in re: nesco, inc. securities litigation 01-cv-00827...
TRANSCRIPT
F I L E DUNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF OKLAHOMA APR 2 2 2002
X U.S. DISTTRICT C 1JRTIn re : NESCO, INC . SECURITIES : Master File No.: 4:0 1 -CV-0827 H(J)LITIGATION
CONSOLIDATEDThis Document Relates to : : AMENDED CLASS ACTIONAll Actions : COMPLAINT
X Jur Trial Demanded
Lead Plaintiffs Ronald Nicol, Colin Nicol, and William and Marjorie Groszkruge r
(collectively, "Plaintiffs") allege the following based upon the investigation conducted by thei r
undersigned attorneys, except as to those paragraphs relating to Plaintiffs, their purchases of th e
securities of Nesco, Inc . ("Nesco" or the "Company"), or their suitability to serve as class
representatives . Those allegations are alleged upon Plaintiffs' personal knowledge. The
investigation of Plaintiffs' counsel has included, but has not been limited to, the following : (a)
the review and analysis of the filings made by Nesco with the United States Securities an d
Exchange Commission ("SEC"); (b) the review and analysis of the press releases identified in
this Consolidated Amended Class Action Complaint (the "Complaint") ; (c) the review and
analysis of the analyst reports, newspaper, magazine and other periodical articles concerning
Nesco; (d) the review and analysis of the filings made by Nesco in Nesco's Chapter I I
bankruptcy proceeding in the United States District Court for the Northern District of Oklahoma ;
and (e) interviews of former Nesco employees conducted by Plaintiffs ' counsel or their agents.
-AAJ .
NATURE OF THE CASE
This is a securities class action brought on behalf of Plaintiffs and all othe r
persons or entities, except for defendants herein , who bought Nesco secu rities during the period
April 26, 2000 through August 16, 2001, inclusive (the "Class Period") .
4 . The defendants include Eddy L . Patterson, who was the Company's Chief
Executive Officer and Chairman of the Board at all relevant times ; James Howell, who was the
Company"s President at all relevant times ; Larry Johnson, who was the Company's Chief
Financial Officer, Vice President , and Secretary at all relevant times ; (collectively referred to
herein as the "Individual Defendants") ; and Tullius Taylor Sartain & Sartain LLP (referred. to
herein as "Tullius Taylor"), the accounting firm that served as Nesco 's outside auditor s
throughout the Class Period .
3 . As alleged herein, during the Class Period, defendants engaged in a
fraudulent scheme that served to substantially overstate Nesco's revenues and earnings for th e
year 2000, and which had the effect of inflating the prices of Nesco' s securities throughout th e
Class Period. More specifically, at the direction of Eddy Patterson, the Company's Chairman o f
the Board and Chief Executive Officer, Nesco employees were instructed to create fictitious o r
inflated invoices for customers . These invoices were known within the Company as "Eddy
invoices ." When creating these fictitious or inflated invoices, the Company then booked the
fictitious or inflated amounts as revenue on services that were not performed, thereby
substantially overstating the Company's revenues and earnings for the periods in question . This
improper practice was in clear violation of the Company's own formal revenue recognitio n
policy and in violation of Generally Accepted Accounting Principles ("GAAP") .
h
4. Thus, throughout the Class Period, defendants issued a series of materially
false and misleading statements about the Company's quarterly and annual financial results fo r
the year 2000. These false financial statements were known to be false by Eddy Patterson, who
personally directed the wrongful activity alleged herein . In addition, given the large number o f
invoices which were inflated (30 to 40 each quarter), the length of time during which the
wrongdoing occurred (for the year 2000), and the total magnitude of the overstatement o f
revenues and earnings ( i .e ., Nesco ' s 2000 earnings were overstated by 79%, and possibly more
considering the Company's subsequent admission that additional revenues of $644,000 wer e
improperly recorded in prior periods), Individual Defendants Howell and Johnson, and th e
Company's accountants, Tullius Taylor, either knew, or were reckless in not knowing, of the
falsity of the statements .
5 . Engaging in this fraudulent activity served various purposes for
defendants: (1) it caused the Company to substantially overstate revenues and earnings, and thus ,
to consistently report seemingly "record" financial results, which were illusory ; (2) it allowed the
Company to falsely create the impression that the Company' s financial growth was a result of its
operations and acquisitions, when in reality, the purported growth was due to fictitious revenues ;
(3) it allowed the Company to acquire various companies using its artificially inflated stock a s
partial consideration for the purchases ; and (4) it enabled the Company to maintain a credi t
facility from its principal lender, Sank One, which it desperately needed to fund its operation s
and investments .
6. At the close of the Class Period, on August 16, 2001, the Company
restated its revenues for 2000 and the first quarter of 2001 to adjust for $3 .65 million in
3
M1
overbooked sales . The overbooked sales, which were the result of the fictitious or inflated "Eddy
invoices ," forced the Company to restate its earnings for 2000 to $588 ,000, or 6 cents a share,
from the previously reported $2.85 million, or 31 cents per share . In other words, earnings fo r
the year 2000 were overstated by 79% . Nesco's restatement of its financial results is an
admission that the financial statements were materially false when issued .
7. On August 16, 2001, the Company further announced that defendants
Patterson and Howell had resigned their positions at the Company . Defendant Johnson' s
employment also was terminated shortly thereafter, in October 2001 .
8 . As a result of these disclosures, trading in Nesco's stock was halted, and
remained so until market officials received information relating to the Company's accountin g
manipulations . Trading resumed on December 31, 2001, on the non NASDAQ OTC market, an d
it has been trading on a very thin volume ever since .
9. The Company further reported on August 16, 2001, that for the year ended
December 31, 2000, the Company was not in compliance with certain covenants of its principal
credit facility with Bank One . In fact, in August 2001, Bank One informed the Company that th e
Company needed to find a new credit facility . Bank One withdrew as Nesco's lender as a result
of the Company's lower than expected profitability . This was a crucial event for the Company
since it desperately needed the credit facility to fund its operations . Without such credit, th e
Company's ability to continue as a going concern became greatly impaired.
10. On November 14, 2001, the Company fi led its Form 1 0-Q for the quarterly
period ended September 30, 2001, reporting that it had "discovered additional invoices totalin g
approximately $644,000 which had been improperly recorded as revenue in prior periods ."
4
11 . On November 26, 2001 . Nesco filed a voluntary bankruptcy petition under
Chapter 11 of the federal Bankruptcy Code in the United States Bankruptcy Court for the
Northern District of Oklahoma .
12. As a result of defendants' wrongdoing , Nesco' s stock price went from a
Class Period high of $ 4 ""h to close at $1 .35 on August 16, 2001, the day of the Cornpauy' s
announced restatement, to now being virtually worthless .
13 . Both the SEC and NASDAQ are now investigating Nesco in connectio n
with its reporting of false financial statements .
JURISDICTION AND VENU E
14 . This action arises under Section 10(b) and 20(a) of the Securitie s
Exchange Act of 1934 (the "Exchange Act"), 15 U .S .C. §§ 78j(b), 78t(a); and Rule 1 Ob- 5
promulgated pursuant to Section 10(b) by the SEC, 17 C .F.R. § 240 .10b-5 .
15 . The jurisdiction of this Court is based on Section 27 of the Exchange Act ,
15 U.S .C. § 78aa; and on Sections 1331 and 1337 of the Judicial Code , 28 U.S .C . §§ 1331 and
1337 .
16, Venue is proper in this District under Section 27 of the Exchange Act, 1 5
U.S .C. § 78aa, and Section 1391(b) of the Judicial Code, 28 U.S .C . § 1391(b) . The Company i s
headquartered in this District and the wrongs alleged in this action occurred in substantial part i n
this District, including the preparation and dissemination to the investing public of false an d
misleading information .
5
17. In connection with the acts and conduct alleged herein , defendants ,
directly and indirectly, used the means and instrumentalities of interstate commerce, includin g
the United States mails and the facilities of the national securities exchanges .
THE PARTIES AND INS O
LEAD PLAINTIFFS
18 . Lead Plaintiffs Ronald Nicol, Colin Nicol, and William and Marjori e
Groszkrugcr were appointed as Lead Plaintiffs in this consolidated action by order of the Court
dated March 4, 2002 . The Lead Plaintiffs each purchased Nesco stock during the Class Period,
and have been damaged as a result of defendants' wrongful conduct as described herein.
NESCO
19 . Nesco is an Oklahoma corporation with its principal executive offices
located at 12331 East 60th S treet , Tulsa, OK 74146. Nesco is engaged in the business o f
providing installation of fueling systems, equipment , maintenance and services to the owners and
operators of fueling facilities, including service stations, convenience stores, grocery store an d
hypermarket chains with fueling facilities, and commercial and industrial fueling facilities .
These services include site management (fuel inventory management, environmental-complianc e
monitoring, and reporting and facility maintenance management) ; site development and
financing (land acquisition, design, construction and financing) ; site installation ; and upgrades .
The Company is also engaged in the business of environmental services (site analysis an d
remediation) .
