-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, FCk6Y1fxF75dcESe23HF7hOb9Jd0igAXOg6FBhn6VnJHK6DXVFpnHvt1q02Big7n iwLXGTrMWnhHD5PdrhWiZg== 0000950129-99-004971.txt : 19991115 0000950129-99-004971.hdr.sgml : 19991115 ACCESSION NUMBER: 0000950129-99-004971 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SERVICE CORPORATION INTERNATIONAL CENTRAL INDEX KEY: 0000089089 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PERSONAL SERVICES [7200] IRS NUMBER: 741488375 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-06402 FILM NUMBER: 99750675 BUSINESS ADDRESS: STREET 1: 1929 ALLEN PKWY STREET 2: P O BOX 130548 CITY: HOUSTON STATE: TX ZIP: 77019 BUSINESS PHONE: 7135225141 MAIL ADDRESS: STREET 1: P O BOX 130548 CITY: HOUSTON STATE: TX ZIP: 77219-0548 10-Q 1 SERVICE CORPORATION INTERNATIONAL - DATED 09/30/99 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO __________ COMMISSION FILE NUMBER 1-6402-1 -------------------- SERVICE CORPORATION INTERNATIONAL (Exact name of registrant as specified in charter) TEXAS 74-1488375 (State or other jurisdiction of (I. R. S. employer incorporation or organization) identification number) 1929 ALLEN PARKWAY, HOUSTON, TEXAS 77019 (Address of principal executive offices) (Zip code) (713) 522-5141 (Registrant's telephone number, including area code) -------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to the filing requirements for the past 90 days. YES X NO --- --- The number of shares outstanding of the registrant's common stock as of October 29, 1999, was 272,060,576 (excluding treasury shares). 2 SERVICE CORPORATION INTERNATIONAL INDEX
Part I. Financial Information Item 1. Financial Statements Consolidated Statement of Income - Three and Nine Months Ended September 30, 1999 and 1998 3 Consolidated Balance Sheet - September 30, 1999 and December 31, 1998 4 Consolidated Statement of Cash Flows - Nine Months Ended September 30, 1999 and 1998 5 Consolidated Statement of Stockholders' Equity - Nine Months Ended September 30, 1999 6 Notes to Consolidated Financial Statements 7 - 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 - 27 Item 3. Quantitative and Qualitative Disclosures about Market Risk 28 Part II. Other Information Item 1. Legal Proceedings 29 Item 5. Other Information 30 Item 6. Exhibits and Reports on Form 8-K 31 Signature 32
3 ITEM 1. FINANCIAL STATEMENTS SERVICE CORPORATION INTERNATIONAL CONSOLIDATED STATEMENT OF INCOME
Three Months Ended Nine Months Ended September 30, September 30, (Dollars in thousands, except per share amounts) 1999 1998 1999 1998 - ----------------------------------------------------------------------------------------------------------------------------- Revenues.............................................................. $ 776,845 $ 712,520 $ 2,511,137 $ 2,101,594 Costs and expenses ................................................... (648,200) (538,814) (1,984,036) (1,524,070) ----------- ---------- ----------- ----------- Gross profit ......................................................... 128,645 173,706 527,101 577,524 General and administrative expenses .................................. (19,322) (15,422) (55,839) (49,681) Restructuring charge ................................................. -- -- (89,884) -- ----------- ---------- ----------- ----------- Income from operations ............................................... 109,323 158,284 381,378 527,843 Interest expense ..................................................... (59,404) (47,816) (173,613) (125,990) Other income ......................................................... (334) 18,087 27,034 35,266 ----------- ---------- ----------- ----------- (59,738) (29,729) (146,579) (90,724) ----------- ---------- ----------- ----------- Income before income taxes and extraordinary gain .................... 49,585 128,555 234,799 437,119 Provision for income taxes ........................................... (17,530) (45,342) (84,848) (154,172) ----------- ---------- ----------- ----------- Income before extraordinary gain ..................................... 32,055 83,213 149,951 282,947 Extraordinary gain on early extinguishments of debt (net of income taxes of $1,071) ................................... -- -- 1,885 -- ----------- ---------- ----------- ----------- Net income ........................................................... $ 32,055 $ 83,213 $ 151,836 $ 282,947 =========== =========== =========== =========== Earnings per share: Basic: Income before extraordinary gain .................. $ .12 $ .32 $ .55 $ 1.11 Extraordinary gain on early extinguishments of debt ........................................ -- -- .01 -- ----------- ---------- ----------- ----------- Net income ........................................ $ .12 $ .32 $ .56 $ 1.11 =========== =========== =========== =========== Diluted: Income before extraordinary gain .................. $ .12 $ .32 $ .55 $ 1.08 Extraordinary gain on early extinguishments of debt ........................................ -- -- .01 -- ----------- ---------- ----------- ----------- Net income ........................................ $ .12 $ .32 $ .56 $ 1.08 =========== =========== =========== =========== Dividends per share .................................................. $ .09 $ .09 $ .27 $ .27 =========== =========== =========== =========== Basic weighted average number of shares .............................. 272,060 257,380 272,354 255,673 =========== =========== =========== =========== Diluted weighted average number of shares ............................ 273,079 263,416 274,368 262,308 =========== =========== =========== ===========
(See notes to consolidated financial statements) 3 4 SERVICE CORPORATION INTERNATIONAL CONSOLIDATED BALANCE SHEET
September 30, December 31, (Dollars in thousands, except share amounts) 1999 1998 - ---------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents .......................... $ 205,837 $ 358,210 Receivables, net of allowances ..................... 598,348 565,552 Inventories ........................................ 209,445 189,070 Other .............................................. 78,974 96,248 ------------ ------------ Total current assets .......................... 1,092,604 1,209,080 ------------ ------------ Investments - insurance subsidiaries ........................ 1,284,291 1,234,678 Prearranged funeral contracts ............................... 3,079,762 2,588,806 Long-term receivables, net of allowances .................... 1,587,720 1,408,076 Cemetery property, at cost .................................. 2,183,996 2,035,897 Property, plant and equipment, at cost (net) ................ 1,956,475 1,824,979 Deferred charges and other assets ........................... 1,285,766 1,151,430 Names and reputations (net) ................................. 2,501,823 1,813,212 ------------ ------------ $ 14,972,437 $ 13,266,158 ============ ============ LIABILITIES & STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accrued liabilities ........... $ 600,058 $ 452,354 Current maturities of long-term debt ............... 88,718 96,067 Income taxes ....................................... 99,551 81,904 ------------ ------------ Total current liabilities ..................... 788,327 630,325 ------------ ------------ Long-term debt .............................................. 4,111,305 3,764,590 Reserves and annuity benefits - insurance subsidiaries ...... 1,292,835 1,207,169 Deferred prearranged funeral contract revenues .............. 3,306,471 2,819,794 Deferred income taxes ....................................... 833,612 797,086 Other liabilities ........................................... 931,760 893,092 Stockholders' equity: Common stock, $1 per share par value, 500,000,000 shares authorized, 272,060,576 and 259,201,104, issued and outstanding (net of 2,796,545 and 68,373 treasury shares, at cost) .............. 272,060 259,201 Capital in excess of par value ..................... 2,156,240 1,646,765 Retained earnings .................................. 1,311,146 1,232,758 Accumulated other comprehensive (loss) income ...... (31,319) 15,378 ------------ ------------ Total stockholders' equity .................... 3,708,127 3,154,102 ------------ ------------ $ 14,972,437 $ 13,266,158 ============ ============
(See notes to consolidated financial statements) 4 5 SERVICE CORPORATION INTERNATIONAL CONSOLIDATED STATEMENT OF CASH FLOWS
Nine months ended September 30, (Dollars in thousands) 1999 1998 - ----------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income ................................................................. $ 151,836 $ 282,947 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ..................................... 185,092 133,880 Provision for deferred income taxes ............................... 18,082 26,762 Restructuring charge .............................................. 89,884 -- Extraordinary gain on early extinguishments of debt, net of income taxes ............................................. (1,885) -- Gains from dispositions (net) ..................................... (15,969) (24,426) Realized gains on sales of investments ............................ (25,495) -- Realized losses on sales of investments ........................... 24,691 -- Change in assets and liabilities, net of effects from acquisitions: Increase in receivables ...................................... (181,753) (162,353) Increase in other assets ..................................... (9,413) (70,405) Increase in payables and other liabilities ................... 101,920 65,204 Other ........................................................ (9,993) 4,329 ----------- ----------- Net cash provided by operating activities .................................. 326,997 255,938 ----------- ----------- Cash flows from investing activities: Capital expenditures .............................................. (160,998) (152,990) Net effect of prearranged funeral production and maturities ....................................................... (74,641) 53,097 Purchases of securities - insurance subsidiaries .................. (1,454,778) (768,315) Sales of securities - insurance subsidiaries ...................... 1,306,616 759,477 Proceeds from sales of property and equipment ..................... 67,125 27,563 Acquisitions, net of cash acquired ................................ (74,064) (668,830) Loans issued by lending subsidiary ................................ (67,429) (115,527) Principal payments received on loans issued by lending subsidiary ............................................... 91,190 62,631 Other ............................................................. (11,085) 1,376 ----------- ----------- Net cash used in investing activities ...................................... (378,064) (801,518) ----------- ----------- Cash flows from financing activities: Net increase in borrowings under revolving credit agreements ................................................ 611,074 257,226 Proceeds from issuance of long-term debt .......................... -- 500,000 Payments of long-term debt ........................................ (228,142) (61,433) Early extinguishments of long-term debt ........................... (365,936) -- Repurchase of common stock ........................................ (45,750) -- Dividends paid .................................................... (72,294) (65,156) Bank overdrafts and other ......................................... (258) (14,954) ----------- ----------- Net cash (used in) provided by financing activities ........................ (101,306) 615,683 ----------- ----------- Net (decrease) increase in cash and cash equivalents ....................... (152,373) 70,103 Cash and cash equivalents at beginning of period ........................... 358,210 46,877 ----------- ----------- Cash and cash equivalents at September 30, 1999 and 1998 ................... $ 205,837 $ 116,980 =========== ===========
