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UNITED STATES DISTRICT COURT
COMPLAINT Plaintiff Securities and Exchange Commission (the "Commission") alleges as follows: NATURE OF THE ACTION 1. This case involves a broad-ranging scheme to manipulate the reported financial results of Physician Computer Network, Inc. ("PCN"). During fiscal years 1996 and 1997, senior members of PCN's management fraudulently inflated the company's reported earnings by materially understating its operating expenses and overstating its revenues. They did this by, among other things, recognizing revenue from fictitious sales to the company's resellers, improperly capitalizing software development costs and operating expenses, manipulating depreciation expense, prematurely recognizing revenue for customer support and maintenance contracts, and recognizing revenue for out-of-period sales. To avoid detection of the scheme, defendants provided false documents and information to PCN's independent auditors. 2. Defendant John F. Mortell, PCN's former President and Chief Operating Officer, orchestrated the fraudulent scheme. Defendants Thomas F. Wraback, PCN's former Chief Financial Officer and Senior Vice President, and Gregory D. Norton, PCN's former Manager of Accounting and Reporting, assisted Mortell. Each of these defendants either made, or directed others to make, improper accounting adjustments or false accounting entries that were not in conformity with Generally Accepted Accounting Principles ("GAAP"). Defendant Glen P. Duffy, PCN's former Director of Accounting, knew of the fraudulent scheme, falsified certain accounting documents, and made false or misleading statements to PCN's auditors. Defendants William S. Edwards, PCN's former Vice President of Operations, and Jerry W. Ross, PCN's former Vice President of Systems Integration, directed improper shipping activities that resulted in PCN recognizing revenue from out-of-period shipments. Defendant Gerald T. Barry, President of G. Barry & Associates, Inc. ("GBA"), provided a false audit confirmation letter to PCN's auditors. 3. In March 1998, after PCN's auditors discovered the accounting irregularities, PCN announced that it would restate its financial results for each of the first three quarters of 1997. The price of PCN's stock dropped approximately 70% as a result of this announcement, falling from $4.25 per share on March 2, 1998 to $1.28 per share at the close of trading on March 3, 1998. In April 1998, PCN announced that it would delay the release of its 1997 results and restate its 1996 results. 4. In August 1999, PCN restated its results for 1996 and for the first time issued consolidated financial statements for 1997. According to the restatement of its 1996 results, PCN overstated its 1996 net income by $31.2 million, or 205%. Though PCN never reported restated 1997 quarterly financial results, as a result of overstating revenue and understating operating expenses, PCN overstated its quarterly 1997 net income by an estimated $7.8 million (173%) in the first quarter, $8.6 million (195%) in the second quarter, and $9.7 million (150%) in the third quarter. 5. Defendants each knew or were reckless in not knowing that, as a result of their conduct, as set forth below, the financial statements included in certain periodic reports that PCN filed with the Commission were materially false and misleading. By knowingly or recklessly causing PCN to issue materially false and misleading financial statements, Mortell, Wraback, Norton, Duffy and Edwards each violated Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Exchange Act Rule 10b-5 (antifraud provisions), and Ross aided and abetted violations of the antifraud provisions. Mortell, Wraback, Norton, Duffy, Edwards and Ross each also violated or aided and abetted violations of Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, 13a-13 and 13b2-1 (reporting, internal controls and record-keeping provisions). In addition, Mortell, Wraback, Norton and Duffy each violated or aided and abetted violations of Exchange Act Rule 13b2-2 (lying to the auditors provision). By knowingly or recklessly providing a false confirmation letter to PCN's auditors in connection with PCN's 1996 audit, Barry aided and abetted violations of certain antifraud, reporting, internal controls, record-keeping and lying to the auditors provisions. 6. The Commission brings this action seeking permanent injunctions and civil penalties against each defendant, and officer and director bars against Mortell and Wraback. JURISDICTION AND VENUE 7. The Commission brings this action pursuant to Sections 21(d) and 21(e) of the Exchange Act [15 U.S.C. §§ 78u(d) and 78u(e)] to permanently restrain and enjoin Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry from engaging in the acts, practices and transactions alleged herein. 8. This Court has jurisdiction over this action pursuant to Sections 21(d), 21(e) and 27 of the Exchange Act [15 U.S.C. §§ 78u(d), 78u(e) and 78aa]. 9. The defendants, directly and indirectly, have made use of the means and instrumentalities of interstate commerce, of the mails, or of the means or instrumentalities of transportation or communication in interstate commerce, and/or the facilities of a national securities exchange, in connection with the acts, practices and transactions alleged herein. DEFENDANTS 10. John F. Mortell, age 59, is a resident of Pleasantville, New York. Mortell served as PCN's Executive Vice President and Chief Operating Officer from March 1995 through December 1997. He became a member of PCN's board of directors in September 1996 and was named the company's President in January 1998. PCN placed Mortell on an involuntary leave of absence in February 1998 and Mortell resigned in May 1998. 11. Thomas F. Wraback, age 41, is a resident of Manalapan, New Jersey. Wraback served as PCN's Senior Vice President and Chief Financial Officer from October 1996 until August 1998, when PCN terminated his employment. Wraback is, and during the relevant period was, a Certified Public Accountant ("CPA"), licensed in New Jersey. 