

122. Regulation S-X (17 C.F.R. §210.4-01(a)(1)) states that financial statements filed

with the SEC which are not prepared in compliance with GAAP are presumed to be misleading

and inaccurate. Regulation S-X requires that interim financial statements must also comply with

GAAP, with the exception that interim financial statements need not include disclosures which

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would be duplicative of disclosures accompanying annual financial statements. 17 C.F.R.

§210.10-01(a).

123. During the Class Period, defendants caused Hanger to issue financial statements

in violation of GAAP and SEC rules and regulations, by failing to properly report its results for

the fiscal years ended December 31, 2003, 2002 and 2001 and the quarter ended March 31, 2004.

Specifically, Defendants manipulated Hanger’s financial statements by:

(a) failing to properly account for accounts receivable and bad debt expense, thereby artificially overstating assets and net income;

(b) failing to properly report and record revenue, thereby overstating revenue and net income; and

(c) failing to properly maintain an adequate system of internal control, thereby rendering Hanger’s financial reporting unreliable and incorrect.

Hanger’s Failure to Properly Account for Accounts Receivable and Bad Debt Expense

124. GAAP considers “[t]he conditions under which receivables exist usually involve

some degree of uncertainty about their collectibility, in which case a contingency exists . . . .

[Contingency is defined as an existing condition, situation, or set of circumstances involving

uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one

or more future events occur or fail to occur . . . .].” Losses from uncollectible receivables shall

be accrued when both conditions in paragraph 8 of SFAS No. 5 are met. Those conditions may

be considered in relation to individual receivables or in relation to groups of similar types of

receivables. If the conditions are met, accrual shall be made even though the particular

receivables that are uncollectible may not be identifiable. SFAS No. 5 ¶ 22.

125. Additionally, GAAP provides that an estimated loss from a loss contingency, such

as the collectibles of receivables, “shall be accrued by a charge to income” if: (i) information

available prior to issuance of the financial statements indicated that it is probable that an asset

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had been impaired or a liability had been incurred at the date of the financial statements; and (ii)

the amount of the loss can be reasonably estimated. SFAS No. 5 ¶ 8. SFAS No. 5 also requires

that financial statements disclose contingencies when it is at least reasonably possible (e.g., a

greater than slight chance) that a loss may have been incurred. The disclosure shall indicate the

nature of the contingency and shall give an estimate of the possible loss, a range of loss or state

that such an estimate cannot be made.

126. The SEC considers the disclosure of loss contingencies to be so important to an

informed investment decision that it promulgated Regulation S-X, which provides that

disclosures in interim period financial statements may be abbreviated and need not duplicate the

disclosure contained in the most recent audited financial statements, except that, “where material

contingencies exist, disclosure of such matters shall be provided even though a significant

change since year end may not have occurred.” 17 C.F.R. § 210.10-01.

127. Accounting Research Bulletin (“ARB”) No. 43 Chapter 3, Section 9 provides that

the objective of providing for reserves against receivables is to assure that, “[a]ccounts

receivable net of allowances for uncollectible accounts . . . are effectively stated as the amount of

cash estimated as realizable.”

128. In addition, CON5 states, “[a]n expense or loss is recognized if it becomes

evident that previously recognized future economic benefits of an asset have been reduced or

eliminated . . . .”

129. Despite these requirements, as alleged in detail above, the Company’s financial

statements during the Class Period failed to properly reflect the Company’s bad debt expense and

accounts receivable as required by GAAP. Instead, the Company’s reported results included bad

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debt expense which was artificially understated by $3.5million and accounts receivable which

was artificially overstated by $3.5 million for the three years 2001, 2002 and 2003.

Hanger’s Improper Accounting and Reporting of Revenue

130. GAAP provides that revenue should not be recognized until it is realized or

realizable and earned. FASB Concepts Statement No. 5, Recognition and Measurement in

Financial Statements of Business Enterprises (“CON 5”) (December 1984), ¶¶ 83-84;

Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research

Bulletins (June 1953) Chapter 1A ¶1; Accounting Principles Board Opinion No. 10 Omnibus

Opinion, (December 1966), ¶12. The conditions for revenue recognition ordinarily are met when

persuasive evidence of an arrangement exists, delivery has occurred or services have been

rendered, the seller price to the buyer is fixed or determinable, collectibility is reasonably

assured, and the seller has substantially accomplished what it must do to be entitled to the

benefits represented by the revenues. Staff Accounting Bulletin No. 101 Revenue Recognition

in Financial Statements (“SAB 101”) (December 1999) and CON 5 ¶ 83.