20. While Nesco's misconduct was co-extensive with that of the individua l
Defendants, the Company is not named as a defendant in this Complaint because, on Novembe r
6
26, 2001, it filed a voluntary bankruptcy petition under Chapter 11 of the United State s
Bankruptcy Code in the United States Bankruptcy Court for the Northern District of Oklahoma .
THE INDIVIDUAL DEFENDANT S
21 . Defendant Eddy L . Patterson was, at a ll relevant times, Chief Executive
Officer and Chairman of the Board of Directors of Nesco .
22. Defendant James Howell was, at all relevant times, President of Nesco .
23 . Defendant Larry Johnson was, at all relevant times, Chief Financial
Officer, Vice President , Secretary, and Treasurer of Nesco .
24 . Defendants Patterson, Howell, and Johnson, are referred to herein as th e
":individual Defendants ."
25 . As officers, directors , and/or controlling persons of a Company which i s
registered with the SEC under the federal securities laws, whose common stock is traded on an
open and efficient market, the Nasdaq Small Cap Market, and which is governed by the
provisions of the federal securities laws, the Individual Defendants had a duty to disseminate
promptly accurate and truthful information with respect to the Company's financial results and t o
correct any previously-issued statements from any source that were materially misleading or
untrue, so that the market price of the Company's publicly traded securities was based upo n
truthful and accurate information. Defendants' representations during the Class Period violate d
these specific requirements and obligations .
26. The Individual Defendants participated in the drafting, preparation , and/or
approval of the various public and shareholder reports and other communications complained o f
herein and were aware of, or recklessly disregarded, the misstatements as alleged herein .
7
Because of their ownership or control of Nesco stock, board membership, and executive an d
managerial positions with Nesco, the Individual Defendants had access to non-public informatio n
about Nesco's financial results as particularized herein, and knew that those facts rendered th e
statements made by and about Nesco and its financial results materially false and misleading .
27. The Individual Defendants , by virtue of their positions of control and
authority as officers and directors of the Company, were able to and did control the contents of
the various quarterly and annual financial reports, SEC filings, and press releases pertaining t o
the Company. The Individual Defendants were provided with copies of Nesco's stockholde r
reports, press releases, and SEC filings alleged herein to be misleading prior to or shortly afte r
their issuance and had the ability to prevent their issuance or cause them to be corrected, but
failed to do so. As a result , the Individual Defendants are each responsible for the accuracy o f
the public reports and releases detailed herein and are therefore primarily liable for the
misrepresentations contained therein .
28 . By reason of their ownership interest, management positions, and
membership on Nesco's Board of Directors, the Individual Defendants were "controllin g
persons" within the meaning of Section 20(a) of the Exchange Act, and had the power an d
influence to direct the management and activities of Nesco and its employees, and to cause Nesc o
to engage in the unlawful conduct complained of herein .
DEFENDANT TULLIUS TAYLO R
29. Defendant Tullius Taylor served as the Company's outside auditor an d
principal accounting fine throughout the Class Period .
8
PLAINTIFFS' CLASS ACTION ALLEGATION S
30. Plaintiffs bring this action as a class action pursuant to Federal Rule o f
Civil Procedure 23(a) and (b)(3) on behalf of a Class, which consists of all persons wh o
purchased Nesco securities from April 26, 2000 through August 16, 2001, inclusive . Excluded
from the Class are defendants herein , the officers and directors of Nesco, and members of thei r
immediate families, any entity in which any defendant has or had a controlling interest, and th e
legal representatives , heirs, successors , or assigns of any such excluded Party .
31 . As of August 28, 2001, 9 .33 million shares of Nesco common stock wer e
issued and outstanding , and were actively traded on an efficient market , the Nasdaq Small Cap
Market, in which thousands of shares were traded during the Class Period . While the exact
number of Class members is unknown to Plaintiffs at this time and can only be ascertaine d
through appropriate discovery, Plaintiffs believe that there are numer ous members of the Clas s
who may be identified from records maintained by Nesco or its transfer agent. The members of
the Class are, therefore, so numerous that joinder of all members is impracticable .
32 . Plaintiffs' claims are typical of the claims of the other members of the
Class in that Plaintiffs and each other Class member purchased shares of Nesco common stoc k
during the Class Period in a market in which the true state of the Company's financial condition
and management's lack of credibility and integrity were not disclosed, and sustained injury as a
result of defendants' wrongful conduct complained of herein ,
33 . Plaintiffs will fairly and adequately protect the interests of the members of
the Class and have retained counsel who are competent and experienced in class action an d
securities litigation .
9
34 . A class action is superior to other available methods of the fair and
efficient adjudication of this controversy since joinder of all Class 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 Class members to seek redres s
individually for the wrongful conduct alleged herein . There will be no difficulty in the
management of this action as a class action .
35 . 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 allege d
herein ;
b. Whether statements made by defendants to the investing public and to Nesco' s
shareholders during the Class Period omitted and misrepresented material fact s
about the financial condition of Nesco;
c. Whether defendants acted wilfully or recklessly in omitting to state and
misrepresenting material facts ;
d. Whether the members of the Class have sustained damages and, if so, th e
proper measure of such damages; and
e. Whether the Individual Defendants are control persons of Nesco within the
meaning of Section 20(a) of the Exchange Act.
36. Plaintiffs envision no difficulty in the management of this litigation as a
class action .
10
n
37. The names and addresses of purchasers of Nesco securities during th e
Class Period are available from Nesco's transfer agent . Notice can be provided to such recor d
owners via first class mail using techniques and a form of notice similar to those customaril y
used in class actions .
THE FACTS AND CIRCUMSTANCES THAT DEMONSTRATETHAT DEFENDANTS' CLASS PERIOD REPRESENTATIONS
WE, RE MATERIALLY FALSE AND ISLEADIN
38 . Throughout the Class Period, defendants made a series of
misrepresentations and omissions concerning Nesco's financial performance that had the effec t
of inflating the prices at which the Company' s securities traded. As alleged in detail below, the
misrepresentations and omissions related to the facts that : (1) the Company's financial statement s
for the year 2000 were false, and misleading in that they grossly overstated revenues and earning s
as a result of the Company's booking of fictitious revenue on phony or inflated customers '
invoices, and thus, would have to be restated; (2) the Company's financial statements were no t
prepared in accordance with GAAP, but rather, were prepared in violation of GAAP and in
violation of the Company's formal revenue recognition policy; and (3) the Company' s purported
record financial results for each quarter throughout 2000 and purported financial growth were not
caused by the Company's business operations and acquisitions, as reported by defendants, bu t
rather, were the result of the recording of fictitious revenues on phony or inflated customers '
invoices .
39. A senior finance employee, who worked in Nesco's Tulsa, Oklahoma
headquarters office from July 2000 to July 2001 and who reported directly to defendant Johnson ,
confirmed that defendants and the Company engaged in serious wrongdoing . This particular
11
employee was hired by Nesco to assist the Company in obtaining financing for its customers .
Nesco built convenience stores (called C-stores in the industry and by Nesco employees) acros s
the United States, conducted site remediation and consulting for new building sites, and buil t
various office structures for a wide variety of clients, from mom-and-pop store owners to
churches to large national corporations .
40_ This senior finance employee stated that defendant Patterson first
approached her about altering invoices in November 2000 . She believes, however, that the
Company had been inflating and changing dates on invoices prior to her joining the Company in
July 2000 because . inter ilia, the Company's records were in serious disarray, and there was n o
paperwork to support the Company's financial statements for the quarterly period ende d
September 2000 .
41 . Defendant Patterson repeatedly requested the senior finance employee to
increase the amounts of customers' invoices . The amounts of inflation were substantial . For
example, Patterson would request that an invoice of $2,500 be increased to $20,000 . (A typica l
invoice contained a $2,500 feasibility study and additional expenses, including environmental
studies and overhead costs) . Despite Patterson's instructions to inflate the amounts of th e
invoices, there was no basis for the inflation, and the Company did not have paperwork t o
support the inflated amounts .
42 . Defendant Patterson gave these same orders to inflate invoices to Bo b
Watson (now deceased), Nesco's former controller, and to another employee, who was a Nesc o
accountant. Accord ing to the senior finance employee : "Patterson forced Bob to do it ." Both
Watson and the accountant followed Patterson's orders, and inflated the amounts on 30 to 40
12
customer invoices each quarter during 2000 and 2001 . As just one example, Nesco inflated the
invoice in the amount of $2,500 to $15,000 for a customer who owned a store in Elk City,
Oklahoma.
43 . Although Nesco ' s customers did not pay the inflated amounts, and may
have never even received the inflated bills, Nesco was improperly booking the inflated invoice s
anyway. This caused Nesco's accounts receivables and reported revenues and earnings to b e
substantially overstated .