12. William S. Edwards, age 56, is a resident of Wrentham, Massachusetts. Edwards served as PCN's Vice President of Operations. 13. Gregory D. Norton, age 39, is a resident of New Providence, New Jersey. Norton served as PCN's Manager of Accounting and Reporting. Norton is, and beginning in April 1997 was, a CPA, licensed in New Jersey. 14. Glen P. Duffy, age 39, is a resident of Needham, Massachusetts. Duffy served as PCN's Director of Accounting. Duffy is, and during the relevant period was, a CPA, licensed in New Jersey. 15. Jerry W. Ross, age 56, is a resident of Huntington Beach, California. Ross served as PCN's Vice President for Systems Integration. 16. Gerald T. Barry, age 52, is a resident of Jamestown, Rhode Island. Barry is President of GBA, a privately-held Rhode Island corporation that was a reseller of PCN's software. OTHER PERSONS AND ENTITIES 17. PCN was a New Jersey corporation with its principle executive offices located in Morris Plains, New Jersey. PCN was engaged in the business of developing and distributing practice management and clinical data software for physician practice groups. At all times relevant to the Complaint, PCN's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act, and traded on the NASDAQ National Market. PCN's stock was suspended from trading in April 1998 and delisted in May 1998. In March 2000, PCN's assets were acquired in accordance with a plan of reorganization filed by PCN under Chapter 11 of the Bankruptcy Code. PCN no longer operates as a public company. THE FRAUDLENT ACCOUNTING SCHEME PCN Adopts Unrealistic Financial Goals In December 1996 18. On December 4, 1996, Mortell and Wraback, after consultation with other senior PCN officials, gave PCN's chairman a proposed business plan for 1997 and 1998, which was to be presented to PCN's full board of directors at its December 10th meeting. The proposed plan established a 1997 revenue goal of $120 million from existing PCN businesses, up from $95 million in 1996, plus additional revenue of $20 million from acquisitions. PCN's chairman was unhappy with the numbers and told Mortell and Wraback to revise the business plan. 19. In response to the pressure from PCN's chairman, Mortell, Wraback and other senior PCN officials increased the 1997 revenue goal to $140 million, even though they knew that the company was unlikely to achieve those results. PCN's board of directors approved the revised business plan. The 1996 Accounting Fraud 20. In December 1996, as PCN's management was establishing the company's revenue projections for the next year, they were also finalizing PCN's 1996 financial results, which were below expectations. Because PCN's performance in 1996 was the floor upon which the unrealistic 1997 revenue goal was based, defendants made or aided and abetted the making of numerous improper accounting entries to inflate the company's net income for the year. As set forth below, they did this by, among other things, engaging in or aiding and abetting the commission of one or more of the following: improperly recognizing revenue from a software license agreement, accelerating recognition of deferred revenue, recognizing revenue from double-booked sales, recording revenue from out-of-period sales, and misusing a restructuring reserve for regular expenses. The GBA Software Agreement 21. On December 17, 1996, PCN and GBA signed a software license agreement ("the December 1996 Agreement"), pursuant to which GBA agreed to pay PCN $3.5 million for the right to sell PCN's software to a defined list of end-users. After the agreement was signed, Barry, GBA's President, was unable to secure financing for the transaction. Nonetheless, on December 31, 1996, a full month before payment was due under the terms of the agreement, Barry sent PCN a check for $3.5 million even though GBA did not have sufficient funds to cover it. 22. Mortell knew about GBA's financial difficulties and directed Wraback not to deposit the check. Nevertheless, at Mortell's direction, Wraback, with the knowledge of Norton and Duffy, recognized $3.5 million in revenue in connection with the December 1996 Agreement and recorded the GBA check on PCN's year-end bank reconciliation as a "deposit in transit." By recognizing revenue on the transaction where collectibility was not probable at year-end 1996, PCN's accounting for the December 1996 Agreement did not conform with GAAP and improperly inflated PCN's 1996 revenue and net income. Barry Sends PCN's Auditors a False Confirmation Letter 23. During the 1996 audit, Wraback provided PCN's auditors with a copy of the GBA check to support the company's accounting for the December 1996 Agreement. Not satisfied with the check, PCN's auditors requested a confirmation letter from GBA verifying the terms of the agreement and the extent of GBA's indebtedness to PCN as of December 31, 1996. 24. On January 31, 1997, Wraback sent GBA a letter requesting that GBA confirm the amount that it owed to PCN as of December 31, 1996. The letter understated GBA's indebtedness to PCN by $3.5 million, falsely indicating that GBA had made a $3.5 million payment to PCN. On February 5, 1997, Barry signed the false confirmation letter and returned it to the auditors. PCN Misleads the Auditors about the December 1996 Agreement 25. Ultimately, GBA failed to obtain financing and never paid PCN for any of the $3.5 million owed under the December 1996 Agreement. Nevertheless, PCN failed to reverse the $3.5 million in revenue from the December 1996 Agreement and continued to list the $3.5 million check as a "deposit in transit" on its monthly bank reconciliation. 26. Before PCN filed its 1996 annual report on Form 10-K with the Commission, PCN's auditors held a meeting with Mortell and Wraback in which they discussed the December 1996 Agreement. Neither Mortell nor Wraback informed the auditors at this meeting, or at any other time, that they had not deposited GBA's $3.5 million check or that the agreement was contingent on financing that had not been obtained. 