131. Hanger’s audited 2003 Form 10-K disclosed the following policy of accounting

for revenue:

Revenues on the sale of orthotic and prosthetic devices and associated services to patients are recorded when the device is accepted by the patient, provided that (i) there are no uncertainties regarding customer acceptance; (ii) persuasive evidence of an arrangement exists; (iii) the sales price is fixed and determinable; and (iv) and collectibility is deemed probable. Revenue is recorded at its net realizable value taking into consideration all governmental and contractual adjustments and discounts.

132. Hanger’s financial statements during the Class Period were materially false and

misleading and in violation of GAAP and the Company’s own disclosed accounting policies

because it improperly booked revenue by, inter alia, forging prescriptions and other documents

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necessary for obtaining reimbursement from insurers (including Medicare and Medicaid),

charging insurers for items or services that were not prescribed for, or not provided to patients,

misrepresenting to insurers the type of item, or the scope of the services, provided to patients,

and improperly billing for items before they were even provided to patients — all as alleged

more fully in ¶¶ 51-77 above. As such, Hanger improperly booked revenue that it knew, or

recklessly disregarded was not realized or not realizable and that was subject to non-payment or

recoupment by third party payors.

Hanger’s Failure to Maintain an Adequate System of Internal Controls

133. Section 13(b)(2)(B) of the Exchange Act requires every issuer that has securities

registered pursuant to Section 12 of the Exchange Act to: (A) make and keep books, records and

accounts which, in reasonable detail, accurately and fairly reflect the transactions and disposition

of the assets of the issuer; and (B) devise and maintain a system of internal accounting controls

sufficient to reasonably assure, among other things, that transactions are recorded as necessary to

permit preparation of financial statements in conformity with GAAP. These provisions require

an issuer to employ and supervise reliable personnel, to maintain reasonable assurances that

transactions are executed as authorized, to properly record transactions on an issuer’s books and,

at reasonable intervals, to compare accounting records with physical assets.

134. The Company suffered from a chronic and systematic breakdown of its internal

accounting controls to properly record accounts receivable, bad debt expense and revenue and

which rendered Hanger’s financial reporting unreliable and incorrect, resulting in materially false

and misleading financial statements. In particular:

(a) the Company maintained insufficient controls relating to the documentation of controls including the documentation of controls relating to patient-care centers as disclosed in Hanger’s Restated 2003 Form 10K/A;

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(b) the Company maintained insufficient controls relating to the recording of transfers between patient-care centers as disclosed in Hanger’s Restated 2003 Form 10K/A;

(c) the Company’s control environment was such that patient care centers generally operated in an uncontrolled and unsupervised manner;

(d) the Company maintained insufficient internal compliance controls, including inadequate auditing and supervision of its patient care facilities to ensure compliance with federal, state, and local regulation and the requirements of private insurers; and

(e) the Company employed, and failed to adequately supervise, personnel in key management and oversight positions, such as Donna Crouse, David Zwicker, Jerry Johnson and Jerry Ritieni, that it knew to be unreliable.

135. As disclosed in the Hanger’s Restated 2003 Form 10-K/A:

During the preparation of our June 2004 financial statements, it became apparent that, with the enhanced visibility provided by our new billing and cash collection system (O/P/S) that our previously reported accounts receivable balance at March 31, 2004 was overstated by $3.8 million. The error has been corrected and financial statements have been restated as appropriate.

The Company is continuing its evaluation of its internal controls in light of the standards adopted by the PCAOB. In the course of its ongoing evaluation, management has identified certain deficiencies which the Company is addressing. Areas requiring improvement include documentation of controls and recording of transfers between patient-care centers. Management will consider these matters when assessing the effectiveness of the Company’s internal control over financial reporting at December 31, 2004. [Emphasis added.]

136. Defendants knowingly or recklessly failed to implement and maintain adequate

internal control systems in a manner that would ensure compliance with GAAP, resulting in

materially false and misleading financial statements throughout the Class Period.

Hanger’s False and Misleading Class Period Financial Statements Were Material

137. In view of “the potential dilution of public confidence in financial statements

resulting from restating the financial statements of prior periods,” GAAP provides that a

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retroactive restatement of financial statements, like Hanger’s, is reserved for material accounting

errors that existed at the time the financial statements were prepared. APB Opinion No. 20,

Accounting Changes 18, 27, 34-38 (July 1971). Because GAAP allows only for correction of

errors that are “material,” by restating its financial statements, Hanger admitted the materiality of

the errors in its previously issued financial statements.

Hanger’s Violations of SEC Regulations

138. Item 7 of Form 10-K and Item 2 of Form 10-Q, Management Discussions and

Analysis of Financial Condition and Results of Operations (“MD&A”) require the issuer to

furnish information required by Item 303 of Regulation S-K [17.C.F.R.229.303]. In discussing

results of operations, Item 303 of Regulation S-K requires the registrant to:

[d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.