(See notes to consolidated financial statements) 5 6 SERVICE CORPORATION INTERNATIONAL CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Accumulated Capital in other Common excess Retained comprehensive (Dollars in thousands) stock of par value earnings income (loss) Total - -------------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1998 ..................... $ 259,201 $ 1,646,765 $ 1,232,758 $ 15,378 $ 3,154,102 Comprehensive income: Net income ................................. 151,836 151,836 Other comprehensive loss: Foreign currency translation ............ (18,727) (18,727) Unrealized loss on securities ........... (27,970) (27,970) ----------- Total other comprehensive loss .......... (46,697) ----------- Comprehensive income ....................... 105,139 Common stock issued: Acquisitions ............................... 15,506 550,325 565,831 Stock option exercises and stock grants .... 170 1,382 1,552 Debenture conversions ...................... 44 657 701 Repurchase of common stock .................... (2,861) (42,889) (45,750) Dividends on common stock ..................... (73,448) (73,448) ----------- ----------- ----------- ----------- ----------- Balance at September 30, 1999 .................... $ 272,060 $ 2,156,240 $ 1,311,146 $ (31,319) $ 3,708,127 =========== =========== =========== =========== ===========
The Company's comprehensive income for the nine months ended September 30, 1998, of $280,583 consisted of net income of $282,947, a foreign currency translation adjustment of $(14,693), and an unrealized gain on securities of $12,329. (See notes to consolidated financial statements) 6 7 SERVICE CORPORATION INTERNATIONAL NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE, RATIO AMOUNTS AND NUMBER OF LOCATIONS) 1. NATURE OF OPERATIONS Service Corporation International (the "Company" or "SCI") is the largest funeral and cemetery company in the world. At September 30, 1999, the Company operated 3,823 funeral service locations, 524 cemeteries and 198 crematoria located in 20 countries on five continents. The Company's operations consist of funeral homes, cemeteries, crematoria and related businesses. Company personnel at the funeral service locations provide all professional services relating to funerals, including the use of funeral facilities and motor vehicles. Funeral related merchandise is sold at funeral locations and certain funeral service locations contain crematoria. The Company sells price guaranteed prearranged funeral contracts whereby a customer selects the terms of a funeral to be performed in the future. The Company's cemeteries provide cemetery interment rights (including mausoleum spaces, lots, and lawn crypts) and certain merchandise including burial vaults and stone and bronze memorials. These items are sold on an at need or preneed basis. Company personnel at cemeteries perform interment services and provide management and maintenance of cemetery grounds. Certain cemeteries contain crematoria. The Company has approximately 167 combination facilities in which a funeral service location is contained within a cemetery. The financial services segment represents a combination of the Company's insurance operations primarily related to the funding of prearranged funeral contracts, prearranged funeral and cemetery trust administration, investment management and lending activities providing capital financing for independent funeral home and cemetery operations. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation: The consolidated financial statements for the three and nine months ended September 30, 1999 and 1998 include the accounts of SCI and all majority-owned subsidiaries and are unaudited but include all adjustments, consisting of normal recurring accruals and any other adjustments which management considers necessary for a fair presentation of the results for these periods. These consolidated financial statements have been prepared in a manner consistent with the accounting policies described in the annual report on Form 10-K filed with the Securities and Exchange Commission (the "Commission") for the year ended December 31, 1998, and should be read in conjunction therewith. The year-end consolidated balance sheet was derived from audited financial statements but does not include all disclosures required by generally accepted accounting principles. Operating results for interim periods are not necessarily indicative of the results that may be expected for the full year period. Certain reclassifications have been made to the prior period to conform to the current period presentation with no effect on previously reported net income, financial condition or cash flows. Use of Estimates in the Preparation of Financial Statements: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and may affect the reported amounts of revenues and expenses during the reporting period. As a result, actual results could differ from these estimates. 3. ACQUISITIONS In January 1999, a wholly owned subsidiary of the Company merged with Equity Corporation International ("ECI") in a stock-for-stock transaction in which ECI shareholders received approximately 15,501 shares of Company common stock valued at approximately $557,000 and approximately 1,200 options to purchase Company common stock valued at approximately $8,628. At the time of the merger, ECI owned 359 funeral service locations and 80 cemeteries in North America. 7 8 Exclusive of the merger with ECI, the Company acquired 72 funeral service locations, 15 cemeteries and 2 crematoria during the nine months ended September 30, 1999, for an aggregate purchase price of approximately $89,700. The Company acquired 255 funeral service locations, 40 cemeteries and 14 crematoria during the nine months ended September 30, 1998, for an aggregate purchase price of approximately $606,800. Additionally in July, 1998, the Company acquired American Memorial Life Insurance Company ("AML"), the prearranged funeral services division of American Annuity Group, for $164,000. AML offers a variety of prearranged and final expense life insurance and annuity products to finance prearranged funerals. The consideration for these acquisitions consisted of combinations of cash, common stock of the Company and issued debt. All acquisitions have been accounted for under the purchase method of accounting; therefore, the operating results of these acquisitions have been included since their respective acquisition dates. The effect of acquisitions, net of cash acquired, on the consolidated balance sheet at September 30, was as follows:
1999 1998 - ------------------------------------------------------------------------------------ Current assets .......................................... $ 109,570 $ 55,577 Investments - insurance subsidiaries .................... -- 622,379 Prearranged funeral contracts ........................... 309,169 47,802 Long-term receivables ................................... 44,891 74,690 Cemetery property ....................................... 201,893 163,680 Property, plant and equipment, net ...................... 160,890 84,342 Deferred charges and other assets ....................... (6,928) 138,391 Names and reputations ................................... 731,474 350,099 Current liabilities ..................................... (136,446) (65,588) Long-term debt .......................................... (338,912) (62,907) Reserves and annuity benefits - insurance subsidiaries... -- (594,848) Deferred prearranged funeral contract revenues .......... (315,753) (45,870) Deferred income taxes and other liabilities ............. (119,953) (51,160) Stockholders' equity .................................... (565,831) (47,757) --------- --------- Cash used for acquisitions ......... $ 74,064 $ 668,830 ========= =========
4. PREARRANGED FUNERAL ACTIVITIES The Company sells price guaranteed prearranged funeral contracts through various programs providing for future funeral services at prices prevailing when the contracts are signed. Payments under these contracts are placed into trust accounts (pursuant to applicable law) or are used to pay premiums on life insurance or annuity contracts. Unperformed price guaranteed prearranged funeral contracts not funded through Company owned insurance subsidiaries are included in the consolidated balance sheet as "Prearranged funeral contracts." This balance represents amounts due from trust accounts, customer receivables, or third party insurance companies. A corresponding credit is recorded to "Deferred prearranged funeral contract revenues." Prearranged funeral contracts are recognized in funeral revenues at the time the funeral services are performed. Trust earnings and increasing insurance benefits from third party insurance companies are intended to cover future increases in the cost of providing price guaranteed funeral services and are accrued and deferred until the funeral services are performed, at which time the funds are recognized in funeral revenues. Net obtaining costs incurred pursuant to the sales of trust funded and third party insurance funded prearranged funeral contracts are included in "Deferred charges and other assets" in the consolidated balance sheet. The net obtaining costs include sales commissions and certain other direct costs which are deferred and amortized over a period representing the estimated life of the prearranged funeral contracts. 8 9 Prearranged funeral contracts may also be funded by insurance policies or annuities written by the Company's wholly-owned insurance subsidiaries. These insurance subsidiaries follow generally accepted accounting principles for life insurance companies. As part of the funding through Company insurance subsidiaries of prearranged funeral contracts, the insurance subsidiaries invest cash received for such contracts in debt and marketable equity securities that are classified as available-for-sale. These securities are included in the consolidated balance sheet as "Investments-insurance subsidiaries" and are included at quoted market values, if readily marketable, or at the Company's estimated fair value if not readily marketable. Policy acquisition costs are deferred and included in "Deferred charges and other assets" in the consolidated balance sheet and amortized in accordance with generally accepted accounting principles for life insurance companies. The total value of unperformed prearranged funeral contracts includes contracts that are to be funded by trust, third party insurance companies, or by the Company's insurance subsidiaries. The total value represents the original contract values plus any accumulated trust fund earnings or increasing insurance benefits. The total value of unperformed prearranged funeral contracts that are trust funded or funded by third party insurance companies are included in "Deferred prearranged funeral contract revenues" in the consolidating balance sheet. In accordance with generally accepted accounting principles for life insurance companies, the Company records an actuarially determined amount included in "Reserves and annuity benefits - insurance subsidiaries" in the consolidated balance sheet representing future amounts to be funded from the Company's insurance subsidiaries for SCI and non-SCI unperformed prearranged funeral contracts. The total value of all SCI unperformed prearranged funeral contracts is shown below as if the contracts funded through the Company's insurance subsidiaries were valued at original contract values plus increasing insurance benefits.