27. Wraback concealed PCN's failure to receive the payment from GBA by making improper adjustments to PCN's consolidated cash flow reports. To make it appear that PCN had received the $3.5 million from GBA, he decreased the amount of cash that the company received from its line of credit by that amount. As a result of these actions, Mortell and Wraback misled PCN's auditors concerning the December 1996 Agreement. Deferred Revenue Acceleration 28. During the relevant time, PCN had several extended contracts with its customers to provide software and hardware support and maintenance. PCN's policy was to account for these contracts as deferred revenue, which was amortized into income each month as the company satisfied its obligations under the contracts. However, during fiscal 1996, Mortell and Wraback caused PCN to improperly recognize revenue from certain customer support and maintenance contracts before PCN had satisfied its contractual obligations. 29. To conceal PCN's premature recognition of deferred revenue, Wraback, at Mortell's direction, instructed a subordinate to prepare an incomplete deferred revenue report to support the falsified deferred revenue entries on PCN's general ledger. Wraback then provided the falsified report to PCN's auditors. These actions caused PCN's 1996 revenue to be overstated by approximately $2.5 million. Double-Booked Sales 30. In 1996, due to difficulties that PCN had integrating companies that it had acquired, PCN mistakenly double-booked invoices related to certain sales on its accounts receivable trial balance. Wraback and Norton learned of this accounting error in January 1997, before PCN's 1996 audit began. However, neither Wraback nor Norton took any steps to eliminate the duplicate sales or inform the auditors of the error. As a result, Wraback and Norton caused PCN's 1996 revenue to be overstated by approximately $1.3 million. Out-of-Period Sales 31. In late December 1996, either Mortell, with Wraback's knowledge, or Wraback, at Mortell's direction, and with Duffy's knowledge, directed Edwards to extend the 1996 year-end so that PCN could claim revenue from products shipped after the end of the reporting period. As directed, Edwards then contacted Ross and directed him to extend the 1996 year-end shipping cut-off beyond December 31, 1996 and to alter PCN's shipping records to reflect that shipping was completed by year-end 1996. 32. Ross initially objected to Edwards' request because he knew that it was improper. Nevertheless, Ross did as he was told and instructed PCN's shipping department to extend the cut-off date. Under Ross's supervision, PCN's shipping department reset the computer clock that dated certain shipping records and generated shipping documents bearing false shipping dates. The documents indicated that certain products were shipped by year-end 1996, when they were actually shipped during the first few days of 1997. Pursuant to his instructions, Ross also obtained, or directed one of his subordinates to obtain, the services of a shipping carrier willing to falsify its shipping documents to reflect inaccurate shipping dates. As a result, PCN recognized revenue for out-of-period shipments, in contravention of GAAP, and overstated its 1996 revenue by approximately $150,000. Misuse of Restructuring Reserve for Ordinary Salary Expenses 33. In 1996, PCN charged employee salaries against a restructuring reserve that had been created in 1995 by falsely claiming that the salaries were severance costs. The charges against the reserve were actually the salaries of employees who had voluntarily terminated their employment with PCN and received no severance. To conceal PCN's misuse of the restructuring reserve, Mortell, Wraback and others, with Norton's knowledge, created false documents to support the improper accounting entries. 34. In early 1997, Wraback created, with Norton's knowledge, a falsified list of terminated employees and their severance amounts. Wraback provided this list to PCN's auditors in connection with PCN's 1996 audit. The list contained numerous employees who were not actually terminated, but who voluntarily left PCN. It also contained false severance amounts that actually represented the final regular salary payments to those employees. After receiving the falsified severance schedule, PCN's auditors requested additional supporting documentation for certain terminated employees listed on the schedule. In response, Wraback directed certain PCN employees to fabricate termination notices that were then backdated, signed by Mortell and another PCN employee, and provided to the company's auditors. By charging regular salary expenses against the restructuring reserve, in contravention of GAAP, PCN improperly reduced its current period operating expenses by $1.3 million. Mortell and Wraback Provide A False Management Representation Letter to PCN's Auditors 35. In February 1997, Mortell and Wraback provided a management representation letter to PCN's auditors that they knew was false and misleading. This letter stated, among other things, that there were no irregularities involving any member of management or employees who had significant roles in the company's internal control structure, and that there were no material transactions that the company improperly recorded in the accounting records underlying the financial statements. Given the accounting irregularities that Mortell and Wraback directed or knew about, these statements were false and misled the auditors concerning the existence of such irregularities at PCN. PCN Overstated its 1996 Net Income By 205% 36. As a result of the accounting scheme, PCN improperly recognized approximately $17.1 million in revenue and understated approximately $12.9 million in operating expenses during fiscal 1996, causing net income to be overstated by approximately $31.2 million, or 205%. These materially false financial results were included in the 1996 annual report on Form 10-K that PCN filed with the Commission. The 1997 Accounting Fraud