139. In addition, the SEC in its May 1989 Interpretive Release No. 34-26831, has

indicated that registrants should employ the following two step analysis in determining when a

known trend or uncertainty is required to be included in the MD&A disclosure pursuant to Item

303 of Regulation S-K:

A disclosure duty exists where a trend, demand, event or uncertainty is both presently known to management and is reasonably likely to have a material effect on the registrant’s financial condition or results of operations.

140. Nonetheless, Hanger’s Class Period Forms 10-K and 10-Q failed to adequately

disclose the uncertainties associated with accounts receivable, bad debt expense, and revenue in

violation of SEC regulations, which defendants knew or recklessly disregarded.

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Hanger’s Additional GAAP Violations

141. In addition to the violations of GAAP noted above, the Company presented its

financial results for accounts receivable, bad debt expense and revenue in a manner that also

violated the following fundamental accounting principles:

(a) The principle that interim financial reporting should be based upon the same accounting principles and practices used to prepare annual financial statements (APB No. 28, ¶12);

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

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

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

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

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

(g) The concept of completeness, which means that nothing is left out of the information that may be necessary to insure that it validly represents

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underlying events and conditions was violated (Concepts Statement No. 2, ¶79); and

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

ADDITIONAL SCIENTER ALLEGATIONS

142. As alleged herein, defendants acted with scienter in that defendants knew that the

public documents and statements issued or disseminated in the name of the Company were

materially false and misleading; knew that such statements or documents would be issued or

disseminated to the investing public; and knowingly and substantially participated or acquiesced

in the issuance or dissemination of such statements or documents as primary violations of the

federal securities laws. As set forth elsewhere herein in detail, defendants, by virtue of their

receipt of information reflecting the true facts regarding Hanger, their control over, and/or

receipt and/or modification of Hanger’s allegedly materially misleading misstatements and/or

their associations with the Company which made them privy to confidential proprietary

information concerning Hanger, participated in the fraudulent scheme alleged herein.

Defendants were motivated to engage in the fraud alleged herein so that Hanger insiders could

sell their personally held Hanger stock at artificially inflated prices. By virtue of Hanger’s

billing fraud and its improper accounting and dissemination of materially false financial

statements, defendants’ scheme succeeded in artificially inflating the Company’s stock price

from $8.88 per share on March 12, 2002 — the day before the Class Period begins — to a Class

Period high of $19.25 on January 22, 2004. During the Class Period, defendants Sabel and

McHenry took advantage of the artificial share price inflation by selling over 50,000 shares of

their Hanger common stock at artificially inflated prices, reaping gross proceeds in excess of

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$850,000. In addition, other corporate insiders at Hanger sold more than $14 million of

Company stock during the Class Period. The following chart summarizes the stock sales of the

Individual Defendants and other corporate insiders during the Class Period:

CLASS PERIOD STOCK SALES BY DEFENDANTS AND CORPORATE INSIDERS

Corporate Insider Date of Sale

No. of Shares Sold

Price/ Share Proceeds

Shares Held During Class Period

Percentage of Holdings Sold2

Ivan R. Sabel Chairman Of The Board And CEO

11/26/03 13,983 $16.55 $231,418.65

11/26/03 10,000 $16.62 $166,200.00

11/26/03 7,400 $16.60 $122,840.00

11/26/03 1,537 $16.63 $25,560.31

11/26/03 100 $16.56 $1,656.00

Total Sabel 33,020 $547,674.96 251,211 13.14%

George E. McHenry CFO And Executive VP

11/7/03 7,200 $16.40 $118,080.00

11/7/03 3,800 $16.39 $62,282.00

11/7/03 2,500 $16.35 $40,875.00

11/7/03 1,300 $16.45 $21,385.00

11/7/03 900 $16.38 $14,742.00

2 This figure reflects the percentage of shares held at the beginning of the class period that were sold during the class period.