September 30, 1999 December 31, 1998 ------------------ ----------------- Deferred prearranged funeral contract revenues $3,306,471 $2,819,794 SCI contracts funded by Company owned insurance subsidiaries 1,072,194 932,056 ------------------ ----------------- Total value of unperformed prearranged funeral contracts $4,378,665 $3,751,850 ================== =================
5. DEBT Debt at September 30, 1999 and December 31, 1998 was as follows:
September 30, 1999 December 31, 1998 ------------------ ----------------- Bank revolving credit agreements and commercial paper $1,269,760 $ 650,596 Fixed rate notes, interest rates ranging from 6.0% - 8.7%, due 2000 through 2020 2,725,811 2,763,137 Convertible debentures 49,278 49,979 Mortgage notes and other debt 174,152 416,833 Deferred loan costs (18,978) (19,888) ------------------ ----------------- Total debt 4,200,023 3,860,657 Less current maturities (88,718) (96,067) ------------------ ----------------- Total long-term debt $4,111,305 $3,764,590 ================== =================
As of September 30, 1999, the Company's primary revolving credit agreements provided for borrowings up to $1,800,000 and consisted of three committed facilities - two 364-day facilities and a 5-year, multi-currency facility. On November 2, 1999, these credit agreements were modified and the maximum available borrowings were reduced to $1,600,000 due to the Company's reduced credit needs. These facilities are primarily used to support commercial paper issuance and for general corporate purposes. One 364-day facility allows for borrowings up to $300,000. This facility expires June 25, 2000, but the outstanding balance may be converted into a two-year term loan at the Company's option. Interest rates are based on various indices as 9 10 determined by the Company. A facility fee, which was 0.125% at September 30, 1999, is paid quarterly on the total commitment amount. On November 2, 1999, this facility fee was increased to 0.25% and can range from 0.25% to 0.50% depending upon the Company's senior debt ratings. The second 364-day facility, which expired on November 2, 1999, permitted borrowings up to $800,000 at September 30, 1999. An annual facility fee is paid quarterly on the total commitment amount and was 0.09% at September 30, 1999. On November 2, 1999, this facility was extended for another 364 days and now allows for borrowings up to $600,000. On this date, the facility fee was increased to 0.25% and can range from 0.25% to 0.50% depending upon the Company's senior debt ratings. The 5-year facility allows for borrowings up to $700,000, including $500,000 in various foreign currencies. This facility expires June 27, 2002. Interest rates on this facility are based on various indices as determined by the Company. An annual facility fee is paid quarterly and can range from 0.07% to 0.15% based on the Company's senior debt ratings and was 0.10% on September 30, 1999. On November 2, 1999, the facility fee was increased to 0.25% and can range from 0.25% to 0.50% depending upon the Company's senior debt ratings. At September 30, 1999, $274,960 in various foreign currencies was outstanding under the 5-year facility with a weighted average interest rate of 4.78%. At December 31, 1998, $217,345 was outstanding in various foreign currencies under the same facility with a weighted average interest rate of 5.65%. At September 30, 1999, $994,800 of commercial paper was outstanding with a weighted average interest rate of 5.90% ($433,251 outstanding at December 31, 1998 with a weighted average interest rate of 6.68%). The Company's commercial paper program is backed by the above facilities. The commercial paper borrowings and revolving notes generally have maturities ranging from 1 to 180 days. Since it is the Company's intent to refinance borrowings under these facilities with long-term debt or equity, the Company has classified such borrowings as long-term debt. The credit facilities described above, as modified, contain customary restrictive covenants requiring the Company to maintain certain financial ratios and places limitations on guarantees, subsidiary borrowings and cash distributions. In March 1999, the Company repurchased two issues of debt. On March 26, the Company repurchased $200,000 floating-rate notes, which were originally due April 2011. These notes were to be remarketed in April 1999 as fixed-rate notes. The Company chose to refinance with commercial paper to maintain floating-rate exposure. The purchase price was $200,000 plus a premium of approximately $22,185 and accrued interest resulting in an extraordinary after tax loss of $14,148. On March 31, the Company repurchased $143,750 of ECI convertible debentures, which were originally due December 2004. This repurchase was effected by a change-of-control clause allowing the holders to put the bonds back to the Company after the acquisition of ECI. The purchase price was $143,750 plus accrued interest and resulted in an extraordinary gain of $25, 141 ($16,033 net of tax) relating to the unamortized premium reflecting the market valuation of the debentures at the date ECI merged with the Company. These debentures were also refinanced with commercial paper. 6. DERIVATIVES The Company has entered into various derivative financial instruments ("swap agreements") with high quality financial institutions to hedge potential exposures in interest and foreign exchange rates. The Company uses local currency borrowings in addition to these swap agreements to hedge the Company's net investment in foreign assets and to manage its mix of fixed and floating rate debt. The Company has procedures in place to monitor and control the use of derivatives and only enters into transactions with a limited group of creditworthy financial institutions. The Company does not engage in derivative transactions for speculative or trading purposes, nor is it a party to leveraged derivatives. Excluding $183,580 of debt related to the Company's lending activities, the Company's debt outstanding at September 30, 1999 had a weighted average interest rate of 6.50% compared to a weighted average interest rate of 6.77% at December 31, 1998. After giving consideration to the interest rate and the cross-currency interest rate swap agreements, the weighted average interest rate at September 30, 1999 was 5.92% compared to 6.16% at December 31, 1998. The financial instruments associated with the 5.92% weighted average interest rate at September 30, 1999, consisted of approximately 58% of fixed interest rate debt at a weighted average interest rate of 6.19% and approximately 42% of floating interest rate debt at a weighted average interest rate of 5.54%. After inclusion of the swap agreements, approximately $1,843 of the Company's indebtedness was foreign-denominated. 10 11 The net fair value of the swap agreements at September 30, 1999, was an asset of $101,100 ($97,944 at December 31, 1998). Fair values were obtained from the counterparties to the agreements and represent their estimate of the amount the Company would pay or receive to terminate the swap agreements based upon the existing terms and current market conditions. 7. RATIO OF EARNINGS TO FIXED CHARGES Nine months ended September 30, 1999 1998 ---------------------------------------- 2.15 3.88 For purposes of computing the ratio of earnings to fixed charges, earnings consist of income before income taxes and extraordinary gain; (1) less undistributed income of equity investees which are less than 50% owned, (2) plus the minority interest of majority-owned subsidiaries with fixed charges and (3) plus fixed charges (excluding capitalized interest). Fixed charges consist of interest expense, whether capitalized or expensed, amortization of debt costs, and one-third of rental expense which the Company considers representative of the interest factor in the rentals. The decrease in the Company's ratio of earnings to fixed charges in 1999 is attributable to the $89,884 pretax restructuring charge recorded during the first quarter of 1999 (see note 10) and increased interest expense related to additional indebtedness attributable to business acquisitions consummated subsequent to September 30, 1998. Without the restructuring charge, the ratio of earnings to fixed charges would have been 2.59. 8. SEGMENT REPORTING The Company manages its operations based on service and geography. The Company's primary reportable operating segments presented below are based on services and include funeral, cemetery, and insurance operations. The Company's geographic segments include North America, France, Other Europe and Other Foreign. The Company conducts funeral operations in all geographical regions, cemetery operations in all regions except France, and insurance operations in North America and France. The Company's reportable segment information was as follows:
Reportable Funeral Cemetery Insurance Segments - ----------------------------------------------------------------------------------------------------------------------- Revenues from external customers: Three months ended September 30, 1999 ...................................................... $ 469,138 $ 233,837 $ 68,654 $ 771,629 1998 ...................................................... 433,276 213,369 60,570 707,215 Nine months ended September 30, 1999 ...................................................... $1,526,957 $ 742,863 $ 224,850 $2,494,670 1998 ...................................................... 1,351,603 636,138 98,888 2,086,629 - ----------------------------------------------------------------------------------------------------------------------- Gross profit: Three months ended September 30, 1999 ...................................................... $ 64,736 $ 56,549 $ 4,891 $ 126,176 1998 ...................................................... 85,253 78,248 7,568 171,069 Nine months ended September 30, 1999 ...................................................... $ 278,531 $ 218,370 $ 22,444 $ 519,345 1998 ...................................................... 308,622 250,365 11,400 570,387 - -----------------------------------------------------------------------------------------------------------------------
11 12 The following table reconciles reportable segment gross profit to the Company's consolidated income before income taxes and extraordinary gain:
Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 - -------------------------------------------------------------------------------------------------------------------- Gross profit reportable segments ............................ $ 126,176 $ 171,069 $ 519,345 $ 570,387 Other financial services income from operations .... 2,469 2,637 7,756 7,137 General and administrative expenses ................ (19,322) (15,422) (55,839) (49,681) Restructuring charge (see note 10) ................. -- -- (89,884) -- --------------------------------------------------- Income from operations ...................................... 109,323 158,284 381,378 527,843 Interest expense ................................... (59,404) (47,816) (173,613) (125,990) Other income ....................................... (334) 18,087 27,034 35,266 --------------------------------------------------- Income before income taxes and extraordinary gain ........... $ 49,585 $ 128,555 $ 234,799 $ 437,119 ===================================================
The Company's geographic segment information was as follows:
North Other Other America France Europe Foreign Total - ---------------------------------------------------------------------------------------------------------------------------------- Revenues from external customers: Three months ended September 30, 1999 ............................................ $ 534,991 $ 122,645 $ 69,673 $ 49,536 $ 776,845 1998 ............................................ 471,295 147,970 62,018 31,237 712,520 Nine months ended September 30, 1999 ............................................ $1,721,566 $ 432,553 $ 230,538 $ 126,480 $2,511,137 1998 ............................................ 1,387,985 446,063 188,032 79,514 2,101,594 - ---------------------------------------------------------------------------------------------------------------------------------- Income from operations before restructuring charge (see note 10): Three months ended September 30, 1999 ............................................ $ 81,356 $ 8,363 $ 4,587 $ 15,017 $ 109,323 1998 ............................................ 123,072 21,324 2,857 11,031 158,284 Nine months ended September 30, 1999 ............................................ $ 366,532 $ 44,087 $ 26,920 $ 33,723 $ 471,262 1998 ............................................ 432,031 52,206 22,287 21,319 527,843 - ---------------------------------------------------------------------------------------------------------------------------------- Income from operations: Three months ended September 30, 1999 ............................................ $ 81,356 $ 8,363 $ 4,587 $ 15,017 $ 109,323 1998 ............................................ 123,072 21,324 2,857 11,031 158,284 Nine months ended September 30, 1999 ............................................ $ 313,467 $ 23,220 $ 13,758 $ 30,933 $ 381,378 1998 ............................................ 432,031 52,206 22,287 21,319 527,843 - ---------------------------------------------------------------------------------------------------------------------------------- Operating locations at September 30: 1999 ............................................ 2,292 1,236 835 182 4,545 1998 ............................................ 1,837 1,200 782 161 3,980 - ----------------------------------------------------------------------------------------------------------------------------------
12 13 Included in the North America figures above are the following United States amounts:
Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 - -------------------------------------------------------------------------------------------------------------------- Revenues from external customers ........................... $ 515,700 $ 452,365 $1,661,179 $1,328,336 Income from operations before restructuring charge.......... $ 78,204 $ 119,173 $ 353,654 $ 417,327 Income from operations ..................................... $ 78,204 $ 119,173 $ 301,546 $ 417,327 Operating locations ........................................ -- -- 2,141 1,680 =====================================================================================================================
9. EARNINGS PER SHARE A reconciliation of the numerators and denominators of the basic and diluted earnings per share computations are presented below:
Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 - --------------------------------------------------------------------------------------------------------------- Income (numerator): Income before extraordinary gain - basic ........... $ 32,055 $ 83,213 $149,951 $282,947 After tax interest on convertible debentures ....... 82 392 408 1,162 -------- -------- -------- -------- Income before extraordinary gain - diluted ......... $ 32,137 $ 83,605 $150,359 $284,109 - --------------------------------------------------------------------------------------------------------------- Shares (denominator): Shares - basic ..................................... 272,060 257,380 272,354 255,673 Stock options and warrants .................. 267 3,959 897 4,515 Convertible debentures ...................... 752 2,077 1,117 2,120 -------- -------- -------- -------- Shares - diluted ................................... 273,079 263,416 274,368 262,308 - --------------------------------------------------------------------------------------------------------------- Earnings per share before extraordinary gain: Basic .............................................. $ .12 $ .32 $ .55 $ 1.11 Diluted ............................................ $ .12 $ .32 $ .55 $ 1.08 - ---------------------------------------------------------------------------------------------------------------
10. RESTRUCTURING CHARGE During the first quarter of 1999, the Company recorded a pretax restructuring charge of $89,884, related to a cost rationalization program initiated in 1999. The $89,884 charge relates to the following: (1) severance costs of $56,757; (2) a charge of $19,123 for terminated projects representing costs associated with certain construction projects that have been cancelled ($2,153) and costs associated with acquisition due diligence which will no longer be pursued ($16,970); (3) a $7,245 charge for business and facility closures, primarily in the Company's European operations; and (4) a remaining charge of $6,759 consisting of various other cost initiatives. The $56,757 for severance costs is related to the termination of five executive contractual relationships and the involuntary termination of approximately 100 employees in North America (of which approximately 20 were located in the corporate office), 600 employees in France, 85 employees in Other European operations and 10 employees in other foreign operations. The positions terminated were both operational and administrative in nature and the severance costs are expected to be paid out over the next 6 to 12 months. The severance costs related to the executive contractual relationships will be paid out according to the terms of the respective agreements and will extend through 2005. At September 30, 1999, approximately $24,867 remained in accrued liabilities, of which $23,838 related to severance costs and $1,029 related to cancellation fees and remaining non-cancellable payments on operating leases. During the three months ended September 30, 1999, the Company made payments totaling $3,345 relating to severance and $519 relating to cancellation fees and non-cancellable leases. 13 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT AVERAGE SALES PRICES, PER SHARE AMOUNTS, AND NUMBER OF LOCATIONS) OVERVIEW: The Company is the largest funeral and cemetery Company in the world conducting funeral services and cemetery operations in 20 countries on five continents. The Company's largest markets are North America and France, which when combined, represent approximately 78% of the Company's total operating locations, and approximately 86% of the Company's total revenues. The majority of the Company's funeral service locations and cemeteries are managed in groups called clusters. Clusters are established primarily in metropolitan areas to take advantage of operational efficiencies, particularly the sharing of service personnel, vehicles, preparation services, clerical staff and certain building facility costs. Personnel costs, the largest operating expense for the Company, is the cost component most beneficially affected by clustering. The sharing of employees, as well as the other costs mentioned, allow the Company to more efficiently utilize its operating facilities. The funeral service locations and cemetery operations consist of the Company's funeral homes, cemeteries, crematoria and related businesses. Both funeral service locations and cemeteries can contain crematoria facilities. The Company has approximately 167 combination facilities in which a funeral service location is contained within a cemetery. The financial services segment represents a combination of the Company's insurance operations primarily related to the funding of prearranged funeral contracts, prearranged funeral and cemetery trust administration, investment management and lending activities providing capital financing for independent funeral home and cemetery operations. RESULTS OF OPERATIONS: The following is a discussion of the Company's results of operations for the three and nine month periods ended September 30, 1999 and 1998. For purposes of this discussion, funeral homes, cemeteries and crematoria owned and operated before January 1, 1998, are referred to as comparable operations. Correspondingly, operations acquired or opened after January 1, 1998, are referred to as acquired operations. THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1998 For the quarter ended September 30, 1999, the Company reported revenues of $776,845, representing a 9.0% increase compared to $712,520 for the third quarter of 1998. Gross profit in the third quarter of 1999 decreased 25.9% to $128,645, compared to $173,706 in the same period of 1998. For the three months ended September 30, 1999 the Company reported net income of $32,055 and diluted earnings per share of $.12 ($.12 basic). The Company reported net income of $83,213 and diluted earnings per share of $.32 ($.32 basic) for the third quarter of 1998. 14 15 Results for the Company's three lines of business were as follows:
Three months ended September 30, Increase % Increase 1999 1998 (Decrease) (% Decrease) ------------------------------------------------------------------ Revenues: Funeral .................... $469,138 $433,276 $ 35,862 8.3% Cemetery ................... 233,837 213,369 20,468 9.6 Financial services ......... 73,870 65,875 7,995 12.1 -------- -------- -------- $776,845 $712,520 $ 64,325 9.0% ======== ======== ======== Gross profit and margin percentage: Funeral .................... $ 64,736 13.8% $ 85,253 19.7% $(20,517) (24.1)% Cemetery ................... 56,549 24.2 78,248 36.7 (21,699) (27.7) Financial services ......... 7,360 10.0 10,205 15.5 (2,845) (27.9) -------- -------- -------- $128,645 16.6% $173,706 24.4% $(45,061) (25.9)% ======== ======== ========
THE FOLLOWING FACTORS CONTRIBUTED TO THE RESULTS FOR THE THIRD QUARTER OF 1999: o Comparable funeral services performed by the Company's worldwide funeral service locations were 1.2% below comparable funeral services performed in the third quarter of 1998 primarily related to weakened death rates in France and United Kingdom. Comparable funeral services performed in the Company's North American funeral service locations in the third quarter of 1999 were equivalent to the comparable funeral services performed in the third quarter of 1998. o The average revenue per funeral service for all funeral service locations in North America was equivalent to the average revenue per funeral service in the third quarter of 1998. On a comparable location basis, the average revenue per funeral service in North America decreased approximately 1.0% when compared to the third quarter of 1998. In their respective local currencies, the average revenue per funeral service at comparable locations increased 3% in France and remained unchanged in the United Kingdom when compared to the third quarter of 1998. o Funeral service gross profit decreased 24.1% to $64.7 million in the third quarter of 1999 related to a 2.1% worldwide decrease in comparable funeral revenue, lower margins from acquired businesses in North America, increased infrastructure costs in areas of technology spending, higher personnel costs and higher amortization of deferred prearranged funeral acquisition costs. o Cemetery revenues increased 9.6% to $233.8 million primarily as a result of total North America preneed cemetery revenues increasing approximately $11.5 million to $126.5 million. Increases in preneed cemetery revenues in North America are primarily attributable to acquired cemetery properties. In comparable cemetery locations in North America, total preneed and atneed revenues decreased approximately 4% compared to the third quarter of 1998. o Cemetery gross profit decreased approximately 28% in the third quarter of 1999 related to weakened death rates, inclement weather conditions in the southeastern United States and the Company's continued strategic initiative to concentrate on the sale of heritage cemetery property. o Realized investment earnings and capital gains related to cemetery trust funds were $20,285 in the third quarter of 1999 compared to $17,236 for the same period of 1998. 15 16 FUNERAL Funeral revenues by geographic segment were as follows:
Three months ended September 30, Increase % Increase 1999 1998 (Decrease) (% Decrease) --------------------------------------------- North America ................. $270,199 $234,880 $ 35,319 15.0% France ........................ 114,248 126,312 (12,064) (9.6) Other European ................ 61,921 56,629 5,292 9.3 Other Foreign ................. 22,770 15,455 7,315 4.7 -------- -------- -------- Total funeral revenues..... $469,138 $433,276 $ 35,862 8.3% ======== ======== ========
The increase in North American funeral revenues was primarily due to the January 1999 merger with ECI as well as revenues from other acquired locations. Revenues from acquired funeral service locations in the third quarter of 1999 were $48,435 compared to $8,154 in the third quarter of 1998. The decrease in French funeral revenue was primarily the result of a $10,484 decrease, or 9.1%, in revenues from comparable locations. The number of funeral services performed at comparable locations in France in the third quarter of 1999 decreased 2.8% compared to the same period of 1998, which the Company believes is primarily mortality driven as the Company's market share in France remained unchanged during the third quarter of 1999. The increase in Other European funeral revenue was the result of a $1,023 increase, or 2.2%, in revenues from comparable locations and a $4,124 increase in revenues from acquired locations. The increase in revenue from acquired locations reflects the Company's 1998 acquisitions growth in Continental Europe. The increase in Other Foreign funeral revenue is primarily the result of a $4,116 increase in acquired funeral operations in South America. Funeral gross profit and margin percentage were as follows:
Three months ended September 30, Increase % Increase 1999 % of Revenue 1998 % of Revenue (Decrease) (% Decrease) ------------------------------------------------------------------------------ North America ..................... $ 50,212 18.6% $59,254 25.3% $(9,042) (15.3)% France ............................ 4,949 4.3 17,609 13.9 (12,660) (71.9) Other European .................... 4,513 7.3 3,710 6.5 803 21.6 Other Foreign .................... 5,062 22.2 4,680 30.3 382 8.2 -------- ------- -------- Total gross profit and margin.. $ 64,736 13.8% $85,253 19.7% $(20,517) (24.1)% ======== ======= ========
The decrease in North American funeral gross profit and margin percentage was primarily the result of increases in operating expenses, coupled with flat comparable volumes and a slight decrease, 1.0%, in the average revenue per funeral service at comparable locations. The decrease in French funeral gross profit and margin percentage was primarily the result of decreased funeral services performed causing reduced profit due to the Company's fixed cost structure compounded by a delay of anticipated reengineering cost saving measures which are now expected to be fully implemented in early 2000. The increase in Other European gross profit and margin percentage is primarily due to acquired funeral service locations in Continental Europe. 16 17 CEMETERY Cemetery revenues by geographic segment were as follows:
Three months ended September 30, 1999 1998 Increase % Increase --------------------------------------------------- North America .................. $199,319 $192,198 $ 7,121 3.7% Other European ................. 7,752 5,389 2,363 43.8 Other Foreign .................. 26,766 15,782 10,984 69.6 -------- -------- -------- Total cemetery revenues..... $233,837 $213,369 $ 20,468 9.6% ======== ======== ========
The increase in North American cemetery revenues was primarily the result of a $22,079 increase in revenues from acquired locations and an increase of $3,049 in realized investment earnings and capital gains from cemetery trust funds, partially offset by a decrease of $16,600 of cemetery revenues from comparable North American operations (which consists of preneed and atneed sales and proceeds from the sale of undeveloped cemetery property). The increase in Other European cemetery revenues is primarily due to a $1,882 increase in revenues from acquired locations. The increase in Other Foreign cemetery revenues was primarily the result of revenue increases from the Company's acquired South American cemetery operations. Cemetery gross profit and margin percentage were as follows:
Three months ended September 30, Increase % Increase 1999 % of Revenue 1998 % of Revenue (Decrease) (% Decrease) ------------------------------------------------------------------------------ North America ........................ $44,909 22.5% $ 70,481 36.7% $(25,572) (36.3)% Other European ....................... 1,685 21.7 1,416 26.3 269 19.0 Other Foreign ........................ 9,955 37.2 6,351 40.2 3,604 36.2 ------- -------- -------- Total gross profit and margin.. $56,549 24.2% $ 78,248 36.7% $(21,699) (27.7)% ======= ======== ========
The decrease in North American cemetery gross profit and margin percentage was primarily the result of weakened death rates, inclement weather conditions in the southeastern United States, and increased property costs and commissions expenses related to strategic initiatives to concentrate on the sale of heritage cemetery property. The Company believes the sale of heritage cemetery property such as lots, lawn crypts, and mausoleums spaces will assist in increasing market share in its cemetery operations. Heritage sales are cemetery contracts, including interment spaces, with new property owners which can usually be expected to lead to additional future merchandise sales, additional new property sales based on referrals, and sales of prearranged and atneed funerals, especially at funeral and cemetery combination operations. The increase in Other Foreign cemetery gross profit was primarily the result of increases in gross profit from the Company's acquired South American cemetery operations. 17 18 FINANCIAL SERVICES Financial services revenues were as follows:
Three months ended September 30, Increase % Increase 1999 1998 (Decrease) (% Decrease) -------------------------------------------------------- Insurance: North America ....................... $ 60,257 $ 38,912 $ 21,345 54.9% France .............................. 8,397 21,658 (13,261) (61.2) -------- -------- -------- Total insurance .......................... 68,654 60,570 8,084 13.3 Lending subsidiary ....................... 5,216 5,305 (89) (1.7) -------- -------- -------- Total financial services revenues ... $ 73,870 $ 65,875 $ 7,995 12.1% ======== ======== =======
Financial services gross profit and margin percentage were as follows:
Three months ended September 30, 1999 % of Revenue 1998 % of Revenue (Decrease) (% Decrease) ------------------------------------------------------------------------------ Insurance: North America.................. $ 1,478 2.5% $ 3,853 9.9% $(2,375) (61.6)% France......................... 3,413 40.6 3,715 17.2 (302) (8.1) --------- ------- ------- Total insurance .................. 4,891 7.1 7,568 12.5 (2,677) (35.4) Lending subsidiary ............... 2,469 47.3 2,637 49.7 (168) (6.4) --------- ------- ------- Total gross profit and margin.. $ 7,360 10.0% $10,205 15.5% $(2,845) (27.9)% ========= ======= =======
The increase in North American insurance revenues is primarily due to the growth of AML since its acquisition by the Company, effective July 1998. This growth is attributed to the Company's initiative of funding prearranged funeral contracts, to the extent possible, through AML. The decrease in gross profit and margin percentage is the result of increased costs from information technology and overhead costs related to the increased utilization of AML by the Company to fund prearranged funeral contracts. The decrease in French insurance revenues is primarily due to a realized loss from a repositioning of the investment portfolio during the quarter. The gross profit and margin percentage for French insurance was only slightly impacted due to French regulatory requirements providing a related significant decrease in costs. The Company's lending subsidiary reported a gross profit of $2,469 for the three months ended September 30, 1999, compared to $2,637 for the same period in 1998. The average outstanding loan portfolio during the current period increased to $244,571 compared to $229,408 in 1998, however, the average interest rate spread decreased to 2.4%, compared to 3.3% in 1998. OTHER INCOME AND EXPENSES General and administrative expenses increased $3,900 to $19,322, compared to in the third quarter of 1998. The increase was related to increased professional fees related to ongoing cost rationalization programs and information technology costs related to the Company's year 2000 preparation. Expressed as a percentage of revenues, general and administrative expenses were 2.5% for the three months ended September 30, 1999, compared to 2.2% for the comparable period in 1998. Interest expense increased $11,588 or 24.2% in the third quarter of 1999 compared to the same period of 1998. The increased interest expense primarily reflects the Company's funding of acquisitions with debt subsequent to the third quarter of 1998. Other income primarily consists of gains and losses from the sales of businesses that are disposed of for strategic or government mandated purposes. In the third quarter of 1999, the Company recorded an approximate $7.1 million loss related to the sale of cemetery operations in the state of Wisconsin as a result of a judicial interpretation of state law. The Company recorded net gains from the sales of business of approximately $14.6 million in the third quarter of 1998. 18 19 The provision for income taxes reflected a 35.4% effective tax rate for the three months ended September 30, 1999, compared to a 35.3% effective tax rate for the comparable period in 1998. The slight increase in the effective tax rate is due primarily to the non-deductibility of increased names and reputations associated with the Company's merger with ECI. NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998 Results for the Company's three lines of business were as follows:
Nine months ended September 30, Increase % Increase 1999 1998 (Decrease) (% Decrease) ------------------------------------------------------------------------- Revenues: Funeral..................... $1,526,957 $1,351,603 $175,354 13.0% Cemetery.................... 742,863 636,138 106,725 16.8 Financial services.......... 241,317 113,853 127,464 112.0 ---------- ---------- -------- $2,511,137 $2,101,594 $409,543 19.5% ========== ========== ======== Gross profit and margin percentage: Funeral..................... $ 278,531 18.2% $ 308,622 22.8% $(30,091) (9.8)% Cemetery.................... 218,370 29.4 250,365 39.4 (31,995) (12.8) Financial services.......... 30,200 12.5 18,537 16.3 11,663 62.9 ---------- ---------- -------- $ 527,101 21.0% $ 577,524 27.5% $(50,423) (8.7)% ========== ========== ========
FUNERAL Funeral revenues by geographic segment were as follows:
Nine months ended September 30, Increase % Increase 1999 1998 (Decrease) (% Decrease) ----------------------------------------------------------------- North America ..................... $ 887,937 $ 752,150 $135,787 18.0% France .......................... 378,306 386,087 (7,781) (2.0) Other European .................... 204,527 170,411 34,116 20.0 Other Foreign ..................... 56,187 42,955 13,232 30.8 ---------- ---------- -------- Total funeral revenues.... $1,526,957 $1,351,603 $175,354 13.0% ========== ========== ========
The increase in North American funeral revenues was the result of increased revenues from acquired locations, primarily due to the January 1999 merger with ECI. Funeral revenues from comparable locations in North America of $721,975 was equivalent to comparable funeral revenues in the same period of 1998 primarily due to flat funeral services performed period over period. The decrease in French funeral revenues was the result of a slight decrease in the number of funerals performed in France and a negative impact of approximately $6,000 related to the French franc to US dollar currency exchange rate. The increase in Other European funeral revenues was the result of a $8,411, or 5.6%, increase in revenues from comparable locations and a $26,070 increase in revenues from acquired locations. The growth in comparable revenue is primarily due to a 6.6% increase in comparable revenue reported by the Company's United Kingdom funeral operations. The growth in revenues reported by acquired locations is primarily the result of acquisitions in Continental Europe. The increase in Other Foreign funeral revenues was the result of a $9,843 increase in revenues at acquired locations. The increase in revenues at acquired locations was primarily due to an increase in the number of funerals performed at the 19 20 Company's South American funeral service locations coupled with increases in comparable funeral revenues in the Pacific Rim. Funeral gross profit and margin percentage were as follows:
Nine months ended September 30, Increase % Increase 1999 % of Revenue 1998 % of Revenue (Decrease) (% Decrease) -------------------------------------------------------------------------- North America ............................. $210,381 23.7% $231,706 30.8% $(21,325) (9.2)% France..................................... 33,845 8.9 44,659 11.6 (10,814) (24.2) Other European ............................ 24,263 11.9 22,457 13.1 1,806 8.0 Other Foreign ............................. 10,042 17.9 9,800 22.8 242 2.5 -------- -------- -------- Total gross profit and margin.......... $278,531 18.2% $308,622 22.8% $(30,091) (9.8)% ======== ======== ========
The decrease in North American funeral gross profit and margin percentage was primarily the result of increases in operating expenses at both comparable and acquired locations. Comparable locations experienced increases in operating expenses, coupled with flat funeral service volumes and average revenue per funeral service. The decline in comparable funeral gross profit was partially offset by acquired locations added in the January 1999 merger with ECI. The decrease in French funeral gross profit and margin percentage was primarily the result of decreased funeral services performed causing reduced profit due to the Company's fixed cost structure compounded by a delay of anticipated reengineering cost saving measures in the third quarter of 1999 which are now expected to be fully implemented in early 2000. CEMETERY Cemetery revenues by geographic segment were as follows:
Nine months ended September 30, 1999 1998 Increase % Increase ----------------------------------------------------------------- North America ..................... $646,559 $581,958 $ 64,601 11.1% Other European .................... 26,011 17,621 8,390 47.6 Other Foreign,..................... 70,293 36,559 33,734 92.3 -------- -------- -------- Total cemetery revenues......... $742,863 $636,138 $106,725 16.8% ======== ======== ========
The increase in North American cemetery revenues was the result of a $12,527 increase in revenues from comparable locations (which consists of preneed and atneed sales and sales of undeveloped cemetery property) and a $65,970 increase in revenues from acquired locations primarily due to the merger in January 1999 with ECI. Partially offsetting these increases was a $11,057 reduction in realized investment earnings and capital gains from cemetery trust funds. Other European cemetery revenues increased due to continued growth in Continental Europe. Revenues from the Company's Belgium and Netherlands cemetery operations increased $4,412 in 1999, primarily as a result of acquisitions. The increase in Other Foreign cemetery revenues was primarily the result of revenue increases from additional South America cemetery operations acquired in December 1998. 20 21 Cemetery gross profit and margin percentage were as follows:
Nine months ended September 30, Increase % Increase 1999 % of Revenue 1998 % of Revenue (Decrease) (% Decrease) -------------------------------------------------------------------------- North America ............................ $186,668 28.9% $232,972 40.0% $(46,304) (19.9)% Other European ........................... 8,021 30.8 5,874 33.3 2,147 36.6 Other Foreign............................. 23,681 33.7 11,519 31.5 12,162 105.6 -------- -------- -------- Total gross profit and margin....... $218,370 29.4% $250,365 39.3% $(31,995) (12.8)% ======== ======== ========
The decrease in North American cemetery gross profit and margin percentage was primarily the result of increases in property costs and commission expenses as a result of heritage cemetery property sales initiatives and reductions in realized investment earnings and capital gains from cemetery trust funds. The increase in Other Foreign cemetery gross profit and margin percentage was primarily the result of increases in gross profit from the Company's acquired South America cemetery operations. FINANCIAL SERVICES Financial services revenues were as follows:
Nine months ended September 30, Increase % Increase 1999 1998 (Decrease) (% Decrease) ----------------------------------------------------------------- Insurance: North America ....................... $170,603 $ 38,912 $131,691 338.4% France............................... 54,247 59,976 (5,729) (9.6) -------- -------- -------- Total insurance......................... 224,850 98,888 125,962 127.4 Lending subsidiary ..................... 16,467 14,965 1,502 10.0 -------- -------- -------- Total financial services revenues.. $241,317 $113,853 $127,464 112.0% ======== ======== ========
Financial services gross profit and margin percentage were as follows:
Nine months ended September 30, 1999 % of Revenue 1998 % of Revenue Increase % Increase ------------------------------------------------------------------------------- Insurance: North America .................. $ 12,202 7.2% $ 3,853 9.9% $ 8,349 216.7% France ......................... 10,242 18.9 7,547 12.6 2,695 35.7 -------- ------- ------- Total insurance ................... 22,444 10.0 11,400 11.5 11,044 96.9 Lending subsidiary ................ 7,756 47.1 7,137 47.7 619 8.7 -------- ------- ------- Total gross profit and margin.. $ 30,200 12.5% $18,537 16.3% $11,663 62.9% ======== ======= =======