37. As the end of the first quarter of 1997 approached, PCN's financial performance was significantly below the projections set forth in its business plan. When Wraback reported the first quarter 1997 results to Mortell, Mortell instructed Wraback both verbally and in writing to make adjustments to several specific revenue and expense entries. Wraback initially objected to Mortell's request because he knew the adjustments were contrary to GAAP. Nevertheless, at Mortell's insistence, Wraback complied with the request. Wraback instructed Norton to alter PCN's general ledger and instructed his subordinates to alter other company records so that they would be consistent with the altered general ledger. They engaged in similar misconduct near the end of each of the first three quarters of 1997. 38. As set forth below, defendants fraudulently overstated PCN's 1997 earnings by, among other things, engaging in or aiding and abetting the commission of one or more of the following: recording fictitious sales to resellers, recognizing fictitious royalty revenue, improperly capitalizing software development costs, making improper inventory adjustments, manipulating depreciation expense, improperly capitalizing merger and acquisition expenses, accelerating recognition of deferred revenue, improperly recording certain operating expenses as fixed assets, understating its allowance for doubtful accounts, recording revenues from out-of-period sales, and entering into an undisclosed side-letter agreement with a reseller. Fictitious Sales to Resellers 39. Mortell, Wraback and Norton, with Duffy's knowledge, recognized revenue for fictitious software sales to certain of the company's resellers. These adjustments caused PCN to overstate its revenue by approximately $2.2 million in the first quarter of 1997, $2.3 million in the second quarter of 1997, and $2.0 million in the third quarter of 1997. Mortell and Wraback booked these sales because PCN's resellers were required to purchase the software to meet the minimum performance requirements under their contracts with PCN. However, PCN neither shipped the resellers any product, nor billed them for any purported sales. Because GAAP require that a company only recognize revenue when earned, PCN's recognition of revenue for these fictitious sales was contrary to GAAP. Fictitious Royalty Revenue 40. Mortell, Wraback and Norton recognized royalty revenue in connection with PCN's electronic statement processing and communication link products, which PCN introduced in 1997. These adjustments caused PCN to overstate its revenue by approximately $1.0 million in the first quarter of 1997. Mortell and Wraback based their recognition of this revenue on unsupported estimates of future sales of these new products. However, because GAAP require that a company only recognize revenue when earned, PCN's recognition of this royalty revenue was contrary to GAAP. Capitalized Software Development Costs 41. Mortell, Wraback and Norton capitalized software development costs and failed to disclose a change in accounting principle related to these costs. These actions caused PCN to understate its expenses by approximately $1.2 million in the first quarter of 1997, $1.5 million in the second quarter of 1997, and $1.8 million in the third quarter of 1997. To properly capitalize software development costs, GAAP require that the costs be measurable and relate to a product that has reached technological feasibility. Mortell and Wraback capitalized software development costs without any documentation to substantiate the costs incurred or the feasibility of the related software. In addition, because the company previously expensed software costs as they were incurred, PCN's capitalization of such costs constituted a change in accounting principle. Although GAAP require that a company disclose its changes in accounting principle, Mortell instructed Wraback not to disclose this change in the company's quarterly reports. As a result, neither PCN's accounting for software development costs nor its related disclosure was consistent with GAAP. Inventory Adjustments 42. Mortell, Wraback and Norton recorded adjustments to inventory in order to reduce cost of sales. These adjustments caused PCN to understate its cost of sales by approximately $500,000 in each of the first three quarters of 1997. Mortell and Wraback based the inventory adjustments and corresponding reduction of cost of sales on unsupported estimates that the value of PCN's physical inventory would exceed the amounts recorded on PCN's general ledger at year-end. GAAP require that inventory valuations be based on supportable estimates of physical inventory. Because Mortell and Wraback did not take physical inventory counts or other steps to generate reliable estimates of the value of the inventory, their adjustments were contrary to GAAP. Depreciation Expense Adjustments 43. Mortell, Wraback and Norton recorded fictitious entries to reduce depreciation expense in connection with a recently acquired PCN subsidiary. These improper adjustments caused PCN to understate its expenses by approximately $250,000 in the first quarter of 1997, $150,000 in the second quarter of 1997, and $250,000 in the third quarter of 1997. Mortell and Wraback predicated their fictitious entries on the unsupported theory that the standard depreciation entry for one of PCN's subsidiaries was overstated. Because GAAP require that depreciation expense be calculated based on reliable estimates, PCN's fictitious reduction of depreciation expense was in contravention of GAAP. Capitalized Merger and Acquisition Expenses 44. Mortell, Wraback and Norton capitalized general business expenses related to prospective corporate acquisitions. These improper adjustments caused PCN to understate its expenses by approximately $875,000 in the first quarter of 1997, $1.3 million in the second quarter of 1997, and $400,000 in the third quarter of 1997. GAAP do not permit capitalization of general business expenses related to acquisitions, but require that they be expensed in the period incurred. Thus, PCN's