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No. of Shares Sold




11/7/03 600 $16.36 $9,816.00

11/7/03 600 $16.60 $9,960.00

11/7/03 400 $16.41 $6,564.00

11/7/03 400 $16.43 $6,572.00

11/7/03 300 $16.37 $4,911.00

11/7/03 200 $16.31 $3,262.00

11/7/03 200 $16.34 $3,268.00

11/7/03 200 $16.54 $3,308.00

11/7/03 200 $16.55 $3,310.00

11/7/03 100 $16.42 $1,642.00

11/7/03 100 $16.57 $1,657.00

Total McHenry 19,000 $311,634.00 34,000 55.88%

Blutt, Michael Director

11/20/02 535200 $11.49 $6,149,448

11/25/02 331414 $12.75 $4,225,395.93

3/5/03 25,000 $10.60 $265,000.00

3/5/03 1,000 $10.62 $10,620.00

3/5/03 29,200 $10.63 $310,396.00

3/5/03 20,000 $10.65 $213,000.00

3/5/03 300 $10.66 $3,198.00

3/6/03 2,300 $10.50 $24,150.00

3/6/03 3,900 $10.55 $41,145.00

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No. of Shares Sold




3/6/03 2,300 $10.56 $24,288.00

3/6/03 400 $10.57 $4,228.00

3/6/03 800 $10.58 $8,464.00

3/6/03 400 $10.59 $4,236.00

3/6/03 16,500 $10.60 $174,900.00

3/6/03 1,300 $10.62 $13,806.00

3/6/03 1,600 $10.63 $17,008.00

3/6/03 500 $10.61 $5,305.00

3/7/03 1,300 $10.04 $13,052.00

3/7/03 200 $10.08 $2,016.00

3/7/03 200 $10.09 $2,018.00

3/7/03 1,600 $10.10 $16,160.00

3/7/03 500 $10.11 $5,055.00

3/7/03 300 $10.12 $3,036.00

3/7/03 1,700 $10.13 $17,221.00

3/7/03 7,800 $10.14 $79,092.00

3/7/03 200 $10.15 $2,030.00

3/7/03 300 $10.16 $3,048.00

3/7/03 400 $10.17 $4,068.00

3/7/03 22,100 $10.19 $225,199.00

3/7/03 1,800 $10.20 $18,360.00

3/7/03 2,400 $10.21 $24,504.00

3/7/03 2,900 $10.22 $29,638.00

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No. of Shares Sold




3/7/03 1,300 $10.24 $13,312.00

3/7/03 1,700 $10.25 $17,425.00

3/7/03 2,100 $10.26 $21,546.00

3/7/03 8,100 $10.27 $83,187.00

3/10/03 4600 $9.99 $45954

3/10/03 600 $10.00 $6000

3/10/03 1300 $10.01 $13013

3/10/03 2500 $10.04 $25100

3/10/03 500 $10.05 $5025

3/10/03 200 $10.06 $2012

3/10/03 20200 $10.09 $203818

3/10/03 1027 $10.14 $10413.78

Total Blutt 1,059,941 12,385,891.00 1,059,941 100.00%

Charrette, Edmond Director

9/13/02 15,000 $17.30 $259,500.00

12/1/03 10,000 $16.90 $169,000.00

Total Charrette 25,000 $428,500.00 28,745 86.97%

- 70 -



No. of Shares Sold




Cooper, Thomas Director

6/3/03 1000 ---3 ---

6/18/03 5,000 $11.44 $57,200.00

10/13/03 500 $16.65 $8,325.00

5/17/04 4,600 $15.50 $71,300.00

5/17/04 200 $15.80 $3,160.00

5/17/04 200 $15.90 $3,180.00

Total Cooper 11,500 $143,165.00 21,475 53.55%

Lavizzo-Mourey, Risa Director

6/3/03 1000 --- ---

6/3/03 1000 --- ---

6/6/03 6,400 $11.11 $71,104.00

6/6/03 4,300 $11.12 $47,816.00

6/6/03 1,400 $11.16 $15,624.00

6/6/03 300 $11.17 $3,351.00

6/6/03 700 $11.18 $7,826.00

6/9/03 10,000 $11.12 $111,200.00

6/9/03 600 $11.15 $6,690.00

3 The notation “---” means that Form 4 filing evidencing the listed transaction does not provide the relevant information.

- 71 -



No. of Shares Sold




6/9/03 300 $11.20 $3,360.00

6/11/03 4,400 $11.15 $49,060.00

6/12/03 4,700 $11.20 $52,640.00

6/12/03 6,900 $11.15 $76,935.00

Total Lavizzo-Mourey

42,000 $445,606.00 54,850 76.57%

Lohrmann, Glenn Vice President and Controller

12/0/03 6000 $16.90 $101,400.00

Total Lohrmann 6,000 $101,400.00 12,000 50.00%

May, Ronald President, Southern Prosthetic Supply, Inc. (subsidiary of Hanger)