44. Moreover, this senior finance employee believes that defendant Tullius
Taylor, the Company's auditors, "must have known about the invoices ." Tullius Taylor sent
three auditors to Nesco's headquarters a couple of times each quarter, and Nesco "never had th e
paperwork to back up the numbers ." The auditors never questioned this senior finance employee
about the Company's books or asked to review additional paperwork . Instead, they were simply
directed to the records that the Company did keep, and they "breezed right through them . "
45 . The fictitious invoicing and improper booking of revenue by the Compan y
was further confirmed by an inte rnal memorandum written by Jim Taylor of defendant Tullius
Taylor, the Company's auditors, dated August 14, 2001 . This memorandum refers to the
auditor's interview with the same Nesco accountant who is referenced above .
46. As reported in Jim Taylor ' s memorandum, according to the Nesco
accountant, Bob Watson came to her around January 17, 2001 and said that defendant Edd y
Patterson wanted everything invoiced out of work-in-progress as of December 31 . Watson told
her whom to invoice, the amounts, and the invoice descriptions . Watson asked her to juggle the
dates so they did not all appear on December 31 . Watson also told her not to mail the invoices to
13
the customers . The accountant was suspicious about this, but Watson was her boss and she felt
she should do what he asked without complaint . The Nesco accountant remembers the day tha t
several of the hatches were entered (January 22, 2001) . Watson came out of defendant
Patterson's office, gave her the information for a group of invoices, went back into Patterson' s
office for a while , came back out with more invoice information , went back into Patterson' s
office, and came out with additional information .
47 . Some time later, the Nesco accountant began to ask Watson about the
invoices . Watson referred to them as "Eddy invoices ," named after defendant Eddy Patterson .
They discussed them on a number of occasions , agreeing on the need to get them off the books a t
some later point . After Tom Franz came to work at Nesco , Watson told the accountant to go t o
Franz with the information about the fictitious invoices . Watson even told her what to call them.
(She had an e-mail copy from Watson to her regarding what he terms "Advanced Billing .") Afte r
that, she began communicating with Toni Franz about them, and Franz asked her to prepare a
complete list of all such invoices, which she did .
48 . The accountant stated that she had brought the invoices up with Miles
Key, accounts receivable supervisor, Rick Batch, a Division Manager, David Roberts, Vice
President of Site Development who reported directly to defendant Howell, and the senior financ e
employee referenced above . These people referred to the invoices as "Eddy invoices." As one
example, the accountant stated that Rick Balch knew the Fellowship Church invoice amount wa s
not real and that she had given Tom Franz an e-mail copy evidencing this .
49 . With regard to later crediting the invoices off Nesco 's books . the
accountant stated that she did so because she had the responsibility "to clean up" account s
14
receivable, so she credited them in rune and July, 2003 . During this time, she communicated
with Tom Franz about the credits . One of the Summit invoices had been credited in March by
Miles Key when he received a copy of the invoice from Wes Hill marked "void . "
50. This Nesco accountant also met with the SEC as part of its investigation of
Nesco .
51 . Finally, according to Nesco's Vice President of Operations, it was Bob
Watson, Nesco's controller, who was responsible for recording Nesco's financial information,
but defendant Patterson, the CEO, "always had the final word" when it came to booking revenue .
With regard to falsifying invoices, this Vice President stated that : It would have had to come
from someone higher up. Patterson would have known about it . "
52. It is within this concrete background describing defendants' wrongdoing
that defendants' false and misleading statements described below should be viewed .
15
DEFENDANTS' FALSE AND MISLEADING STATEMENTS
53 . On or about March 24, 2000, Nesco filed its Form 10-K for the fiscal yea r
ended December 31, 1999 with the SEC . The 10-K explained the Company' s revenue
recognition policy :
The Company enters into fixed fee, cost-plus-fee, and performanceincentive contracts . For long term contracts, other than .performance incentive contracts, revenue is recognized on thepercentage of completion method measured by the percentage ofdirect costs to date to estimated total direct costs for each longterm contract . For performance incentive contracts, revenue andcontract costs are recognized upon attainment of the performancecriteria specified in the contracts . For short-term and mnultiplo unitcontracts, revenue is recognized as services are rendered, based onphysical completion of the project . Related costs are expensed asincurred. Provisions for estimated losses on uncompleted contractsare made in the period in which such losses are determined .
54 . On April 26, 2000, the beginning of the Class Period, the Company
announced its first quarter 2000 financial results . For the three months ending March 31, 2000 ,
reported revenues were $9,532,000, or 26.6 percent more than revenue for the first quarter o f
1999. Net income increased to $1,206,000, or $0.13 per share, compared to $940,000, or $0 .1 0
per share, for the same quarter of 1999 . Defendant Patterson commented :
The significant increase in both revenues and net income is due toimproved results in our overall business and the benefits of full integrationof acquisitions made in 1999 . Because of these operating results and newbusiness like the recent announcement of a contract to build 30convenience stores in Texas over the next three years, we continue tobelieve that we will meet or exceed our sales and financial goals for 2000and beyond .
55. On or about May 9, 2000 , Nesco filed its Form 10-Q for the first fiscal
quarter ended March 31, 2000 with the SEC, reporting substantially the same financia l
16
information as it reported in the April 26, 2000 press release . The increase in revenues was
attributed to growth from existing offices and new acquisitions . In the Form 10-Q's Notes to
Consolidated Financial Statements, it stated :
In the opinion of management, the accompanying condensed financialstatements contain all adjustments of a normal recurring nature necessaryto present fairly the financial position of the Company as of March 31,2000 and the results of operations and cash flows for the three monthperiods ended March 31, 2000 and 1999 .
Defendant Johnson signed the Form I O-Q .
56 . The statements appearing in the April 26, 2000 press release and Form 10-
Q filed on May 9, 2000, referenced above, were false and misleading because the reporte d
revenues and earnings were grossly overstated as a result of defendants' improper booking o f
fictitious revenues on phony or inflated customer invoices, and would later be restated ; the
financial statements were not prepared in accordance with GAAP , but rather, were prepared in
violation of GAAP and in violation of the Company's own formal revenue recognition policy;
and the Company's financial results and growth were not caused by the Company's business
operations and acquisitions, but rather, were the result of booking fictitious revenues on phony o r
inflated customer invoices .
57 . On May 23, 2000, the Company announced that it had established a new
banking relationship with Bank One, Oklahoma, NA, beginning with a $25 .3 million loan
facility. The $25.3 million loan agreement includes a revolving line of credit, a term loan for
equipment, real estate and two acquisitions, and a line of credit for additional acquisitions . This
facility replaces loans of approximately $14.5 million from various other institutions . According
to defendant Patterson :
17
Our new loan facility will not only improve Nesco's cost of money, it willalso help us to continue to grow when the opportunity arises to acquirecompanies which fit our strategic growth plans . We are also very pleasedto begin a new banking relationship with Bank One, Oklahoma . Theirmanagement team worked very hard to develop an agreement that providesus with both the resources and the flexibility to achieve our business goals .
58 . On June 12, 2000, Nesco acquired all of the issued and outstanding shares
of Hopkins Appraisal Services, Inc . The purchase price was $3,000,000. The definitive
agreement provided for the payment to David E . Hopkins of 250,000 shares of Nesco common
stock over a period of five years (to a maximum of 50,000 shares per year) subject to the
attainment of certain performance objectives of Hopkins Appraisal Services, Inc .
59. On July 25, 2000, the Company issued a press re lease announcing recor d
revenues and net income for the second quarter and first six months ended June 30, 2000. For
the three months ended . June 30, total revenues were $9,441,000, or 48 percent more than the
$6,364,000 in revenues reported in the second quarter of 1999 . Net income increased 14 8
percent to $911,000, or $0 .10 per share, for the same period in 1999 . For the six months ending
June 30, total revenues increased 37 percent to $18,972,000 when compared to the $13,896 .000
in revenues reported for the period of 1999 . Net income for the six months ending June 30, 200 0
increased 65 percent to $2,118,000 or $.23 per share versus $1,317,000 or $ .14 per share for the
first half of 1999 . In the press release, Defendant Patterson stated :
We are pleased to report record revenues for both the quarter and the firstsix months of this year . It reflects our continued growth through ourexisting business operations and the initial impact of key acquisitions wehave made over the past year. We are on target not only to continue thisrecord growth through the remainder of this year, but also to exceed it aswe continue to meet the goals called for in our business plan .
18
s
60. On or about August 7, 2000, the Company filed its Form 10-Q for th e
second fiscal quarter ended rune 30, 2000 with the SEC, reporting substantially the same
financial information as it reported in the July 25, 2000 press release. The increase in revenues
was attributed to growth from existing operating locations and new acquisitions . In the Form 10-
Q's Notes To Consolidated Financial Statements, it stated:
In the opinion of management, the accompanying condensed financialstatements contain all adjustments of a normal recurring nature necessaryto present fairly the financial position of the Company as of June 30, 2000and the results of operations and cash flows for the six month period endedJune 30, 2000 and 1999 .
Defendant Johnson signed the Form 10-Q .
61 . The statements appearing in the July 25, 2000 press release and Form 10-Q
filed on August 7, 2000 , referenced above , were false and misleading because the reporte d
revenues and earnings were grossly overstated as a result of defendants' improper booking o f
fictitious revenues on phony or inflated customer invoices , and would later be restated; the
financial statements were not prepared in accordance with GAAP , but rather, were prepared i n
violation of GAAP and in violation of the Company's own formal revenue recognition policy;
and the Company's financial results and growth were not caused by the Company's business
operations and acquisitions . but rather, were the result of booking fictitious revenues on phony or
inflated customer invoices.