capitalization of these costs was not in conformity with GAAP. Deferred Revenue Acceleration 45. As they had done in 1996, Mortell, Wraback and Norton continued to recognize revenue from certain customer support and maintenance contracts during fiscal 1997. These adjustments caused PCN to overstate its revenue by approximately $2.0 million in the first quarter of 1997 and $1.5 million in the second quarter of 1997. Because GAAP require that a company only recognize revenue when earned, PCN's premature recognition of this revenue was not in conformity with GAAP. Unsubstantiated Fixed Asset Additions 46. Mortell, Wraback and Norton capitalized certain operating expenses related to PCN's computer systems. These improper adjustments caused PCN to understate its operating expenses and to overstate its assets by approximately $748,000 in the first quarter of 1997. Because GAAP do not permit the capitalization of normal operating expenses and require that they be expensed in the period incurred, PCN's capitalization of these costs was not in conformity with GAAP. Understated Allowance for Doubtful Accounts 47. Wraback understated the company's allowance for doubtful accounts, and thereby caused PCN to understate its operating expenses by approximately $2.0 million in each of the first three quarters of 1997. GAAP require that a company maintain an adequate reserve for accounts on which collection is doubtful. Despite his knowledge that the company's collections problems in 1997 required a greater reserve, Wraback caused PCN to establish an inadequate reserve for bad debt expense, in contravention of GAAP. Out-of-Period Sales 48. As he did at year-end 1996, Mortell directed that the second and third quarters of 1997 be extended so that PCN could claim revenue from products that were shipped after the end of the period. To carry out Mortell's directives, either Edwards, with Wraback's knowledge, or Wraback instructed Ross to extend the quarters. 49. Once again, Ross recognized that he was being asked to do something improper and he objected. But, once again, Ross did what he was told and instructed PCN's shipping department to extend the shipping cut-off for the second and third quarters. Under Ross's direct supervision, PCN's shipping department reset the computer clock that dated certain shipping records and generated shipping documents bearing false shipping dates. The documents indicated that certain products were shipped by quarter-end, when they were actually shipped during the first few days of the subsequent quarter. Pursuant to his instructions, Ross also obtained the services of a shipping carrier willing to falsify its shipping documents to reflect inaccurate shipping dates. As a result, PCN recognized revenue for out-of-period shipments, in contravention of GAAP, and overstated its revenue by approximately $553,000 in the second quarter of 1997 and $1.6 million in the third quarter of 1997. The PCMI Side-Letter 50. On September 30, 1997, PCN and Physician Computer Management, Inc. ("PCMI"), a PCN reseller, entered into a bulk software sales contract in the amount of $1.5 million. Mortell signed the agreement on behalf of PCN. On the same day, Mortell also signed a side-letter granting PCMI the right to cancel the contract if PCMI did not obtain the financing it was seeking. In October 1997, during a discussion concerning PCN's third quarter financial results, PCN's auditors asked Mortell whether PCMI, a new reseller experiencing financial troubles, had the ability to perform the obligations under the contract. Mortell misrepresented PCMI's ability to perform under the contract and failed to inform the auditors about the existence of the side-letter. 51. Ultimately, PCMI did not obtain financing for the transaction or make any payments to PCN. To properly recognize revenue from a bulk software sales agreement, GAAP require that the transaction fee be fixed or determinable. Due to the provisions of the side-letter that granted PCMI the right to cancel the contract, the transaction fee was neither fixed nor determinable and, therefore PCN's recognition of revenue for the PCMI deal was not in conformity with GAAP. As a result, PCN improperly recognized $1.5 million of revenue during the third quarter of 1997. PCN Materially Overstated its Net
52. PCN improperly recognized revenue and understated expenses to boost income in each of the first three quarters of 1997. In the first quarter of 1997, PCN improperly recognized an estimated $5.2 million in revenue and understated an estimated $2.5 million in operating expenses, thus overstating net income by approximately $7.8 million, or 173%. In the second quarter of 1997, PCN improperly recognized an estimated $3.9 million in revenue and understated an estimated $4.2 million in operating expenses, thus overstating net income by approximately $8.6 million, or 195%. In the third quarter of 1997, PCN improperly recognized an estimated $3.5 million in revenue and understated an estimated $5.1 million in operating expenses, thus overstating net income by approximately $9.7 million, or 150%. Consequently, PCN's financial statements included in its quarterly reports filed with the Commission during 1997 were materially false and misleading. The Fourth Quarter of 1997 53. In the fourth quarter of 1997, PCN's financial results were once again below the goals set forth in its business plan. As he had previously done, Mortell instructed Wraback to adjust several revenue and expense items to increase PCN's net income. Wraback, with Norton's assistance and Duffy's knowledge, again made the adjustments that Mortell requested. 54. In the fourth quarter, Mortell and Wraback, with Norton's assistance and Duffy's knowledge, made several improper accounting adjustments that were similar to those that they made in the first three quarters of 1997. They also made additional adjustments, including: improperly establishing a restructuring accrual; deferring certain costs to the next period; overstating cash; and understating accounts payable. 