The increase in North American insurance revenues and gross profit is primarily due to the acquisition of AML effective July 1998. The decrease in French insurance revenues is due to decreased investment income related to a repositioning of the investment portfolio. The gross profit and margin percentage for French insurance did not experience similar losses due to French regulatory requirements providing a related significant decrease in costs. The Company's third party lending subsidiary reported a gross profit of $7,756 for the nine months ended September 30, 1999, compared to $7,137 for the same period in 1998. The average outstanding loan portfolio during the current period increased to $267,705 compared to $218,475 in 1998, however, the average interest rate spread decreased to 2.6%, compared to 3.2% in 1998. 21 22 OTHER INCOME AND EXPENSES General and administrative expenses increased $6,158 to $55,839, compared to the nine months ended September 30, 1998. The increase primarily relates to increased professional expenses related to ongoing cost rationalization programs and information technology costs related to the Company's Year 2000 preparation. Expressed as a percentage of revenues general and administrative expenses were 2.2% for the nine months ended September 30, 1999, compared to 2.4% for the comparable period in 1998. Interest expense increased 37.8% or $47,623 in the nine months ended September 30, 1999, compared to the same period of 1998. The increased interest expense primarily reflects the Company's funding of acquisitions with debt subsequent to the third quarter 1998. Other income primarily consist of gains and losses from the sales of businesses that are disposed of for strategic or government mandated purposes. In the third quarter of 1999, the Company recorded an approximate $7.1 million loss related to the sale of cemetery operations in the state of Wisconsin as result of a judicial interpretation of state law. The provision for income taxes reflected a 36.1% effective tax rate for the nine months ended September 30, 1999, compared to a 35.3% effective tax rate for the comparable period in 1998. The increase in the effective tax rate is due primarily to the non-deductibility of increased names and reputations associated with the Company's merger with ECI. During the first quarter 1999, the Company recorded a pretax restructuring charge of $89,884, related to a cost rationalization program initiated in 1999. At September 30, 1999, approximately $24,867 remained in accrued liabilities, of which $23,838 related to severance costs and $1,029 related to cancellation fees and remaining non-cancelable payments on operating leases. Payments of these accrued liabilities will occur through 2005. The Company does not expect these payments will have a significant effect on its liquidity or financial position. The effect of the cost rationalization program, coupled with other cost reduction initiatives, is expected to produce future annualized cost savings of at least $60,000, on a pretax basis, primarily through the reduction of personnel and facility costs. FINANCIAL CONDITION AND LIQUIDITY AT SEPTEMBER 30, 1999: General The Company is currently pursuing a strategy to reduce debt, improve cash flows and generate improved returns on invested capital. Key initiatives include (i) operational improvement resulting from strategic revenue and marketing initiatives combined with cost-improvement programs through business reengineering; (ii) working capital improvement through accelerated cash receipts expected from the Company's recently announced consumer financing program related to the Company's atneed funeral and atneed and preneed cemetery activities; (iii) disposition of selected operating businesses and certain non-core assets; (iv) limiting the Company's acquisition program; (v) reduction of capital expenditures; and (vi) suspension of the cash dividend on the Company's common stock. Management believes that these initiatives will improve cash flows and result in debt reduction in the range of $200,000 to $400,000 by the end of 2000. Historically, the Company had funded its working capital needs and capital expenditures primarily through cash provided by operating activities and borrowings under bank revolving credit agreements and commercial paper. Funding required for the Company's acquisition program has been generated through public and private offerings of debt and the issuance of equity securities supplemented by the Company's revolving credit agreements and additional securities registered with the Securities and Exchange Commission. In January 1999, the Company merged with ECI in a stock-for-stock transaction in which ECI shareholders received approximately 15,501 shares of Company common stock valued at approximately $557,000 and approximately 1,200 options to purchase Company common stock valued at approximately $8,628. In connection with the merger, the Company assumed approximately $310,000 of ECI indebtedness. The ECI merger added 359 funeral homes and 80 cemeteries in North America. Excluding the ECI transaction, for the nine-month period ended September 30, 1999, the Company acquired 72 funeral service locations, 15 cemeteries and 2 crematoria for an aggregate purchase price of approximately $89,700. As of October 21, 1999, the Company had received signed letters of intent to acquire an additional 3 funeral service locations for an aggregate purchase price of approximately $12,400. Combined, these businesses are expected to produce approximately 22 23 $56,700 in annualized revenues. The Company has significantly limited its acquisition program and is concentrating instead on key initiatives described above to replace operating profit growth historically generated through acquisitions without the outlay of significant additional capital. At September 30, 1999, the Company had net working capital of $304,277 and a current ratio of 1.39:1, compared to working capital of $578,755 and a current ratio of 1.92:1 at December 31, 1998. SOURCES AND USES OF CASH Cash flows from operating activities: Net cash provided by operating activities was $326,997 for the nine months ended September 30, 1999, compared to $255,938 for the same period in 1998, an increase of $71,059. Significant components of cash flow provided by operating activities for the nine months ended September 30, 1999 included: (1) net income adjusted for non-cash items, (2) the original $89,884 pretax restructuring provision (of which $24,867 remains at September 30, 1999, and the decrease is reflected through the change in payables and other liabilities), partially offset by (3) an increase in receivables of $181,753 primarily attributed to the sales of preneed cemetery products and services ($396,700 in North America for the nine months ended September 30, 1999) which are usually financed on an installment basis in excess of 12 months. In reference to the increase in receivables, the Company entered into a consumer financing agreement subsequent to the third quarter of 1999. The consumer financing program has been designed to be consumer-friendly to the Company's client families and is non-recourse to the Company. After national implementation of the consumer financing program in the United States, the program is expected to improve cash flows from funeral and cemetery operations. Cash flows from investing activities: Net cash used in investing activities was $378,064 for the nine months ended September 30, 1999, compared to $801,518 for the same period in 1998, a decrease in the use of cash of $423,454. Significant components of cash used in investing activities for the nine months ended September 30, 1999 included $160,998 in capital expenditures and approximately $148,162 of purchases in excess of sales of securities at the Company's insurance subsidiaries. One of the subsidiaries had an approximate $80,000 cash position at December 31, 1998, in which a significant portion of the excess cash was used to purchase securities. Cash flows from financing activities: Net cash used in financing activities was $101,306 for the nine months ended September 30, 1999, compared to net cash provided by financing activities of $615,683 for the same period in 1998. The $615,683 includes $500,000 of proceeds from the issuance of long-term debt. Significant components of cash used in financing activities for the nine months ended September 30, 1999, included $365,936 for the early extinguishment of certain floating rate debt and the ECI convertible debentures, as well as $160,254 to repay other debt assumed in connection with the ECI merger. As of September 30, 1999, the Company's debt to capitalization ratio was 53% compared to 55% at December 31, 1998 (52% and 54%, respectively, excluding the Company's third party lending subsidiary). The interest coverage ratio for the nine months ended September 30, 1999, was 2.78:1 (excluding the 1999 restructuring charge of $89,884), compared to 4.29:1 for the same period in 1998. The Company expects adequate sources of funds to be available to conduct its future operations through internally generated funds, borrowings under credit facilities and the issuance of securities. As of September 30, 1999, the Company had approximately $530,000 of available borrowings under its primary revolving credit agreements. As of November 2, 1999, following the renewal and modification of the revolving credit agreements, the Company had approximately $239,000 of available borrowings under these facilities. As of September 30, 1999, the Company also had the ability to issue $900,000 in securities registered with the Commission under a shelf registration. In addition, 12,870 shares of common stock and a total of $187,000 of guaranteed promissory notes and convertible debentures are registered with the Commission under a separate shelf registration to be used exclusively for future acquisitions. 23 24 PREARRANGED FUNERAL ACTIVITIES The Company sells price guaranteed prearranged funeral contracts through various programs providing for future funeral services at prices prevailing when the contracts are signed. Payments under these contracts are placed into trust accounts or are used to pay premiums on life insurance or annuity contracts. Trust earnings and increasing insurance benefits are accrued and deferred until funeral services are performed, at which time, all funds are recognized in funeral revenue. Trust earnings and increasing insurance benefits are intended to cover future increases in the cost of providing a price guaranteed funeral service. The total value of unperformed prearranged funeral contracts includes contracts that are to be funded by trust, third party insurance companies, or the Company's insurance subsidiaries. The total value represents the original contract values plus any accumulated trust fund earnings or increasing insurance benefits. At September 30, 1999, the total value of unperformed prearranged funeral revenues expected to be recognized in future periods was $4,378,665 which is an approximate 17% increase over the December 31, 1998, balance of $3,751,850. Approximately 8% of the increase from December 31, 1998, relates to acquisitions and 16% of the increase relates to additional prearranged funeral contract sales, accumulated trust fund earnings and increasing insurance benefits. Such increases are offset primarily by maturities, which accounts for approximately 6%, as well as unfavorable foreign currency fluctuations of 1%. The Company's investment program targets a real return in excess of the amount necessary to cover future increases in the cost of providing a price guaranteed funeral services. The investment portfolio is allocated to the appropriate investments that more accurately match the anticipated maturity of the contracts. The Company's current asset allocation in its investment portfolio is approximately 50% equity and 37% fixed income with the remainder held in cash, cash equivalents and other investments. The sales of prearranged funeral contracts afford the Company the opportunity to protect both current market share as well as expand market share in certain markets. On a comparable basis, prearranged funeral services fulfilled as a percent of North American funerals performed was 28.7% for the nine months ended September 30, 1999, (26.3% for the nine months ended September 30, 1998) and is expected to increase over time. OTHER MATTERS: Year 2000 Issue - --------------- The Year 2000 issue, also known as "Y2K," refers to the inability of some computer programs and computer-based microprocessors to correctly interpret the century from a date in which the year is represented by only two digits (e.g., 98). As a result, on or before January 1, 2000, computer systems used by companies throughout the world may experience operating difficulties unless they are modified or upgraded to properly process date related information. The Y2K issue can arise at any point in a company's supply, manufacturing, processing, distribution, or financial chains. The Company has established Y2K program offices at its corporate offices in Houston, Texas and Birmingham, England. These program offices, under the direction of senior management, are responsible for advising and monitoring the numerous facets of the Company's Y2K preparations. The Company is utilizing internal personnel, contract programmers and testers, as well as other third party vendors, to identify Y2K issues, test and implement the chosen solutions. In order to adequately address the Y2K issue, efforts have been directed to the following categories: production systems, networks, desktops, user developed applications, vendor supplied software, facilities and telecommunications, and the Company's supply chain. The following phases are common to all of these categories: inventory and determination of criticality; discovery to determine Y2K problems; and analysis to determine corrective action, correction, testing, and implementation. In addition to these activities, promotion of Y2K awareness and development of contingency plans are part of the Company's Y2K preparation effort. State of Readiness The majority of the Company's internal Y2K exposure exists at the corporate office locations where the accounting and processing of the Company's business transactions takes place. Individual operating locations (primarily funeral homes and cemeteries) are substantially technologically independent and thus face few Y2K risks from internal systems. 