62 . On August 31, 2000, Nesco acquired certain assets and assumed certai n
liabilities of Trust Environmental Services Company, LLC . The purchase price was $1,000,000
and warrants to purchase 120,000 shares of Nesco common stock at $4 .00 per share .
19
63 . On September 1, 2000, the Company acquired an office building located i n
Independence, Missouri, from David E . and Margaret Hopkins, in exchange for 100,000 shares
of the Company's common stock, which was valued at $3 .83 on September 1, 2000 .
64. On September 29, 2000, Nesco acquired all of the issued and outstanding
shares of Atlanta Petroleum Equipment Company, Inc. The purchase price was $2 .8 million and
options to purchase 80,000 shares of Nesco common stock at $4 per share for a period of five
years following closing .
65. On November 3, 2000, the Company issued a press release announcing
record revenues and net income for the third . quarter and first nine months ending September 30 ,
2000. For the three months ending September 30, revenues were $12,138,000 or 46.6 percent
more than the $8,279,000 in revenues for the third quarter of 1999 . Net income increased 9 3
percent to $1,397,000 or $ .15 per share compared to $724,000 or $ .0$ per share for the same
quarter last year . For the nine months ending September 30, total re venues increased 40 .7
percent to $31,111,000 when compared to the $22,226,000 in revenues for the same period a yea r
ago. Net income for the nine months ending September 30 increased 76 .8 percent to $3,516,000
or .38 per share versus $ 1,988,000 or $.22 per share for the first nine months of 1999 .
66. Defendant Patterson commented :
As we once again achieve record revenues and net income , it is importantto note that these outstanding results are the natural outcome of ourcontinuing to meet the aggressive goals we set for the year . These goalsare part of our long-term strategic growth plan . So we are especiallypleased that we are on track to meet our 2000 goals even while absorbingthe costs of three acquisitions during the third quarter.
20
67 . On or about November 13, 2000, the Company filed its Form 1 Q-Q for the
third fiscal quarter ended September 30, 2000 with the SEC, reporting substantially the sam e
financial information as it reported in the November 3, 2000 press release . Increases in revenues
were attributed to growth from existing operating locations and new acquisitions . In the Form
I O-Q's Notes To Consolidated Financial Statements, it states :
In the opinion of management, the accompanying condensed financialstatements contain all adjustments of a normal recurring nature necessaryto present fairly the financial position of the Company as of September 30,2000 and the results of operations and cash flows for the nine monthperiods ended September 30, 2000 and 1999 .
Defendant Johnson signed this Form 10-Q .
68. The statements referenced in the Company's November 3, 2000 pres s
release and Form 10-Q filed on November 13, 2000, referenced above, were false and misleadin g
because the reported revenues and earnings were grossly overstated as a result of defendants '
improper booking of fictitious revenues on phony or inflated customer invoices, and would later
be restated ; the financial statements were not prepared in accordance with GAAP, but rather ,
were prepared in violation of GAAP and in violation of the Company's own formal revenue
recognition policy ; and the Company's financial results and growth were not caused by th e
Company's business operations and acquisitions, but rather, were the result of booking fictitious
revenues on phony or inflated customer invoices .
69. On February 16, 2001, Nesco managers met in Clearwater, Florida for a
marketing meeting , which was run by defendant Howe]] . Despite the Company's reported
"record" financial results, the senior finance employee who attended thexmeeting could sense tha t
there were serious problems with the Company 's financial stability . At the meeting, defendant
21
Howell told division managers and sales representatives that "money was tight" and that the y
needed to get projects underway. Defer d.ant Howell also told them that they had to line up
customers or they would be fired . Nesco's financial condition was so poor that, from early 200 1
to July 2001, Nesco stopped making payments to its contractors and vendors . The vendors then
ceased their supplies to Nesco, and the contractors refused to complete their work, so Nesco, i n
turn, could not continue its work for customers or fill new orders .
70. On March 8, 2001, Nesco announced record financial results for the fourth
quarter and year ending December 31, 2000 . The Company reported record revenues o f
$40,606,000 and net earnings of $2,847,000 or $0 .31 per share for 2000, compared with revenues
of $29,567,000 and net earnings of $2,164,000 or $0 .24 per share for 1999 . This performance
represents revenue growth of 37%, net earnings growth of 32%, and earnings per share growth of
29%. For the quarter ended December 31, 2000, the Company reported revenues of $10,962,000 ,
and net income of $67,000, compared to revenues of $7,451,000 and net income of $176,000 in
1999.
71 . On March 27, 2001, the Company filed a Form 10-QSB/A for th e
quarterly period ended September 30, 2000. This filing constitutes an amendment to its prio r
Form I 0-Q for that period . In this amended Form 10-Q, revenues for the three month perio d
ended September 30, 2000 were restated to $10,671,000 from the previously reporte d
$12,138,000, and net income was restated to $662,000 from the previously reported $1,397,000 .
The Company offered no explanation for the restatement. This amended Form 10-Q was signed
by defendant Johnson.
22
72 . On or about April 2, 2001, the Company filed Form 10-K for the fiscal
year ending December 31, 2000 with the SEC, reporting substantially the same financial
information as it reported in the March 8, 2001 press release .
73 . This Form 10-K contained the Report of Independent Auditors , Tullius
Taylor, which stated :
We have audited the accompanying consolidated balance sheet of Nesco,Inc. as of December 31, 2000, and the related consolidated statements ofincome, changes in shareholders' equity and cash flows for each of the twoyears in the period then ended . These financial statements are theresponsibility of the Company's management . Our responsibility is toexpress an opinion on these financial statements based on our audits .
We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that weplan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements . An audit also includes assessingthe accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation . We believe that our audits provide a reasonable basis for ouropinion.
In our opinion, the financial statements referred to above present fairly, inall material respects, the financial position of Nesco, Inc . as of December31, 2000, and the results of its operations and its cash flows for each of thetwo years in the period then ended in conformity with accountin gprinciples generally accepted in the United States of America .
74. The Form 10-K again reiterated the Company's revenue recognitionpolicy:
REVENUE RECOGNITION - The Company enters into fixed fee, cost-plus-fee, and performance incentive contracts . For long-term contracts,other than performance incentive contracts, revenue is recognized on thepercentage of completion method measured by the percentage of directcosts to date to estimated total direct costs for each long-term contract .For performance incentive contracts, revenue is recognized upo n
23
attainment of the performance criteria specified in the contracts . Forshort-term and multiple unit contracts, revenue is recognized as servicesare rendered, based on physical completion of the project . Related costsare expensed as incurred. Provisions for estimated losses on uncompletedcontracts are made in the period in which such losses are determined .
75 . In connection with Nesco's Credit Agreement with Bank One, the For m
I4-K reported that : "For the year ended December 31, 2000, the Company was not in compliance
with three debt covenants related to the minimum current ratio, minimum debt service coverag e
ratio , and the maximum leverage ratio . . . The Company has obtained a waiver from the lender
as of December 31, 2000 waiving non-compliance through December 31, 2000 ."
76. The Form 10-K was signed by Individual Defendants Patterson, Howell ,
and Johnson, as well as Robert Watson, Nesco's Controller .
77. The statements appearing in the Company's March 8, 2001 press release ,
Form 1 O-K filed on April 2, 2001, and in the Report of Independent Auditors, referenced above ,
were false and misleading because the reported revenues and earnings were grossly overstated a s
a result of defendants' improper booking of fictitious revenues on phony or inflated custome r
invoices, and would later be restated ; the financial statements were not prepared in accordanc e
with GAAP, but rather, were prepared in violation of GAAP and in violation of the Company's
own formal revenue recognition policy; and the Company's financial results and growth were not
caused by the Company's business operations and . acquisitions, but rather, were the result of
booking fictitious revenues on phony or inflated customer invoices .
78. In addition, contrary to the statements made in its audit opinion , Tullius
Taylor did not conduct its audit in accordance with GAAS . In fact , it failed to examine sufficient
competent evidential matters relating to Nesco's customer contracts, accounts receivables ,
24
revenues and earnings derived from customer contracts, billings on uncompleted contracts, or th e
Company 's revenue recognition practices . Had they properly examined such matters, and tested
Nesco's books and transactions, as they were required to do in accordance with GAAS, the y
would have known that the financial statements were false .
79. Finally, had the Company not reported overstated revenues and earnings ,
Bank One would have known of the true extent of the Company's breach of the financial
covenants in the Credit Agreement . Thus, Bank One may not have waived Nesco's non-
compliance with the Credit Agreement, and may not have waited another eight months, unti l
August 2001, to withdraw as Nesco's lender . Indeed, in August 2001, when Bank One learned of
the Company' s true financial condition and the true extent of its breaches of the Credit
Agreement , Bank One demanded that Nesco transfer the credit facility to another institution an d
repay Bank One, thereby seriously impairing Nesco's ability to continue as a going concern .