55. PCN's board approved a special fourth quarter charge to write down goodwill according to FASB No. 121 and to record certain restructuring charges. As a result of the overstated revenue and understated expense items that PCN recorded during the first three quarters of 1997, PCN had several problem assets on its balance sheet. In an effort to conceal their fraud, Mortell directed Wraback to write off certain assets and include them in the special year-end charge. For example, Wraback improperly included in the special charge a write-off of the accounts receivable resulting from the fictitious software sales to resellers. Thus, in the fourth quarter of 1997, Mortell and Wraback used an otherwise appropriate special charge to cover up their fraud in the prior three quarters. 56. As a result, in the fourth quarter of 1997, PCN improperly recognized an estimated $18.0 million in revenue and understated an estimated $23.5 million in expenses, thus overstating its net income by approximately $43.7 million, or 75%. PCN's auditors discovered defendants' accounting fraud during the course of the 1997 audit. Consequently, PCN never reported its false fourth quarter financial results to the public. Defendants Mislead PCN's Auditors About Accounting Activity 57. PCN's independent auditors started their 1997 audit fieldwork on January 26, 1998. To deceive the auditors and to prevent detection of their scheme, Mortell, Wraback, Norton, Duffy, Edwards and Ross each, directly or indirectly, made false and misleading statements to the auditors, provided or caused to be provided false documents to the auditors, or withheld from or delayed providing material information to the auditors in connection with the 1997 audit. 58. For example, in February 1998, Mortell, Wraback and Norton each made false and misleading statements to PCN's auditors concerning a June 1997 loan agreement with GBA that concealed from the auditors GBA's failure to pay PCN for the December 1996 Agreement. To support their false statements, Wraback provided the auditors with a memorandum falsely describing the loan agreement as a cash loan for working capital purposes. Similarly, in January and February 1998, in an effort to provide support for certain of the write downs that were included in the fourth quarter special charge and other previous adjusting journal entries recorded by the company, Wraback, with Norton's and Duffy's knowledge, fabricated nearly 150 sales invoices that he backdated and gave to the company's auditors. Mortell and Wraback each made false and misleading statements about the invoices to the auditors. Duffy did not disclose that the invoices were fabricated and, when questioned by the auditors about the invoices, Norton failed to tell them that he knew they were fabricated. Norton also made false entries on PCN's general ledger concerning the company's depreciation expense and presented a general ledger history report to the auditors that he misrepresented as complete and accurate when he knew it was not. 59. To implement their out-of-period shipping scheme, Mortell, Wraback, Edwards and Ross, with Duffy's knowledge, falsified or caused to be falsified shipping documents that made it appear that shipments occurred before year-end 1997 when, in fact, they had not. When the auditors requested that PCN provide documentation to support the year-end shipping activities, each of these defendants made false and misleading statements to the auditors, provided the auditors with or caused to be provided falsified shipping documents or failed to inform the auditors that they knew the information and documentation that the auditors were receiving was false. 60. Wraback, Norton and Duffy made other efforts to conceal their scheme from the auditors. Duffy, knowing that a PCN employee had presented a falsified "unmatched receiver report" to the auditors, took steps to conceal the falsification from the auditors by instructing an employee to delay recording certain incurred liabilities and to withhold payment of the unrecorded liabilities until after the auditors finished the audit. Wraback, with Duffy's knowledge, prepared or caused to be prepared falsified deferred revenue documents that he then provided to the auditors. Norton directed his subordinates to falsify fixed assets additions and deletions schedules that they then provided to the auditors with falsified invoice schedules to support the improper fixed asset additions included in the fixed asset reports. Duffy, with Wraback's knowledge, intentionally provided PCN's auditors with a partial journal entry concerning a credit in PCN's revenue accounts, which he falsely told the auditors was complete and accurate. Finally, Mortell and Wraback signed a management representation letter concerning PCN's 1997 second quarter financial statements, which they knew was false and misleading. Defendants Acted Knowingly or Recklessly in Causing PCN to
61. When PCN filed its 1996 annual report on Form 10-K with the Commission, each of the defendants knew or was reckless in not knowing that the financial statements included therein were not presented fairly, in all material respects, in conformity with GAAP. Mortell and Wraback each knew or was reckless in not knowing that PCN had improperly recognized revenue from the December 1996 Agreement, accelerated recognition of deferred revenue, recorded revenue from out-of-period sales and misused a restructuring reserve, and Wraback knew or was reckless in not knowing that PCN had recognized revenue from double booked sales. Norton knew or was reckless in not knowing that PCN had improperly recognized revenue from the December 1996 Agreement, recognized revenue from double booked sales, and misused the restructuring reserve. Duffy knew or was reckless in not knowing that PCN had improperly recognized revenue from the December 1996 Agreement and recorded revenue from out-of-period sales. Edwards and Ross each knew or was reckless in not knowing that they had provided, or caused to be provided, inaccurate shipping information that PCN would record in its books and records and would rely upon to determine its revenues. Barry knew or was reckless in not knowing that the worthless check that he sent to PCN pursuant to the December 1996 Agreement and the false confirmation letter that he provided to the auditors would be reflected in PCN's books and records and relied upon to determine PCN's revenues. Each of the defendants knew or was reckless in not knowing that they made false and misleading statements or provided or caused to be provided false and misleading documents and information to PCN's auditors in 1996 or in connection with the 1996 audit. Each of the defendants, therefore, knew or was reckless in not knowing that PCN's 1996 financial statements included in its annual report on Form 10-K were materially false and misleading. Mortell, Wraback, Norton, Duffy, Edwards and Ross Acted Knowingly or Recklessly