5/8/03 1,500 $12.07 $18,105.00

6/2/03 2,500 $11.06 $27,650.00

6/3/03 4,000 $10.61 $42,440.00

9/3/03 4,166 $15.18 $63,239.88

6/9/04 3,900 $16.00 $62,400.00

6/9/04 1,100 $16.04 $17,644.00

Total May 17,166 $231,478.88 25,166 68.21%

- 72 -



No. of Shares Sold




Owen, Jason Treasurer

3/15/02 600 $9.15 $5,490

3/15/02 5650 $9.25 $52,262.5

5/31/02 3,000 $14.84 $44,520.00

11/27/02 6250 $13.15 $82,187.5

8/4/03 6,000 $13.75 $82,500.00

1/5/04 1,000 $15.57 $15,570.00

1/5/04 700 $15.60 $10,920.00

1/5/04 800 $15.61 $12,488.00

1/5/04 250 $15.62 $3,905.00

1/5/04 2,000 $15.63 $31,260.00

1/5/04 1,000 $15.65 $15,650.00

1/5/04 500 $15.67 $7,835.00

1/5/04 500 $15.72 $7,860.00

1/5/04 500 $15.75 $7,875.00

6/2/04 700 $16.04 $11,228.00

6/2/04 200 $16.03 $3,206.00

6/2/04 700 $16.04 $11,228.00

6/2/04 200 $16.03 $3,206.00

6/2/04 2,900 $16.01 $46,429.00

6/2/04 1,200 $16.00 $19,200.00

Total Owen 34,750 $474,820 39,750 87.42%

- 73 -



No. of Shares Sold




Taylor, Richmond Executive Vice President

11/6/03 500 $16.30 $8,150.00

11/6/03 5,000 $16.31 $81,550.00

11/6/03 1,800 $16.35 $29,430.00

11/6/03 1,600 $16.37 $26,192.00

11/6/03 1,500 $16.38 $24,570.00

11/6/03 100 $16.39 $1,639.00

11/6/03 2,000 $16.40 $32,800.00

11/6/03 800 $16.41 $13,128.00

11/6/03 300 $16.42 $4,926.00

11/6/03 700 $16.43 $11,501.00

11/6/03 4,134 $16.45 $68,004.30

11/6/03 200 $16.46 $3,292.00

11/6/03 200 $16.47 $3,294.00

11/6/03 600 $16.48 $9,888.00

11/6/03 200 $16.49 $3,298.00

11/6/03 300 $16.50 $4,950.00

11/6/03 3,400 $16.53 $56,202.00

Total Taylor 23,334 $382,814.30 53,334 43.75%

Total All Insiders 1,271,711 $15,452,984.14 1,580,202 80.48%

- 74 -


143. The above-listed stock sales are particularly suspicious given that none of the

Individual Defendants and insiders listed above sold any stock at all for over three years before

the Class Period. This, despite the fact that the Individual Defendants and the other insiders held

1,580,202 shares of stock during the three year period preceding the Class Period, including

251,211 shares and 34,000 shares held by Defendants Sabel and McHenry, respectively.

Applicability Of Presumption Of Reliance: Fraud-On-The-Market Doctrine

144. At all relevant times, the market for Hanger’s securities was an efficient market

for the following reasons, among others:

(a) Hanger’s stock met the requirements for listing, and was listed and actively traded on the NYSE, a highly efficient and automated market;

(b) As a regulated issuer, Hanger filed periodic public reports with the SEC and the NYSE;

(c) Hanger regularly communicated with public investors via established market communication mechanisms, including through regular disseminations of press releases on the national circuits of major newswire services and through other wide-ranging public disclosures, such as communications with the financial press and other similar reporting services; and

(d) Hanger was followed by several securities analysts employed by major brokerage firms who wrote reports, which were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace.

145. As a result of the foregoing, the market for Hanger’s securities promptly digested

current information regarding Hanger from all publicly available sources and reflected such

information in Hanger’s stock price. Under these circumstances, all purchasers of Hanger’s

securities during the Class Period suffered similar injury through their purchase of Hanger’s

securities at artificially inflated prices and a presumption of reliance applies.

- 75 -


NO SAFE HARBOR

146. The statutory safe harbor provided for forward-looking statements under certain

circumstances does not apply to any of the allegedly false statements pleaded in this complaint.

Many of the specific statements pleaded herein were not identified as “forward-looking

statements” when made. To the extent there were any forward-looking statements, there were no

meaningful cautionary statements identifying important factors that could cause actual results to

differ materially from those in the purportedly forward-looking statements. Alternatively, to the

extent that the statutory safe harbor does 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 knew that the particular

forward-looking statement was false, and/or the forward-looking statement was authorized

and/or approved by an executive officer of Hanger who knew that those statements were false

when made.

FIRST CLAIM

Violation Of Section 10(b) Of The Exchange Act And Rule 10b-5

Promulgated Thereunder Against All Defendants

147. Plaintiffs repeat and re-allege each and every allegation contained above as if

fully set forth herein.