24 25 Production systems: All of the Company's critical production systems have been assessed for Y2K readiness. Of these, six systems have not progressed through all phases that the Company requires for Y2K readiness. During the third quarter of 1999, the Company determined that the full deployment of the newly developed proprietary funeral home and cemetery production systems to all of its North American operations could not feasibly be completed by December 31, 1999. Thus, interim Y2K compliant patches to the existing system have been developed and tested, and are being implemented at the remaining locations beginning November 15. Full implementation of the interim patches is expected to be completed by the middle of December. Testing of the Company's Y2K-ready payroll system in France is also nearing completion. However, production use of the new system will not begin until January 2000, as the existing system will be used for year-end 1999 tax reporting requirements. Four less critical systems are nearing the end of the correction, testing, and implementation phases and will be implemented by the middle of December 1999. Networks: All of the Company's critical computer networks have been assessed for Y2K readiness. Upgrades and replacements are substantially complete in North America and Australia. Critical networks for the Company's European operations are in the process of being upgraded or consolidated with the Company's North American infrastructure. All critical networks are expected to be Y2K ready by the end of November 1999. Desktops: Testing has been conducted to determine the extent to which the Y2K problem associated with desktops will affect the Company's ability to conduct business. As none of the Company's critical computer systems directly access date information from the desktop's real time clock, it has been determined that very few desktops will pose a critical Y2K issue. As part of ongoing technology refresh programs and new production systems' deployment, desktops are being upgraded, as needed, to better meet the Company's business needs. As part of contingency planning, personnel have been instructed on how to verify each desktop's date, and reset if necessary, after January 1, 2000. User developed applications: Inventory and discovery for items in this category have been achieved. Very few critical applications were found to have date dependencies. Those that have date dependencies continue to be tested to ensure no problems arise because of Y2K issues. As these applications often work in tandem with the Company's production systems, final testing and implementation has/will coincide with those systems. Vendor supplied software: It is the policy of the Company to query each manufacturer of critical "off-the-shelf" software to ascertain the vendor's statement regarding the Y2K readiness of their products. Once the vendor's statement is obtained, upgrades, replacements and testing are conducted to minimize the risk of Y2K issues arising from the software. The Company will continue to apply new software patches from third party vendors as they are reported necessary until November 1999, when all systems will be frozen from further modifications (unless currently unknown critical software patches are received) to prepare for the transition to the year 2000. Facilities and telecommunications: The Company recognizes the potential for Y2K issues to arise from embedded technology systems which may be in use at its numerous facilities. Telecommunications equipment has proven the most vulnerable, however, replacements and/or upgrades have been completed as necessary. Supply chain: Due to the Company's geographically dispersed locations and methods of operation, assessing the Y2K readiness of the Company's supply chain must occur at both the corporate level (for core supply chain relationships) and the local level (for those relationships unique to a location). Inventory and discovery have been completed at a number of operating locations and is completed at the Company's headquarters. Activities were undertaken to assign criticality to both corporate and local supply relationships and additional efforts have been made to ascertain the Y2K readiness of critical suppliers. Where the assessment raised concern about a critical supplier's Year 2000 preparations, contingency plans have been created. Costs The aggregate costs for the Company to achieve Y2K readiness are not expected to exceed $33 million of which $3.8 million represents lease payments which will be incurred from 2000-2002. All costs associated with Y2K readiness are expected to be funded from cash flows from operations. The Company's actual costs incurred associated with Y2K readiness through September 30, 1999, are estimated at $22.6 million, of which approximately $9.1 million has been expensed and approximately $13.5 million has been capitalized. Approximately $6.8 million of the estimated remaining expenditures will be expensed and 25 26 approximately $3.6 million will be capitalized. The capitalized expenditures represent new hardware and new enterprise software that introduces new functionality to the Company. In an effort to report material costs related to the Company's Y2K effort, the Company has adopted a policy of capturing all contractor expenses and internal costs for dedicated resources (those working exclusively on Y2K issues). As such, the Company acknowledges that there are many internal resources working part-time on Y2K-related issues for which no payroll or overhead costs are being reported. Risks and Contingency Plans: The majority of the Company's internal Y2K exposure exists at its corporate offices where the Company's production systems operate. The failure to correct a material Y2K problem at these locations could result in an interruption of certain normal corporate business activities. Such a failure would not, however, render the Company's various operating locations unable to deliver goods and services. The Company believes that the greatest risks continue to arise from the uncertainty of the Y2K readiness of critical third party suppliers, both private businesses and government entities, especially in the Company's international markets. The possible consequences of critical third party suppliers not being Y2K ready by January 1, 2000 could include temporary location closings, delays in the delivery of goods and services, delays in the receipt of goods and invoice and collection errors. Efforts made by the Company to ascertain the Y2K status of critical third party suppliers is expected to significantly reduce the Company's level of uncertainty in this arena and, through the use of contingency planning, the possibility of significant interruptions in normal operations should be reduced. At this time, the Company has no substantiated reason to believe that one or more key third party suppliers will not be able to meet their obligations to the Company after January 1, 2000. With respect to the systems controlled by the Company, the Company believes that the greatest risks exist with the two critical production systems that are not yet fully Y2K ready. If the interim Y2K compliant patches to the existing North American funeral home and cemetery production systems are not implemented at all locations that require them by December 15, 1999, contingency plans will be invoked. Under these plans, locations unable to process their own transactions will forward their data to another location with input capability. Because the first payroll processing date under the new system in France does not occur until the third week of January, the Company is confident that it will be able to identify and correct any significant items noted in its final testing during November and December. Should difficulties arise in the first payroll processing, contingency plans will be invoked to ensure that all French employees are adequately compensated. Because of the many uncertainties that exist, it is part of the Company's Y2K preparation that contingency plans be established for critical systems in each of the categories outlined above. Contingency planning is being approached both from an information technology perspective and from a business perspective. Information technology plans encompass each critical system and outline a course of action should a date related problem occur. Business plans encompass each critical business function and outline a course of action should a supporting computer system or infrastructure item not be available (i.e., electricity, phone service, etc.). Although these contingency plans are at different stages at the Company's various locations, contingency plans for all critical production systems and for all individual operating locations are in place or are expected to be in place by the end of December 1999. In addition to contingency plans, the Company has developed preliminary transition plans aimed at detailing operations immediately before and after the date change to 2000. These transition plans include procedures for establishing a Y2K Transition Command Center, backing-up critical files, shutting down non-essential processing, staffing, and emergency communications during the transition time period. These transition plans will be continuously updated and reviewed through the end of December 1999. Recent Accounting Pronouncements - -------------------------------- In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities-Deferral of the Effective Date of FASB Statement No. 133." 26 27 SFAS No. 137 defers the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. The Company plans to adopt SFAS No. 137 during the first quarter of the year ended December 31, 2001. Cautionary Statement on Forward-looking Statements - -------------------------------------------------- The statements contained in this filing on Form 10-Q that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be accompanied by words such as "believe," "estimate,""project,""expect," "anticipate," or "predict," that convey the uncertainty of future events or outcomes. These statements are based on assumptions that the Company believes are reasonable; however, many important factors could cause the Company's actual results in the future to differ materially from the forward-looking statements made herein and in any other documents or oral presentations made by, or on behalf of, the Company. Important factors which could cause actual results of the Company to differ materially from those in forward-looking statements include, among others, the following: 1) Changes in general economic conditions both domestically and internationally impacting financial markets (e.g. marketable security values, as well as currency and interest rate fluctuations) that could negatively affect the Company, especially the Company's anticipated cemetery trust revenues. 2) Changes in domestic and international political and/or regulatory environments in which the Company operates, including tax and accounting policies. Changes in regulations may impact the Company's ability to enter or expand new markets. 3) Changes in consumer demand and/or pricing for the Company's products and services caused by several factors, such as changes in local death rates, cremation rates, competitive pressures and local economic conditions. 4) The Company's ability to sell preneed heritage cemetery property which is usually associated with new customers to the Company's cemeteries. 5) The Company's ability to successfully integrate acquisitions into the Company's business and to realize expected cost savings in connection with such acquisitions. 6) The Company's ability to successfully implement certain cost reduction initiatives, including the cost reduction initiatives previously announced, as well as changes in domestic and international political and/or regulatory environments which could negatively effect the implementation of the Company's cost initiatives. 7) The Company's ability to successfully implement certain strategic revenue and marketing initiatives resulting in increased volume through its existing facilities and the Company's ability to successfully implement certain strategic cash flow initiatives, including the presently announced funeral and cemetery consumer financing program, which could improve or generate cash flow for the Company. 8) The Company's ability to successfully complete the disposition of selected operating businesses and certain non-core assets in order for the proceeds from such dispositions to assist in the reduction of the Company's debt. 9) The Company's ability to successfully leverage its substantial purchasing power with certain of the Company's vendors. 10) The ability of the Company, or its critical third-party suppliers, to adequately complete "Y2K" preparation efforts. "Y2K" refers to the inability of some computer programs and computer-based microprocessors to correctly interpret the century from a date in which the year is represented by only two digits. The Company assumes no obligation to publicly update or revise any forward-looking statements made herein or any other forward-looking statements made by the Company. 27 28 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK For information regarding the Company's exposure to certain market risks, see Item 7A, Quantitative and Qualitative Disclosures about Market Risk, in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. Except as noted below, there have been no material changes to the disclosure on this matter made in such Form 10-K. Cemetery Merchandise Trust Funds The cost and market value associated with the assets held in cemetery merchandise trust funds are stated below as of December 31, 1998, and September 30, 1999. The Company records a receivable due from cemetery merchandise trust funds which is included at cost in current and long-term receivables in the Company's consolidated balance sheet. The Company does not believe the unrealized loss at September 30, 1999, associated with the assets held in the cemetery merchandise trust funds is permanent in nature and therefore does not believe a related provision for impairment is necessary.