62. When PCN filed its 1997 quarterly reports on Form 10-Q with the Commission, Mortell, Wraback, Norton, Duffy, Edwards and Ross each knew or was reckless in not knowing that the financial statements included therein were not presented fairly, in all material respects, in conformity with GAAP. Mortell, Wraback, and Norton each knew or was reckless in not knowing that PCN had recorded fictitious sales to resellers, recognized fictitious royalty revenue, improperly capitalized software development costs, improperly adjusted inventory, manipulated depreciation expense, improperly capitalized merger and acquisition expenses, accelerated recognition of deferred revenue, improperly recorded certain operating expenses as fixed assets, and recorded revenues from out-of-period sales. Mortell knew or was reckless in not knowing that PCN had entered into an undisclosed side-letter agreement with a reseller and Wraback knew or was reckless in not knowing that PCN had understated its allowance for doubtful accounts. Duffy knew or was reckless in not knowing that PCN had recorded fictitious sales to resellers and recorded revenues from out-of-period sales. Edwards and Ross each knew or was reckless in not knowing that they had provided, or caused to be provided, inaccurate shipping information that PCN would record in its books and records and would rely upon to determine its revenues for the second and third quarters of 1997. Mortell, Wraback, Norton, Duffy, Edwards and Ross each knew or was reckless in not knowing that they made false and misleading statements or provided or caused to be provided false and misleading documents and information to PCN's auditors in 1997 or in connection with the 1997 audit. Mortell, Wraback, Norton and Duffy each, therefore, knew or was reckless in not knowing that the financial statements included in PCN's quarterly report on Form 10-Q for the first quarter of 1997 were materially false and misleading and Mortell, Wraback, Norton, Duffy, Edwards and Ross each knew or was reckless in not knowing that the financial statements included in PCN's quarterly reports on Form 10-Q for the second and third quarters of 1997 were materially false and misleading. FIRST CLAIM Violations of Section 10(b) of the Exchange Act and Rule 10b-5 Thereunder [Against Defendants Mortell, Wraback, Edwards, Norton and Duffy] 63. Paragraphs 1 through 62 above are re-alleged and incorporated herein by reference. 64. Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 [17 C.F.R. § 240.10b-5] thereunder prohibit a person from, inter alia, employing any device, scheme or artifice to defraud; making any untrue statement of a material fact or omitting to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 65. By virtue of the conduct described herein, defendants Mortell, Wraback, Edwards, Norton and Duffy each violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. SECOND CLAIM Violations of Section 13(b)(5) of the Exchange Act and Rule 13b2-1 Thereunder [Against Defendants Mortell, Wraback, Edwards, Norton, Duffy and Ross] 66. Paragraphs 1 through 65 above are re-alleged and incorporated herein by reference. 67. Section 13(b)(5) of the Exchange Act [15 U.S.C. § 78m(b)(5)] and Rule 13b2-1 [17 C.F.R. § 240.13b2-1] thereunder prohibit a person from, inter alia, knowingly circumventing internal accounting controls and falsifying corporate books and records. 68. By virtue of the conduct described herein, defendants Mortell, Wraback, Edwards, Norton, Duffy and Ross each violated Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder. THIRD CLAIM Violations of Rule 13b2-2 under the Exchange Act [Against Defendants Mortell and Wraback] 69. Paragraphs 1 through 68 above are re-alleged and incorporated herein by reference. 70. Rule 13b2-2 under the Exchange Act [17 C.F.R. § 240.13b2-2] prohibits an officer or director, inter alia, from making material misstatements or omissions to an accountant in connection with an audit or a filing with the Commission. 71. By virtue of the conduct described herein, defendants Mortell and Wraback each violated Rule 13b2-2 under the Exchange Act. FOURTH CLAIM Aiding and Abetting Violations of Section 10(b)
[Against Ross and Barry] 72. Paragraphs 1 through 71 above are re-alleged and incorporated herein by reference. 73. PCN filed with the Commission an annual report on Form 10-K for its fiscal year 1996, and filed quarterly reports on Form 10-Q for the first three quarters of fiscal year 1997, all of which included financial statements that were materially false and misleading because PCN's revenue and net income had been fraudulently inflated. 74. By reason of the foregoing, PCN violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. 75. Section 20(e) of the Exchange Act [15 U.S.C. § 78t(e)] provides, inter alia, that a person who knowingly provides substantial assistance to another person in violation of the Exchange Act, or any rule or regulation issued under the Exchange Act, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided. 76. Defendant Ross knowingly provided substantial assistance to PCN in connection with the company's violations of the aforesaid provisions relating to its annual report on Form 10-K for fiscal year 1996 and its quarterly reports on Form 10-Q for the second and third quarters of fiscal year 1997. 77. Defendant Barry knowingly provided substantial assistance to PCN in connection with the company's violations of the aforesaid provisions relating to its annual report on Form 10-K for fiscal year 1996. 78. By virtue of the conduct described herein, and pursuant to Section 20(e) of the Exchange Act [15 U.S.C. § 78t(e)], defendants Ross and Barry each aided and abetted PCN's violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. FIFTH CLAIM Aiding and Abetting Violations of Section 13(a)