148. During the Class Period, Hanger and the Individual Defendants, and each of them,

carried out a plan, scheme and course of conduct which was intended to and, throughout the

Class Period, did: (a) deceive the investing public, including plaintiffs and other Class members,

as alleged herein; (b) artificially inflate and maintain the market price of Hanger’s securities; and

(c) cause plaintiffs and other members of the Class to purchase Hanger’s securities at artificially

- 76 -


inflated prices. In furtherance of this unlawful scheme, plan and course of conduct, defendants,

and each of them, took the actions set forth herein.

149. 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 not misleading; and (c) engaged in acts, practices, and a course of business which

operated as a fraud and deceit upon the purchasers of the Company’s securities in an effort to

maintain artificially high market prices for Hanger’s securities in violation of Section 10(b) of

the Exchange Act and Rule 10b-5. All defendants are sued either as primary participants in the

wrongful and illegal conduct charged herein or as controlling persons as alleged below.

150. In addition to the duties of full disclosure imposed on defendants as a result of

their making of affirmative statements and reports, or participation in the making of affirmative

statements and reports to the investing public, defendants had a duty to promptly disseminate

truthful information that would be material to investors in compliance with the integrated

disclosure provisions of the SEC as embodied in SEC Regulation S-X (17 C.F.R. Sections

210.01 et seq.) and Regulation S-K (17 C.F.R. Sections 229.10 et seq.) and other SEC

regulations, including accurate and truthful information with respect to the Company’s

operations, financial condition and earnings so that the market price of the Company’s securities

would be based on truthful, complete and accurate information.

151. Hanger and the Individual Defendants, individually and in concert, directly and

indirectly, by the use, means or instrumentalities of interstate commerce and/or of the mails,

engaged and participated in a continuous course of conduct to conceal adverse material

information about the business, operations and future prospects of Hanger as specified herein.

- 77 -


152. These defendants employed devices, schemes and artifices to defraud, while in

possession of material adverse non-public information and engaged in acts, practices, and a

course of conduct as alleged herein in an effort to assure investors of Hanger’s value and

performance and continued substantial growth, which included the making of, or the

participation in the making of, untrue statements of material facts and omitting to state material

facts necessary in order to make the statements made about Hanger and its business operations

and future prospects in the light of the circumstances under which they were made, not

misleading, as set forth more particularly herein, and engaged in transactions, practices and a

course of business which operated as a fraud and deceit upon the purchasers of Hanger’s

securities during the Class Period.

153. The Individual Defendants’ primary liability, and controlling person liability,

arises from the following facts: (a) the Individual Defendants were high-level executives and

directors at the Company during the Class Period; (b) the Individual Defendants were privy to

and participated in the creation, development and reporting of the Company's internal budgets,

plans, projections and/or reports; and (c) the Individual Defendants were aware of the Company's

dissemination of information to the investing public which they knew or recklessly disregarded

was materially false and misleading.

154. The defendants had actual knowledge of the misrepresentations and omissions of

material facts set forth herein, or acted with reckless disregard for the truth in that they failed to

ascertain and to disclose such facts, even though such facts were available to them. Such

defendants’ material misrepresentations and/or omissions were done knowingly or recklessly and

for the purpose and effect of concealing Hanger’s operating condition and future business

prospects from the investing public and supporting the artificially inflated price of its securities.

- 78 -


As demonstrated by defendants’ overstatements and misstatements of the Company’s business,

operations and earnings throughout the Class Period, defendants, if they did not have actual

knowledge of the misrepresentations and omissions alleged, were reckless in failing to obtain

such knowledge by deliberately refraining from taking those steps necessary to discover whether

those statements were false or misleading.

155. As a result of the dissemination of the materially false and misleading information

and failure to disclose material facts, as set forth above, the market price of Hanger’s securities

was artificially inflated during the Class Period. In ignorance of the fact that market prices of

Hanger’s publicly-traded securities were artificially inflated, and relying directly or indirectly on

the false and misleading statements made by defendants, or upon the integrity of the market in

which the securities trade, and/or on the absence of material adverse information that was known

to or recklessly disregarded by defendants but not disclosed in public statements by defendants

during the Class Period, plaintiffs and the other members of the Class acquired Hanger securities

during the Class Period at artificially high prices and were damaged thereby.

156. At the time of said misrepresentations and omissions, plaintiffs and other

members of the Class were ignorant of their falsity, and believed them to be true. Had plaintiffs

and the other members of the Class and the marketplace known of the true financial condition

and business prospects of Hanger, which were not disclosed by defendants, plaintiffs and other

members of the Class would not have purchased or otherwise acquired their Hanger securities,

or, if they had acquired such securities during the Class Period, they would not have done so at

the artificially inflated prices which they paid.