80. On or about May 14, 200 1., the Company issued 730,000 shares of
common stock at $2.00 per share in accordance with a Private Placement Memorandum.
Additionally, for every two shares of common stock purchased, purchasers received one warrant
to purchase one share of common stock at a price of $2 .00 per share . The warrants were t o
expire on August 31, 2001 . The Company's Form 10-K for the year ended December 31, 2000 ,
which contained overstated revenues and earnings and which would later be restated, was
referenced in the Memorandum . Plaintiffs purchased common stock through this Offering .
81 . On or about May 15, 2001, Nesco fi led its From 10-Q for the first fiscal
quarter ended March 31, 2001 with the SEC. The. Company reported revenues of $1 1,545,000
and net income of $41,000 . Defendant Johnson signed this Form 10-Q .
25
82. On June 27, 2001 , just weeks before the Company disclosed the truth
about its financial statements, Mr. Sumner, a member of Nesco 's Audit Committee , sold 133,334
shares of Nesco stock , reaping over $200,000 in proceeds .
83 . On July 5, 2001, the Company announced that it signed a letter of intent to
sell its Hopkins Appraisal Services division back to David Hopkins, the principal operator of th e
division. Nesco acquired Hopkins in June 2000 . Defendant Howell stated :
We are satisfied with the final result of this matter and we believe the
disposition of Hopkins is consistent with our long-term strategy and focus .
Hopkins accounted for less than six percent of our sales during the last
fiscal year, and we firmly believe that by focusing on our core business,service to the convenience store and fueling industries, we can continue to
grow our business at a rapid pace . By reallocating the proceeds of this sale
and our resources to the core business, we believe Nesco will be betterpositioned to continue executing its growth strategy .
84. On July 10, 2001 , it was reported in PR Newswire that Nesco was cited in
Fortune Small Business magazine's list of "America's 100 Fastest-Growing Small Companies . "
Defendant Patterson stated :
On behalf of the employees and shareholders of Nesco, we are pleased tobe recognized by a respected publication such as Fortune Small Business .In the past three years, Nesco has become a far stronger Company . Wehave a diverse customer base and we serve a dynamic, growing industry .We offer best-in-class services to the fueling systems and conveniencestore industries, and our employees deserve to be proud .
Defendant Patterson continued :
We are excited a magazine the caliber of Fortune recognized theachievements Nesco has produced in recent years, We believe oursuperior performance has yet to be recognized in the price of our stock,and we have recently retained RCG Capital Markets Group, Inc . to conveyour value to the investment community . RCG has an establishedreputation for excellence and we believe their proactive efforts will assistNesco in delivering shareholder value .
26
THE TRUTH IS REVEALE D
85 . On August 16, 2001, the Company announced that its financial statement s
for the fiscal year ended December 31, 2000 and for the quarter ended March 31, 2001 will be
restated due to the Board of Directors' determination that certain items of approximately $3 .25
million which had been included in work-in-process and accounts receivables should not hav e
been recognized as revenue due to certain "accounting irregularities ." The Company further
announced that defendant Patterson, Chairman of the Board and CEO, and defendant Howell ,
President, have resigned their positions as officers, directors, and employees of the Company .
Robert Sumner, a director, has been named Chairman of the Board, and Wesley Hill, a manager ,
has been appointed President .
86. That same day, August 16, 2001, the Company further announced that th e
Company's lender, Bank One, informed the Company that it was requiring the Company t o
transfer its banking relationship to another institution . Accordingly, all amounts owed under
notes to the lender have been classified as current in the Company's financial statements .
87 . On August 17, 2001, before the market opened , Nasdaq announced that
trading was halted in Nesco . The stock was selling at $1 .35 per share when trading stopped .
Nasdaq said that trading will remain hatted until market officials receive more information abou t
the accounting irregularities that caused the restatement .
88. On August 18, 2001, the Tulsa World reported that defendant Johnso n
stated that the Company simply billed its customers more than it should have for ongoin g
projects : "There was more profit booked than should have been booked on. those partially
completed jobs. There were certain invoices created that should not have been created .
27
That is very inappropriate ." Defendant Johnson added that the accounting methods used t o
book revenues "were not acceptable and won't be tolerated . "
89. That same day, The Saturday Oklahoman quoted defendant Johnson as
saying: "There were some accounts receivables that were not valid receivables . There were
problems with some works in process , jobs that allow you to recognize revenue based on the
completion of the project . It's a sophisticated transaction . . . but there were some things that
were not accurate . "
90 . It was further reported that replacing the outgoing executives are Robert
Sumner as Chairman and Wesley Hill as President . Both of these newcomers sold large amount s
of stock in the Company just weeks before the current problems were announced. On June 27, i n
a single transaction , Sumner sold 133,334 shares for proceeds of $200,000 . From May 2001 to
July 2001, Hill sold 93,000 shares for a total of $173,486 . The sales occurred in 28 separat e
transactions, the latest on July 31, 2001 . According to Tulsa money manager Frederick Russell :
It's disturbing to see such decisive selling - with no buying - so close tothe replacement of two top officers . It's as if the insiders had issued theirverdict on the Company's fortune, and the verdict was not good .
91 . On or about August 20, 2001, Nesco filed an amended Form 10-K for th e
year ended December 31, 2000, signed by defendant Johnson. The amended Form 10- K
addressed the restatements, stating :
In July and August 2001, members of Company managementdetermined that certain accounts receivable recorded in December2000 might have resulted from accounting irregularities . Inaddition, it was determined that estimated earnings in excess ofbillings of uncompleted contracts may have been recorded, incontravention of the Company's revenue recognition accountingpolicy, for certain performance incentive contracts for which th e
28
contractual performance criteria had not been met, The AuditCommittee was informed of these matters in August . At the AuditCommittee's direction, the investigation that was begun continued .The investigation confirmed that 2000 revenue was overstated dueto irregularities in the recording of the accounts receivableinvoices, the need for certain other accounts receivabl eadj ustruents, and the need to adjust previously reported contractearnings . Based on this investigation, the Company and the AuditCommittee concluded that the 20.00 financial statements requiredadjustments of the amounts previously reported for account sreceivable of $2,729,238 and contract costs and estimated earningsin excess of billings in the amount of $923,244. Net of the relatedprovisions for income tax, net income reported in th eaccompanying financial statements has been reduced by$2,264,610 from the amount previously reported .
92. With regard to its credit facility and liquidity, the amended Form 10-Kstated :
For the year ended December 31, 2000, the Company was not incompliance with three debt covenants of its principal credit facility. Thesecovenants related to minimum current ratio, minimum debt coverageservice ratio, and the maximum leverage ratio . The lending institutionwaived the noncompliance, prior to the adjustments described above, as ofDecember 31, 2000, and again at March 31, 2000 . The Companycontinues to be out of compliance with these covenants and in August2001, the lending institution informed the Company that it was requiringthe Company to transfer its banking relationships to another institution .Accordingly, all amounts owed under notes to the financial institutionhave been classified as current in the accompanying financial statements .
During 2000 and continuing in 2001, the Company's operating activitieshave not produced positive cash flow. During 2000, the Company reliedon its primary credit facility to fund operations and investments . Lack ofliquidity in 2001 has impeded the Company's ability to pay vendors andsubcontractors when due, which affects operations in the ordinary courseof business. As a result, in the near term, the Company's ability t ocontinue as a going concern is dependent on the actions of the currentlending institution and, in the longer term, it depends on the speed it canput in place, and the adequacy of the replacement credit facility . Theaccompanying financial statements do not contain any adjustmentsresulting from this contingency.
29
At the August 16, 2001 Board of Directors meeting, the Company'sChairman and President resigned .
93 . Finally, the amended Form IO-K contained a Report of Independen t
Auditors, Tullius Taylor, which stated :
The accompanying financial statements have been prepared assuming theCompany will continue as a going concern. As discussed in Note 15 to thefinancial statements, the Company is experiencing severe liquidityproblems and is in violation of certain debt covenants . The leadinginstitution has informed the Company that it is requiring the Company totransfer its banking relationship and the company is negotiating with otherinstitutions. These conditions raise substantial doubt about the Company'sability to continue as a going concern. The financial statements do notinclude any adjustments that might result from the outcome of thisuncertainty .
94. On August 23, 2001 , Nesco announced its restated financial results for
fiscal 2000 and the first quarter of 2001 . The Company's press release stated :
The financial statements were restated due to the Board'sdetermination that certain items in the approximate amount of$3 .65 million which had been included in work-iii-process andaccounts receivable should not have been recognized as revenuedue to previously announced accounting irregularities . Theamounts recorded as accounts receivable were the result ofinvoices entered into the accounting system for services which hadnot been rendered. The 2000 financial statements requiredadjustments of the amounts previously reported for accountsreceivable of $2,729,238 and contract costs and estimated earningsin excess of billings in the amount $923,244 . Net of the relatedprovision for income tax, net income reported in the accompanyingfinancial statements has been reduced by $2,264,610 from theamount previously reported .