[Against Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry] 79. Paragraphs 1 through 78 above are re-alleged and incorporated herein by reference. 80. Section 13(a) of the Exchange Act [15 U.S.C. § 78m(a)] requires all issuers with securities registered under Section 12 of the Exchange Act to file periodic and other reports with the Commission containing such information as the Commission's rules prescribe. Exchange Act Rules 13a-1 and 13a-13 [17 C.F.R. §§ 240.13a-1 and 240.13a-13] require issuers to file accurate annual and quarterly reports. Exchange Act Rule 12b-20 [17 C.F.R. § 240.12b-20] requires that reports include such further material information as may be necessary to make the required statements, in light of the circumstances under which they were made, not misleading. 81. PCN filed with the Commission an annual report on Form 10-K for its fiscal year 1996, and filed quarterly reports on Form 10-Q for the first three quarters of fiscal year 1997. The financial statements in each of these filings were materially false and misleading because PCN's revenue and net income had been fraudulently inflated. 82. By reason of the foregoing, PCN violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. 83. Defendants Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry each knowingly provided substantial assistance to PCN in connection with PCN's violations of the aforesaid provisions. 84. By virtue of the conduct described herein, and pursuant to Section 20(e) of the Exchange Act, defendants Mortell, Wraback, Edwards, Norton, Duffy and Ross each aided and abetted PCN's violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. 85. By virtue of the conduct described herein, and pursuant to Section 20(e) of the Exchange Act, defendant Barry aided and abetted PCN's violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder. SIXTH CLAIM Aiding and Abetting Violations of Section 13(b)(2)(A) of the Exchange Act [Against Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry] 86. Paragraphs 1 through 85 above are re-alleged and incorporated herein by reference. 87. Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. § 78m(b)(2)(A)] requires, inter alia, issuers to make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer. 88. Throughout fiscal year 1996 and the first three quarters of fiscal year 1997, PCN's books, records, and accounts did not accurately and fairly reflect the transactions and dispositions of the assets of PCN. 89. By reason of the foregoing, PCN violated Section 13(b)(2)(A) of the Exchange Act. 90. Defendants Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry each knowingly provided substantial assistance to PCN in connection with PCN's violations of the aforesaid provision. 91. By virtue of the conduct described herein, and pursuant to Section 20(e) of the Exchange Act, defendants Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry each aided and abetted PCN's violations of Section 13(b)(2)(A) of the Exchange Act. SEVENTH CLAIM Aiding and Abetting Violations of Section 13(b)(2)(B) of the Exchange Act [Against Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry] 92. Paragraphs 1 through 91 above are re-alleged and incorporated herein by reference. 93. Section 13(b)(2)(B) of the Exchange Act [15 U.S.C. § 78m(b)(2)(B)] requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, inter alia, transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP or any other criteria applicable to such statements. 94. Throughout fiscal year 1996 and the first three quarters of fiscal year 1997, PCN did not maintain internal accounting controls sufficient to permit the preparation of financial statements in conformity with GAAP. 95. By reason of the foregoing, PCN violated Section 13(b)(2)(B) of the Exchange Act. 96. Defendants Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry each knowingly provided substantial assistance to PCN in connection with PCN's violations of the aforesaid provision. 97. By virtue of the conduct described herein, and pursuant to Section 20(e) of the Exchange Act, defendants Mortell, Wraback, Edwards, Norton, Duffy, Ross and Barry each aided and abetted PCN's violations of Section 13(b)(2)(B) of the Exchange Act. EIGHTH CLAIM Aiding and Abetting Violations of Rule 13b2-2 under the Exchange Act [Against Norton, Duffy and Barry] 98. Paragraphs 1 through 97 are re-alleged and incorporated herein by reference. 99. Defendants Norton and Duffy each knowingly provided substantial assistance to Mortell and Wraback, who were PCN officers, in connection with their violations of Exchange Act Rule 13b2-2. 100. Defendant Barry knowingly provided substantial assistance to Wraback, who was a PCN officer, in connection with his violations of Exchange Act Rule 13b2-2. 101. By virtue of the conduct described herein, and pursuant to Section 20(e) of the Exchange Act, defendants Norton and Duffy each aided and abetted Mortell's and Wraback's violations of Exchange Act Rule 13b2-2. 102. By virtue of the conduct described herein, and pursuant to Section 20(e) of the Exchange Act, defendant Barry aided and abetted Wraback's violations of Exchange Act Rule 13b2-2. PRAYER FOR RELIEF WHEREFORE, the Commission respectfully requests that this Court enter a final judgment:
Dated: _____________ ____, 2002 Respectfully submitted, Linda Chatman Thomsen
Attorneys for Plaintiff
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