157. By virtue of the foregoing, defendants have violated Section 10(b) of the

Exchange Act, and Rule 10b-5 promulgated thereunder.

- 79 -


158. As a direct and proximate result of defendants’ wrongful conduct, plaintiffs and

the other members of the Class suffered damages in connection with their respective purchases

and sales of the Company's securities during the Class Period.

SECOND CLAIM

Violation Of Section 20(a) Of The Exchange Act Against the Individual Defendants

159. Plaintiffs repeat and re-allege each and every allegation contained above as if

fully set forth herein.

160. The Individual Defendants acted as a controlling person of Hanger within the

meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their high-level

positions, and their ownership and contractual rights, participation in and/or awareness of the

Company's operations and/or intimate knowledge of the statements filed by the Company with

the SEC and disseminated to the investing public, the Individual Defendants had the power to

influence and control and did influence and control, directly or indirectly, the decision-making of

the Company, including the content and dissemination of the various statements which plaintiffs

contends are false and misleading. The Individual Defendants were provided with or had

unlimited access to copies of the Company's reports, press releases, public filings and other

statements alleged by plaintiffs to be misleading prior to and/or shortly after these statements

were issued and had the ability to prevent the issuance of the statements or cause the statements

to be corrected.

161. In particular, the Individual Defendants had direct and supervisory involvement in

the day-to-day operations of the Company and, therefore, are presumed to have had the power to

control or influence the particular transactions giving rise to the securities violations as alleged

herein, and exercised the same.

- 80 -


162. As set forth above, Hanger and the Individual Defendants each violated Section

10(b) and Rule 10b-5 by their acts and omissions as alleged in this Complaint. By virtue of their

positions each as a controlling person, the Individual Defendants are liable pursuant to Section

20(a) of the Exchange Act. As a direct and proximate result of Hanger’s and the Individual

Defendants’ wrongful conduct, plaintiffs and other members of the Class suffered damages in

connection with their purchases of the Company’s securities during the Class Period.

PRAYER FOR RELIEF

WHEREFORE, plaintiffs pray for relief and judgment, as follows:

A. Determining that this action is a proper class action and certifying plaintiffs as

class representatives under Rule 23 of the Federal Rules of Civil Procedure and plaintiffs’

counsel as lead counsel for the Class;

B. Awarding compensatory damages in favor of plaintiffs and the other Class

members against all defendants, jointly and severally, for all damages sustained as a result of

defendants’ wrongdoing, in an amount to be proven at trial, including interest thereon;

C. Awarding plaintiffs and the Class their reasonable costs and expenses incurred in

this action, including counsel fees and expert fees; and

D. Such other and further relief as the Court may deem just and proper.

DATED: June 12, 2006

Respectfully submitted, TYDINGS & ROSENBERG LLP By: /s/ _ John B. Isbister (Fed. Bar No. 00639) 100 E Pratt Street 26th Floor Baltimore, Maryland USA 21202 Phone: (410) 752-9700 Fax: (410) 727-5460 Local Counsel for Plaintiffs

- 81 -


MILBERG WEISS BERSHAD &

SCHULMAN LLP Barry Weprin (BW-8637)

Peter Sloane (PS-4672) One Pennsylvania Plaza New York, NY 10119-0165 Telephone: (212) 594-5300 Facsimile: (212) 868-1229 -and- LERACH COUGHLIN STOIA GELLER

RUDMAN & ROBBINS LLP Samuel H. Rudman (SR-7957) David A. Rosenfeld (DR-7564) Mario Alba, Jr. (MA-7240) 2000 Broadhollow Road, Suite 406 Melville, NY 11747 Telephone: (631) 367-7100 Facsimile: (631) 367-1163 Co-Lead Counsel for Plaintiffs

- 82 -


EXHIBIT A

PRESCRIPTION

PATIENT ' S NAME AND ADDRESS

GERALDINE MCKOY

47-15 206TH STREET

BAYS I DE, NY 1136 1

PHYSICIAN ' S NAME AND ADDRESS

Carl Richie

146-01 45th Avenue

Suite 205

Flushing, NY 11355

DIAGNOSIS ( ICD-9 AND/OR NARRATIVE)

8976 AMPUTATION LEG, BILAT

DESCRIPTION OF ITEM/SERVICES ORDERED

PATIENT ' S DATE OF BIRTH

03/29/1925

PHYSICIAN ' S PHONE & FAX NUMBER

(718) 445-7223

PHYSICIAN'S UPIN

E22222

2 Replacement Below Knee Prosthetic Socket ; 2 Custom Shaped ProtectiveCover ; 4 Test Socket, BK ; 2 Total Contact Modification ; 2 Modular Alignable

System ; 2 Ultralight Weight Construction Material ; 2 Acrylic Socket, BK; 2

Foam Cushion Insert ; 2 Molded Distal Cushion ; 12 Below Knee ProstheticSheath ; 18 Multi-Ply Below Knee Socks ; .