30
f
95 . The August 23 press release summarized the results of the restatement asfollows :
As Restated Previousl yReported
i 131100 12/31 1
Revenues $36,954,000 $40,606,000
Net income $588,000 $2,847,000
Earnings Per $0 .06 $0.3 1Share
Accordingly, earnings were overstated by 79% during fiscal 2000, and possibly more due to the
Company's later admission that additional revenues of $644,000 had been improperly recorded
in prior periods, as described below .
96. On September 26, 2001, The Daily Oklahoman reported that Nesco closed
offices in two states and shed roughly 20 percent of its 260 employees . In light of its accounting
improprieties and its departing lender, Nesco indicated that its ability to continue as a goin g
concern is in question.
97. On November 12, 2001, the Company announced . that the SEC and
Nasdaq have initiated inquiries of the Company due to the issues relating to the Company's
restatement of its 2000 financial statements . The Company further announced tliat, in October
2001, the employment of defendant Johnson, Vice President, and Charles Nance, Vice Presiden t
of Operations, was terminated .
98. On November 14, 2001, the Company filed its Form l 0-Q for the quarterl y
period ended September 30, 2001 . In the Fonn 10-Q, it states :
31
21110%
During the third quarter of 2001, the Company discovered additionalinvoices totaling approximately $644,000 which had been improperlyrecorded as revenue in prior periods .
The Company failed to indicate in which prior periods the revenues were improperly recorded ,
99. According to Brett Kramer of Pinnacle Investment Advisers in Tulsa, an
overstatement of revenue may have helped the Company acquire loans and investors under false
pretenses . "It deceives investors and bankers . It completely distorts the balance sheet and cause s
your stock to go up . "
100, On November 26 , 2001, the Company filed a voluntary petition for
bankruptcy pursuant to Chapter 11 of the Bankruptcy Code in the United States Bankruptc y
Court for the Nor-them District of Oklahoma .
101 . On December 14, 2001, Tulsa World reported that, according to a
memorandum written by Jim Taylor of defendant Tullius Taylor, Nesco manipulated its books t o
inflate profits, and tried to conceal its wrongdoing by juggling the dates on bogus invoices . Jim
Taylor wrote the memo after interviewing a Nesco employee, who stated that she was instructe d
to record revenues on Nesco's uncompleted projects and not to mail the invoices to the
customers . Nesco officials familiar with the practice called the inflated or bogus invoices, "Eddy
invoices ," named after defendant Eddy Patterson . The employee was told "whom to invoice, th e
amounts and the invoice descriptions ." Taylor reviewed the invoices with the employee . Taylor
noted that the dates on the invoices (December 19-31, 2000) did not match the dates that wer e
entered into the Company' s books. (January 17-22, 2001) .
32
VIOLATIONS OF GAAP BY THE INDIVIDUAL DEFENDANT S
102 . GAAP .are those principles recognized by the accounting profession as the
conventions, rules, and procedures necessary to define accepted accounting practice at a
particular time . SEC Regulation S-X (17 C .F.R. § 210 .4-01 (a)(1)) states that financial statements
filed with the SEC which are not prepared in accordance with GAAP are presumed to be
misleading and inaccurate .
103 . At the end of the Class Period, Nesco admitted that certain revenues wer e
improperly recognized and that estimated earnings in excess of billings of uncompleted contract s
were recorded, in contravention of the Company's revenue recognition accounting policy, fo r
certain performance incentive contracts for which the contractual performance criteria had no t
been met. As a result of defendants' accounting improprieties during the Class Period, th e
Company presented its financial results and statements in a manner which violated GAAP ,
including the following fundamental accounting principles :
(a) The principle that interim financial reporting should be based upon th e
same accounting principles and practices used to prepare annual financia l
statements, (APB No . 28, ¶ 10) ;
(b) The principle that financial repo rt ing should provide information that i s
useful to present and future investors and creditors and other users in makin g
rational investment, credit, and similar decisions . (FASB Statement of Concepts ,
No. 1, !" 34)-
3 3
F
(c) The principle that financial reporting should provide information about th e
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 . (FASB Statement of Concepts No . 1, ¶ 40) ;
(d) The principle that financial . reporting should provide information abou t
how management of an enterprise has discharged its stewardship responsibility to
owners (stockholders) for the use of enterprise resources entrusted to it . To the
extent that management offers securities of the enterprise to the public, i t
voluntarily accepts voider responsibilities for accountability to prospective
investors and to the public in general . (FASB Statement of Concepts No. 1, ¶ 50) ;
(e) The principle that financial reporting should provide information about a n
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' expectation s
about future enterprise performance, those expectations are commonly based at
least partly on evaluations of past enterprise performance. (FAS]3 Statement of
Concepts No. 1, ¶42) ;
(#] The principle that the percentage of completion method recognizes income
as a percentage of estimated total income [either] (a) that incurred cost to dat e
bear to estimated total costs after giving effect to estimates of costs to complete
based upon most recent information or (b) that may be indicated by such othe r
34
measure of progress toward completion as may he appropriate having due regard
to work performed. (AICPA Accounting Research Bulletin 45, ¶ 15) ;
(g) The principle that financial reporting should be reliable and that i t
represents what it purports to represent . That information should be reliable a s
well as relevant is a notion that is central to accounting . (FASB Statement of
Concepts No. 2, ¶ 58) ;
(h) The principle of completeness, which means that nothing is left out of th e
information that may be necessary to ensure that it validly represents underlyin g
events and conditions. (FASB Statement of Concepts No . 2, ¶'79) ; and
(i) The principle that conservatism be used as a prudent reaction t o
uncertainty to try to assure that uncertainties and risks inherent in busines s
situations are adequately considered . The best way to avoid injury to investors i s
to try to ensure that what is reported represents what it purports to represent .
(FASB Statement of Concepts No . 2, IT 95, 97) .
104. Nesco's restatement of its previously-issued financial statements is an
admission that its previously-issued financial reports were materially false and misleading, an d
not prepared in accordance with GAP .
VIOLATION OF GAAS BY DEFENDANT TLTL-L-IUS TAYLOR
105. Tullius Taylor issued an unqualified audit opinion on Nesco's financia l
statement for the fiscal year 2000, and stated that its audit was performed in conformity with
GAAS and, inter Ali-a, that in its opinion, the'financial statements "present fairly" Nesco' s
financial position and results from operations and cash flows in conformity with GAAP for the
35
fiscal years ended December 31, 1999 and December 31, 2000. However, as al leged herein,
Tullius Taylor 's audit opinion was false and misleading because the financial statements upon
which Tullius Taylor issued its unqualified opinion contained numerous and material violations
of GAAP.
106. Tullius Taylor conducted audit examinations and pa rt icipated in
investigations of Nesco's business, operations, financial , accounting and management contro l
systems . In the course of these audits and investigations , Tullius Taylor should have been alerted
to its obligations under GAAS, detailed below, to further examine the financial statements an d
determine the extent of any errors or irregularities .
107. Had Tullius Taylor conducted its audit in accordance with GAAS, it would
have discovered the accounting irregularities that resulted in the issuance of the false and
misleading financial statements . Tullius Taylor's representations that the audit conformed to
GAAS were false and misleading for, j rnte alia, the following reasons :
(a) Tullius Taylor violated GAAS General Standard No. 3 that
requires that due professional care must be exercised by the auditor in the performance of the
audit and the preparation of the report . Tullius Taylor failed to exercise due care in performing
its audit and preparing its report ,
(b) Tullius Taylor violated GAAS Standard of Field' Work No . 3 that
required sufficient, competent evidential matter to be obtained through inspection, observation ,
inquiries and confirmations to afford a reasonable basis for an opinion regarding the financia l
statements under audit . Tullius Taylor failed to obtain sufficient. competent evidential material s
as to the validity of Nesco's recorded accounts receivables, revenues, and earnings ;
36
(c) Tullius Taylor violated GAAS Standard of Reporting No. 1 which
requires the auditor, in preparing the report, to state whether the financial statements ar e
presented in accordance with GAAP ; and
(d) Tullius Taylor violated GAAS Standard of Reporting No. 3 which
requires informative disclosures in the financial statements which are to be regarded as
reasonably adequate unless otherwise stated in the report .
108. In the course of issuing its unqualified audit opinion as to Nesco's yea r
end 2000 financials, and prior to the Company°s public announcement of these results, Tulliu s
Taylor was required to adhere to all of the standards of GAAS, including the requirement that th e
financial statements comply in all material respects with GAAP. In issuing its unqualified
opinion, Tullius Taylor's audit and reports therein represented an extreme departure from GAAS ,
and the manner in which Nesco's financial results were reported as part of the Company' s
financia l statements represented an extreme departure from GAAP .
SCIENTER OF THE INDIVIDUAL DMFENDAi1T_TS
109 . As alleged herein, the Individual Defendants acted with scienter in that
they knew or recklessly disregarded that the public documents and statements issued or
disseminated in the name of the Company were materially false and misleading ; knew or
recklessly disregarded that such statements or documents would be issued or disseminated to th e
investing public ; and knowingly or recklessly 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 herein, defendants acted with a knowing or conscious disregard for
the falsity of Nesco's financial statements .