FUNCTIONAL CAPACITY (from K1-K4 )

PRESCRIPTION DATE (START DATE ) EXPECTED LENGTH OF NEED

04/30/200 4

PROGNOSIS

MEDICAL NECESSITY

I AUTH IZE THE ITEMS/SERVICES SHOWN ABOVE AND CERTIFY THAT THE INFORMATION

PROVI HE IN IS TRUE AND ACCURATE .

PHYSI 'S (ORIGINAL) SIGNATURE DAT

Hanger Prosthetics & Orthotics East, Inc .

151 Hempstead Turnpike

West Hempstead,. NY 11552

(516)481-9670

Fax : (516)481-3725

PLEASE SIGN AND DATE THIS PRESCRIPTION AND RETURN IT TO US IN THE ENCLOSEDSELF ADDRESSED STAMPED ENVELOPE .

CERTIFICATE OF MEDICAL NECESSIT Y

Patient' s Name : GERALDINE MCKO Y

Date of Birth : 03/29/1925

Address : 47-15 206THSTREETBAYSIDE, NY, 11361-

Physician DetailsCarl Richie

146-01 45th Avenue

Suite 205

Flushing, NY, 11355-

Diagnosis : 8976 AMPUTATIONLEG, BILAT

Prognosis ;

Reason for Need :

Use [ ] Day [ ] Evening [ ] 24 hours

Length of Time Neede d

[ J Have Orthotist/Prosthetist call after consultation with patient

Ins. ID : 239226285B

Date: 05/17/2004

UPIN #: E22222

Telephone: (718)445-7223

Other License#:

[ I Pre-Op [ I Post-Op

RC Replacement Below Knee Prosthetic Socket ; Custom Shaped Protective Cover ;

Test Socket, BK ; Total Contact Modification ; Modular Alignable System ;

Ultralight Weight Construction Material ; Acrylic Socket, BK ; Foam Cushion

Insert ; Molded Distal Cushion ; Below Knee Prosthetic Sheath ; Multi-Ply

Below Knee Socks ;

[ ] Substitution Allowed ] Dispense as Writte n

Prescriber 's Signature 4, 0 Date ? 4 J~ y

Please return in this signed docdi ent in the enclosed, stamped self addressed envelope.

Hanger Prosthetics & OrthoticsWest Hempstead, NY

151 Hempstead TurnpikeWest Hempstead, NY, 11552

Tel : (516)481-9670

Fax : (516)481-3725

Page I of I

EXHIBIT B

1Iangei1151 Hempstead Turnpike

West Hempstead, NY, 11552

VALIDATION OF RECEIPT

GEORGE KOUVARISRecipient's Nam e

HCFA Code - Quantity - Description

03/15/200 4

L5700 1 REPLACE SOCKET BELOW KNEE ; L5620 2 TEST SOCKET BELOW KNEE ; L5637 1 BELOW

KNEE TOTAL CONTACT ; L5910 1 ENDO BELOW KNEE ALIGNABLE ; L5940 1 ENDO BK

ULTRA-LIGHT MATERI ; L5629 1 BELOW KNEE ACRYLIC SOCKET ; L5645 1 BK FLEX INNER

SOCKET EXT F ; L5662 2 SOCKET INSERT BK SILICONE ; L8420 6 PROSTHETIC SOCK MULTI

PLY ; L8470 6 PROS SOCK SINGLE PLY BK;

I have received and am satisfied with the device provided to me by the above named practice . I certify that a qualified

representative of the facility named above has provided me with education concerning the care and use of my equiprme o tand/or medical supplies . Also, I understand it is my responsibility to : 1) see my prescribing physician if special mcd 4 cal

management or further care pertaining to the wearing of the orthosis/prosthesis is necessary , and 2) inform the above

facility should any adjustments be needed .

I give the above noted practice , or its representative , permission .to contact me via telephone , or by other mealis,

regarding follow-up care and/or maintenance for this device or to discuss new devices or technologies that may apply to

my medical care . . I ,

Signature of Patient or'Responsible Party

Signature of Responsible Party (acknowledging receipt only )

Address of RepresentativeStree t

Signature of Witness (if patient signing with mark )

Address of WitnessStreet

City Stat e

City State

' Da

Date

---Lip

Date

Zip

Page Iof I