37
110. Pursuant to GAAP, to restate a prior year's financial results , the restated
financial information must have been material and in existence at the time the original financia l
statements were prepared . Accordingly, defendants , by virtue of the restatements, admitted that
the previously-announced financi al results were materia lly false and misleading at the time they
were issued .
IM Indeed, in the amended l0-K filed on August 20, 2001, defendants
disclosed the need to restate their 2000 financial statements, and defendants admitted that certai n
accounts receivables and estimated earnings in excess of billings of uncompleted contracts were
recorded improperly, and in violation of GAAP. Defendant Johnson himself was quoted in news
articles on August 18, 2001 that "There were certain invoices created that should not have bee n
created," and "there were some accounts receivables that were not valid receivables ."
112. As alleged herein, defendant Patterson personally directed the creation o f
phony or inflated customer invoices, and the improper booking of revenues derived from thos e
invoices . This improper practice was common knowledge throughout the Company, as
numerous people referred to the phony invoices as "Eddy invoices ." Defendant Johnson, the
Chief Financial Officer, and Defendant Howell , the President, either knew of this wrongdoing o r
were reckless in not knowing of it. They worked together with Patterson, who orchestrated the
fraudulent scheme, and the people that directly reported to defendants Johnson and I low, ell ha d
knowledge of what was taking place .
113 . As alleged herein, defendant Patterson made numerous public statement s
in conjunction with the Company's false earnings releases issued each quarter and year end 2000 .
He knowingly gave the false impression that the Company's financial performance and growt h
38
were attributed to the Company's business operations and acquisitions, which was not the case .
Defendant Johnson, as Chief Financial Officer, was responsible for the reporting ofNesco' s
financial results. He knew or was reckless in not knowing that Nesco's financial statements wer e
prepared in violation of GAAP and in violation of the Company' s own revenue recognitio n
policy. He personally signed each Form 10-Q which contained the false financial results. Each
of the Individual Defendants - Patterson, Johnson, and Howell - signed the Form 10-K for the
fiscal year ended 2000, which contained false financial results .
114 . The Individual Defendants are each sophisticated individuals holdin g
executive, managerial, or other relationships and positions with the Company . Each of the
Individual Defendants had the access and the ability to receive and obtain information concernin g
the Company's accounting systems and the preparation and dissemination of the Company' s
financial statements . Therefore, because of their positions and responsibilities, defendants were
fully aware of or consciously disregarded the accounting practices utilized by Nesco which
resulted in the improper accounting for revenues and net income . The defendants, in their public
statements concerning Nesco's financial results and the need for restated financial statements,
have never claimed that they were denied access to the Company's records .
115. Defendants ' violations of GAAP were not isolated incidents but were
repeated over the year 2000 and possibly longer, and caused material misstatements of the
Company's financial results for those reporting periods . The frequency (at least over the year
2000) and magnitude (earnings were overstated 79% for 2000) of defendants' false and
misleading statements are strong evidence that defendants acted with knowledge of the falsity o f
their statements or, at a minimum, with conscious disregard for their falsity .
39
116 . Finally, the Individual Defendants had a motive to commit fraud. The
material misstatements benefitted defendants and Nesco by : allowing the Company to report
"record" financial results and to create the appearance of financial growth ; allowing th e
Company to acquire several companies with the Company's stock as partial consideration with a
stock price artificially inflated by the fraud ; allow ing the Company to maintain its credit facility
with Bank One throughout the Class Period, which it desperately needed to survive as a goin g
concern; and allowing the Individual Defendants to maintain their executive positions with th e
Company along with their compensation and other benefits derive therefrom .
SCIENT R OF DEFENDANT TUE'LUUS TAY OR
117 . In delivering a clean audit opinion concerning the Company's financial
statements for the year ended December 31, 2000, Tullius Taylor ignored numerous red flags tha t
demonstrated that those financial statements were not prepared in accordance with GAAP and
did not fairly present the financial condition of Nesco . Because those red flags were of such an
obvious character, Tullius Taylor either knew of their existence but nevertheless ignored them, o r
was grossly reckl ess in failing to take note of those facts .
118. In either event, Tullius Taylor's clean audit opinion - a critical statemen t
delivered during the Class Period - was grossly reckless .
119 . Among other red flags, Tullius Taylor ignored the fact that Nesco was
generating about 80% of its earnings for 2000 from the bogus customer invoices alleged herein .
The magnitude of those transactions, and the fact that there were 30 to 40 phony invoices entere d
each quarter , should have caused Tullius Taylor to further examine and test the substance o f
those transactions .
40
}
120. Had Tullius Taylor further investigated those transactions - as it was
obligated to do - it would have determined that they were merely part of Nesco's scheme t o
create the false impression that the Company was enjoying substantial financial growth . As
stated by a senior finance employee of Nesco, the auditors "must have known about the invoices "
because they sent three auditors to Nesco's headquarters a couple of times a quarter, and Nesc o
"never had the paperwork to back up the numbers ." She further stated that the auditors "never
questioned me about the books or asked to see additional paperwork . I just showed them where
the records were [and they] breezed right through them." This same employee compares the
work done by Tullius Taylor to the audit work of Bank One's auditors . She suggested that after
Bank One reviewed Nesco's financial records, they were skeptical of the numbers .
121 . By virtue of its position as Nesco's independent accountant and auditor ,
Tullius Taylor had complete access to the files and key employees of the Company at all relevan t
times. In. particular , prior to issuing its clean audit opinion with respect to the Company's 200 0
financial statements, Tullius Taylor had complete access to Nesco's confidential financial ,
operating, and business information. Documents and information that did or would hav e
revealed the Individual Defendants' accounting fraud to Tullius Taylor were therefore readil y
accessible to Tullius Taylor prior to the time that it issued its materially misleading audit opinion .
Indeed, in August 2001, Jim Taylor of Tullius Taylor wrote a detailed memorandum regarding
his interview with a Nesco accountant who fully described the improper accounting practices an d
who provided examples to him of phony invoices . Tullius Taylor has never claimed that suc h
persons or documents were unavailable to it before it issued its audit opinion . Under GAAS ,
SAS No. 58, if there were any restrictions placed on the audit, whether imposed by the client o r
41
by circumstances, such as the inability to obtain sufficient competent evidential matter, thes e
restrictions may require the auditor to qualify its opinion or to disclaim an opin ion. Tullius
Taylor did neither .
122. Furthermore, Tullius Taylor auditors were frequently present at Nesco' s
headquarters - a couple of times per quarter . As a result, Tullius Taylor had ample opportunity to
discover the obvious accounting improprieties alleged herein, none of which Nesco attempted t o
conceal from Tullius Taylor.
123 . Tullius Taylor also knew or should have known that the Individual
Defendants were under significant pressure to report improving financial results so that they
could maintain their credit facility with Bank One, and continue with their many acquisitions .
Such factors should have heightened Tullius Taylor's awareness when conducting its audit . Yet,
Tullius Taylor failed to conduct its audit in a manner designed to uncover the fraudulen t
transactions conducted by the Ind ividual Defendants .
124. The nature of the fraud engaged in by the Individual Defend ants during the
Class Period also supports the conclusion that Tullius Taylor acted knowingly or in a grossl y
reckless manner in issuing its clean audit opinion in that the "audit" was so deficient as t o
amount to no audit at all . Although defendants' fraud involved significant dollar amounts, it was
neither sophisticated nor difficult to uncover . Rather, that fraud consisted simply of grossl y
inflating numerous customer invoices throughout the Class Period so as to overstate account s
receivables, revenues , and earnings . In light of the number and the size of those transactions ,
they should have been particularly easy for Tullius Taylor to detect .
42
125. It is clear that Tullius Taylor failed to examine sufficient competen t
evidential matters relating to Nesco's customers contracts, accounts receivables, revenues an d
earnings derived from customer contracts, billings on uncompleted contracts, and revenu e
recognition practices. Had they properly examined such matters, as they were required to d o
under GAAS, they would have known the truth .
126 . Thus , in violation of its obligations under GAAS - including but not
limited to its obligations under, inter ajia, AU § 316.04 to design its audit to provide reasonable
assurance of detecting errors and intention al misstatements and under ACS § 230 . 01 to exercise
due professional care in performing its audit - Tullius Taylor either failed to determine that the
Individual Defendants were fraudulently accounting for customer invoices and reporting fals e
financial results for Nesco or recklessly disregarded that information .
PLAINTIFFS AND THE CLASS REASONABLY RELIED UPON THEINTEGRITY OF THE MARKET PRICES FOR NESCO SECURITIES
IN PURCHASING THOSE SECURITIES DURING THE CLASS PERIO D
127. Plaintiffs and all of the members of the Class are entitled to the
presumption of reliance upon the material misrepresentations and omissions alleged herein that i s
provided by the fraud on the market doctrine .
128. The fraud on the market doctrine's presumption of reliance arises here for
the following reasons :
a. As a regulated issuer, Nesco filed periodic public reports with th e
SEC that disclosed information that was promptly disseminated to investors .
b. Nesco regularly communicated with public investors vi a
established market communication mechanisms , such as the regular dissemination of pres s
43
releases on major newswire services and regular communications with the financial and trad e
press .
C . Nesco securities were traded in developed and efficient markets .
That is, the information disclosed by defendants to the public concerning Nesco was incorporate d
by the market for Nesco securities into the market price for those securities in a manner tha t
caused the market price of Nesco securities to reflect all publicly-available information
concerning Nesco. Of course, the market price ofNesco securities did not reflect the informatio n
that defendants concealed from the market throughout the Class Period . By concealing that
information, defendants therefore caused the Company's securities to trade at inflated price s
throughout the Class Period.
d. Throughout the Class Period, Nesco common stock met the
requirements for listing on the NASDAQ system, a highly efficient market .
e. Defendants made material misrepresentations during the Clas s
Period and failed to disclose material facts that they were obligated to disclose under th e
circumstances .
f. Plaintiffs and the other members of the Class purchased their
Nesco securities between the time defendants made the misrepresentations and omissions allege d
herein and the time the market learned the adverse facts concerning the Company's financia l
performance that defendants concealed throughout the Class Period.
129. Plaintiffs and members of the Class are therefore entitled to a presumptio n
of reliance upon the integrity of the market for Nesco securities for the purposes of class
certification and for the ultimate proof of their claims on the merits. Similarly, Plaintiffs and th e
44
members of the Class are entitled to a presumption of reliance upon the material omission s
alleged herein .
NO SAFE HARBOR
130. The statutory safe harbor provided for forward-looking statements unde r
certain circumstances does not apply to any of the misrepresentations or omissions alleged
herein, because such misrepresentations or omissions related to present existing facts .
13 1 . Defendants did not adequately identify any of the misrepresentation s
alleged herein as "forward-looking statements" at the time those representations were made .
132 . Furthermore, those representations were not accompanied by meaningfu l
cautionary language identifying important factors that could cause actual results to differ
materially from those in the specific statements .
133 . To the extent that the statutory safe harbor could apply to any of the
misrepresentations pleaded herein, those . statements are actionable because, at the time thos e
representations were made, the speaker knew that the particular forward-looking statement was
false, and/or the forward-looking statement was made by or with the approval of an executiv e
officer of Nesco who knew that the statement was false or misleading .
FIRST CLAIM FOR RELIEF(Against Individual Defendants ,
And Defendant Tu llius Taylor UnderSection I.Dtbk, Of The Exchange Act)
134. Plaintiffs incorporate by reference all of the foregoing paragraphs as i f
fully set forth herein .
45
135. During the Class Period, defendants named in this Count singularly and in
concert, directly and indirectly, engaged and participated in a plan, scheme, and unlawful cours e
of conduct pursuant to which they knowingly or recklessly engaged in acts, transactions ,
practices, and courses of business that operated as a fraud upon Plaintiffs and the other member s
of the Class and made various untrue statements of material facts and omitted to state materia l
facts necessary in order to make the statements made, in light of the circumstances under which
they were made, not misleading to Plaintiffs and the other members of the Class .
136. Defendants had actual knowledge of the misrepresentations and omission s
of material facts set forth herein, or acted with reckless disregard for the truth in that they faile d
to ascertain and to disclose such facts, even though such facts were available to them .
Defendants' material misrepresentations and omissions were done knowingly or recklessly an d
for the purpose and effect of concealing Nesco's operating condition, finances, busines s
practices, and future business prospects from the investing public . As demonstrated by
defendants' misstatements of the Company's finances throughout the Class Period, defendants, i f
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 step s
necessary to discover whether those statements were false or misleading .
137. 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 Nesco
stock was inflated throughout the Class Period . Plaintiffs and the other purchasers of Nesc o
common stock similarly situated, at the time of said misrepresentations and omissions, wer e
ignorant of, and could not have known of, the falsity of these statements . In reliance upon the
46
4
integrity of the market, and the fidelity, integrity , and superior knowledge of defendants, and i n
ignorance of the truth, Plaintiffs and the other Class members were induced to and did purchas e
Nesco stock at prices that were affected by defendants' conduct and were damaged thereby .
138. By virtue of the foregoing, defendants violated Section 10(b) of th e
Exchange Act, and Rule 1.4b-5 promulgated thereunder .
139 . As a direct and proximate result of defendants' wrongful conduct ,
Plaintiffs and the other members of the Class suffered damages in connection with thei r
purchases of the Company's securities during the Class Period .
SECOND CLAIM FOR RELIEF(Against Individual Defendants
Under Section 20(a) . Fxcli&n-ge- Act
140. Plaintiffs incorporate by reference all of the foregoing paragraphs as i f
fully set forth herein.
141 . This claim is asserted against the Individual Defendants and is based o n
Section 20(a) of the Exchange Act. The Individual Defendants were control persons of Nesco
within the meaning of Section 20(a) of the Exchange Act . The Individual Defendants, by reaso n
of their management positions, had the power and authority to cause or to prevent the wrongful
conduct complained of herein, and did influence and control, directly or indirectly, the decision-
making of the Company, including the content and dissemination of the various statements that
Plaintiffs contend are false and misleading . The Individual Defendants were provided with o r
had unlimited access to copies of the Company's reports, press releases, public filings and other
statements alleged by Plaintiffs to be misleading before or shortly after these statements were
47
issued and had the ability to prevent the issuance of the statements or cause the statements to be
corrected.
142. Because each of the Individual Defendants is a "controlling person" o f
Nesco and the other Individual Defendants, each of whom has committed violations of Sectio n
10(b) of the Exchange Act, the Individual Defendants are secondarily liable for those primary
violations pursuant to Section 20(a) of the Exchange Act . As a direct and proximate result of the
Individual Defendants' wrongful conduct, Plaintiffs and the other members of the Class suffere d
damages in connection with their purchases of the Company's securities during the Class Period .
I AVER FUR RELIEF
WHEREFORE, Plaintiffs respectfully pray for judgment as follows ;
A. An order certifying the Class as set forth herein and designating Plaintiffs
as the Class representatives ;
B . A judgment declaring the conduct of the Defendants to be in violation of
laws as set forth herein;
C. A judgment awarding Plaintiffs and all other members of the Clas s
damages against all defendants jointly and severally in an amount that may be proven at trial ,
together with prejudgment interest thereon;
D. A judgment awarding Plaintiffs reasonable attorneys' fees and expert fees,
together with interest, costs and disbursements ; and
E. For such other relief as this Court appears just and proper .
48
DEMAND FOR A JURY TRIAL
Pursuant to Rule 38 (b) of the Federal Rules of Civil Procedure , Plaintiffs hereby
demand trial by j ury of all issues ,
Dated : April 22, 2002 FI DERN yl' & SH W OK D
L'y. -W' lam B . . Berman
t} N. Robinson Avenue, Suite 2720Oklahoma City, OK 73102(405) 235-1560/fax (405) 239-211 2
Liaison Counsel for Plaintiffs and the Clas s
BERGER & MONTAGUE, P .C .Sherrie R . SavettMichael T. Fartini1622 Locust StreetPhiladelphia, PA 19103(215) 875-3000 (Telephone)(215) 875-4636 (Facsimile)
Load Counsel for Plaintiffs And The Clas s
49
3
C RT[FJC TE MAII G
The undersigned hereby certi fies that on this ay of 2002, a true and correctcopy of the above and foregoing was ma iled, by U . S. Mail, with ostage prepaid thereon, to thefollowing:
Sam G . Bratton,1r1Doerner, Saunders, Daniel & Anderson32(1 S . Boston Avenue, Suite 500Tulsa, OK 74103-372 5
Charles Michael CopelandJones Givens Gotcher & Bogan15 E. 5" St, Suite 3800Tulsa, OK 74103-430 9
Joseph H. WeissWeiss & Yourman551 Fifth AvenueNew York, NY 1017 6
Jules BrodyAaron BrodyTzivia BrodyStull Stull & Brody6 E 45th Stree tNew York , NY 10017
Ray Thomson HillisBarkley Titus Hillis & Reynolds
1.5 E. 5t1i Street, Suite 2750Tulsa, OK 7410 3
Larry G. Johnson10248 East 89"` Street, NorthOwasso, Oklahoma74055
Gerald Joseph Lovo i324 S. Main Street, Suite 900Tulsa, OK 74103
Bruce Murphy265 Llwyd's LaneVero Beach, FL 332963-325 2
Brian MurrayRabin & Peckel LLP275 Madison AvenueNew York, NY 1001 6
C. Raymond PattonConner & Winte r15 E . 5Th Street , Suite 3700Tulsa , OK 74103
Stephen G . LevyLevy and Levy, P .C .One Stamford Plaza263 Tresser boulevard , 9' FloorStamford , Connecticut 0690 1
James Reed, Esq.Hall Estill Hardwick Gable Golden & Nelson320 S. Boston Avenue, Suite 400Tulsa, OK 74103-370 8
B. Federma n
I:1NescOAmcnded Complai nt . wv d
50