December 31, 1998 September 30, 1999 ------------------------ ------------------------ Cost Market Cost Market -------- -------- -------- -------- $662,564 $656,408 $795,518 $751,527
28 29 SERVICE CORPORATION INTERNATIONAL PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS Previously Reported Litigation. The following discussion describes certain litigation as of November 11, 1999, which was previously reported: Civil Action H-99-0280; In Re Service Corporation International; In the United States District Court for the Southern District of Texas, Houston Division ("the Consolidated Lawsuit"). The Consolidated Lawsuit is pending before Judge Lynn N. Hughes and includes all 21 class action lawsuits that were filed in the Southern District of Texas and two class action lawsuits that were originally brought in the United States District Court for the Eastern District of Texas, Lufkin Division. The Consolidated Lawsuit names as defendants the Company and three of the Company's current or former executive officers or directors: Robert L. Waltrip, L. William Heiligbrodt and George R. Champagne (the "Individual Defendants"). The plaintiffs have filed a Consolidated Class Action Complaint in the Consolidated Lawsuit alleging that defendants violated federal securities laws by making materially false and misleading statements and failing to disclose material information concerning SCI's preneed funeral business. The Consolidated Lawsuit seeks to recover an unspecified amount of monetary damages. Since the litigation is in its very preliminary stages, no discovery has occurred, and the Company cannot quantify its ultimate liability, if any, for the payment of damages. However, the Company believes that the allegations in the Consolidated Lawsuit do not provide a basis for the recovery of damages because the Company has made all required disclosures on a timely basis. The Company and the Individual Defendants have filed an Answer to the Consolidated Class Action Complaint, and the Company intends to aggressively defend this lawsuit. The Consolidated Lawsuit has been brought on behalf of all persons and entities who (i) acquired shares of Company common stock in the merger of a wholly owned subsidiary of Company into Equity Corporation International ("ECI"); (ii) purchased shares of Company common stock during the period July 17, 1998, through January 26, 1999 ("the Class Period"); (iii) purchased Company call options in the open market during the Class Period; (iv) sold Company put options in the open market during the Class Period; (v) held employee stock options in ECI; and (vi) held Company employee stock options granted during the Class Period. Excluded from the foregoing categories are the Individual Defendants, the members of their immediate families and all other persons who were directors or executive officers of the Company or its affiliated entities at any time during the Class Period. Judge Hughes has certified the Consolidated Lawsuit as a class action. 29 30 The Company and the Individual Defendants have filed a Motion to Dismiss the Consolidated Lawsuit, and the plaintiffs have filed their Opposition to Defendants' Motion to Dismiss the Consolidated Lawsuit. The Company and the Individual Defendants intend to file promptly a pleading in response to the plaintiffs' most recent filing. The foregoing pleadings will be considered by Judge Hughes in due course. Copies of the complaint in the Consolidated Lawsuit and the pleadings that have been filed in response thereto and that are referred to herein are filed as exhibits to this Quarterly Report on Form 10-Q. 9-99-CV58; Charles Fredrick v. Service Corporation International; In the United States District Court for the Eastern District of Texas, Lufkin Division. This additional securities fraud case has been brought against the Company by a former shareholder of ECI alleging causes of action exclusively under Texas statutory and common law. The Company has requested that the case be transferred to the Southern District of Texas to be consolidated with the Consolidated Lawsuit. Additional Litigation. On November 10, 1999, James P. Hunter, III and a related family trust filed a lawsuit against the Company, the Individual Defendants, two other officers, an employee of the Company and PricewaterhouseCoopers LLP, the Company's auditors, in state District Court in Angelina County, Texas ("State Litigation"). The plaintiffs allege, among other things, violations of Texas securities law and statutory and common law fraud, and seek unspecified compensatory and exemplary damages. Mr. Hunter is currently an employee of the Company and was Chairman, President and Chief Executive Officer of ECI at the time of its merger with a wholly-owned subsidiary of the Company. Since the litigation has only been recently initiated and no discovery has occurred, the Company cannot quantify its ultimate liability, if any, for the payment of damages. However, the Company believes that the allegations in the State Litigation, like those in the Consolidated Lawsuit, do not provide a basis for the recovery of damages because all required disclosures were made in a timely basis. The Company intends to aggressively defend this litigation. A copy of the Plaintiff's Original Petition in the State Litigation is filed as an exhibit to this Quarterly Report on Form 10-Q. Item 5. OTHER INFORMATION On November 11, 1999, the Company amended its Bylaws to add a new section, Section 10 of Article I, providing for advance notice of certain shareholder proposals to bring business before a shareholder meeting. Any shareholder desiring to bring business before the Company's 2000 Annual Meeting of Shareholders scheduled to be held on May 1, 2000 in a form other than a shareholder proposal in accordance with Rule 14a-8 of the rules and regulations of the Commission must give written notice that is received by the Company, addressed to the Secretary, no earlier than January 14, 2000, and no later than February 3, 2000. 30 31 A shareholder must also comply with other requirements as set forth in such advance notice provision. Any such notice should be addressed to the Secretary of the Company, 1929 Allen Parkway, P.O. Box 130548, Houston, Texas 77219-0548. Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 3.1 Bylaws, as amended. 12.1 Ratio of earnings to fixed charges for the nine months ended September 30, 1999 and 1998. 27.1 Financial data schedule. 99.1 Consolidated Class Action Complaint filed September 3, 1999 in Civil Action No. H-99-280, In re Service Corporation International. 99.2 Defendants' Answer to the Consolidated Class Action Complaint filed September 17, 1999 in Civil Action No. H-99-280, In Re Service Corporation International. 99.3 Defendants' Motion to Dismiss the Consolidated Class Action Complaint filed October 8, 1999 in Civil Action No. H-99-280, In re Service Corporation International. 99.4 Plaintiffs' Opposition to Defendants' Motion to Dismiss the Consolidated Class Action Complaint filed November 5, 1999 in Civil Action No. H-99-280, In Re Service Corporation International. 99.5 Plaintiff's Original Petition filed November 10, 1999 in Cause No. __________, James P. Hunter, III and James P. Hunter, III Family Trust v. Service Corporation International, Robert L. Waltrip, L. William Heiligbrodt, George R. Champagne, W. Blair Waltrip, James M. Shelger, Wesley T. McRae and PriceWaterhouseCoopers, L.L.P.; in the __________ Judicial District Court of Angelina County, Texas. (b) Reports on Form 8-K There were no reports on Form 8-K during the quarter ended September 30, 1999. 31 32 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. November 12, 1999 SERVICE CORPORATION INTERNATIONAL By: /s/ George R. Champagne ---------------------------------- George R. Champagne Executive Vice President Chief Financial Officer (Principal Financial Officer) 32 33 INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION - ------- ----------- 3.1 Bylaws, as amended. 12.1 Ratio of earnings to fixed charges for the nine months ended September 30, 1999 and 1998. 27.1 Financial data schedule. 99.1 Consolidated Class Action Complaint filed September 3, 1999 in Civil Action No. H-99-280, In re Service Corporation International. 99.2 Defendants' Answer to the Consolidated Class Action Complaint filed September 17, 1999 in Civil Action No. H-99-280, In Re Service Corporation International. 99.3 Defendants' Motion to Dismiss the Consolidated Class Action Complaint filed October 8, 1999 in Civil Action No. H-99-280, In re Service Corporation International. 99.4 Plaintiffs' Opposition to Defendants' Motion to Dismiss the Consolidated Class Action Complaint filed November 5, 1999 in Civil Action No. H-99-280, In Re Service Corporation International. 99.5 Plaintiff's Original Petition filed November 10, 1999 in Cause No. __________, James P. Hunter, III and James P. Hunter, III Family Trust v. Service Corporation International, Robert L. Waltrip, L. William Heiligbrodt, George R. Champagne, W. Blair Waltrip, James M. Shelger, Wesley T. McRae and PriceWaterhouseCoopers, L.L.P.; in the __________ Judicial District Court of Angelina County, Texas. EX-3.1 2 BYLAWS 1 EXHIBIT 3.1 BYLAWS OF SERVICE CORPORATION INTERNATIONAL SHAREHOLDERS ARTICLE I Section 1. Annual Meeting. The annual meeting of shareholders shall be held on the second Thursday in May of each year at ten o'clock in the morning, if not a legal holiday, and, if a legal holiday, then on the next succeeding business day, for the purpose of electing directors. Any business may be transacted at an annual meeting, except as otherwise provided by law or by these bylaws. The Board of Directors may alter or postpone the time of holding the annual meeting of shareholders as they shall deem advisable. Section 2. Special Meeting. A special meeting of shareholders may be called at any time by the holders of at least ten percent (10%) of the outstanding stock entitled to be voted at such meeting, by the Board of Directors, by the Chairman of the Board or by the President. Only such business shall be transacted at a special meeting as may be stated or indicated in the notice of such meeting. -1- 2 Section 3. Place. The annual meeting of shareholders may be held at any place within or without the State of Texas designated by the Board of Directors. Special meetings of shareholders may be held at any place within or without the State of Texas designated by the Chairman of the Board, if he shall call the meeting; by the President, if he shall call the meeting; or the Board of Directors, if they shall call the meeting. Meetings of shareholders shall be held at the principal office of the corporation unless another place is designated for meetings in the manner provided herein. Section 4. Notice. Written or printed notice stating the place, day and hour of each meeting of shareholders and, in case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten (10) nor more than fifty (50) days before the date of the meeting, either personally or by mail, to each shareholder of record entitled to vote at such meeting. Section 5. Quorum. The holders of at least a majority of the outstanding stock entitled to vote thereat and present in person or by proxy shall constitute a quorum. Except as otherwise required by law, the articles of incorporation or these bylaws, the act of a majority of the stock at any meeting at which a quorum is present shall be the act of the shareholders' meeting. -2- 3 The Chairman of the meeting or the holders of a majority of stock present at any meeting, though less than a quorum, may adjourn the meeting and any business may be transacted at the adjournment that could be transacted at the original meeting. No notice of adjournment, other than the announcement at the meeting, need be given. Section 6. Proxies. At all meetings of shareholders, a shareholder may vote either in person or by proxy executed in writing by the shareholder or by his duly authorized attorney in fact. Such proxies shall be filed with the Secretary of the corporation before or at the time of the meeting. No proxy shall be valid after eleven (11) months from the date of its execution unless otherwise provided in the proxy. Each proxy shall be revocable unless expressly provided therein to be irrevocable or unless otherwise made irrevocable by law. Proxies solicited by management shall be for the meetings set forth in the Proxy Statement or Statements with respect to which the Proxy is being solicited and any recesses or adjournments thereof, and shall cover only matters referred to in such Proxy Statement or Statements. Section 7. Voting of Shares. Each outstanding share entitled to vote upon a matter submitted to a vote at a meeting of -3- 4 shareholders shall be entitled to one vote on such matter, unless otherwise provided in the articles of incorporation. Section 8. Officers. The President shall preside at and the Secretary shall keep records of each meeting of shareholders, and in the absence of either such officer, his duties shall be performed by some person appointed by the meeting. Section 9. List of Shareholders. A complete list of shareholders entitled to vote at each shareholders' meeting, arranged in alphabetical order, with the address of and number of shares held by each, shall be prepared by the Secretary and filed at the registered office of the corporation and subject to inspection by any shareholder during usual business hours for a period of ten (10) days prior to such meeting and shall be produced at such meeting and at all times during such meeting be subject to inspection by any shareholder. Section 10. Notice of Shareholder Business. Only such business shall be conducted at shareholder meetings and only such persons shall be eligible to serve on the Board of Directors as shall have been brought before the meeting or nominated, as applicable, (a) by or at the direction of the Board of Directors or (b) by any shareholder of the Corporation who shall be entitled to vote at such meeting who complies with the notice procedures -4- 5 set forth in this Section 10 and who complies with all other requirements imposed by these Bylaws. For business to be properly brought before a shareholder meeting by a shareholder, the shareholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a shareholder's notice for nominations or other matters to be considered at an annual meeting must be delivered to, or mailed and received at, the principal executive offices of the Corporation not more than 120 days and not less than 100 days prior to the first anniversary of the previous year's annual meeting; provided, however, that if no annual meeting of shareholders was held in the previous year or if the date of the annual meeting is advanced by more than 30 days prior to, or delayed by more than 60 days after, such anniversary date, notice by the shareholder to be timely must be so delivered, or mailed and received, not later than the close of business on the 10th day following the day on which the date of such meeting has been first publicly disclosed. To be timely, a shareholder's notice of the nomination of persons for election to the Board of Directors at a special shareholder meeting at which one or more directors is to be elected must be delivered to, or mailed and received at, the principal executive offices of the Corporation not later than the close of business on the 10th day following the day on which the date of such meeting has been first publicly disclosed. Notwithstanding anything in this Article 1, Section 10 of these Bylaws to the contrary, in the event that the number of -5- 6 directors to be elected to the Board of Directors is increased and there is no public disclosure naming all of the nominees for election or reelection to the Board of Directors or specifying the size of the increased Board of Directors made by the Corporation at least 130 days prior to the first anniversary of the preceding year's annual meeting, a shareholder's notice of nomination shall be timely, but only with respect to nominees for any new positions created by such increase, if it shall be delivered to, or mailed and received at, the principal executive offices of the Corporation not later than the close of business on the 10th day following the day on which public disclosure of such increase in the number of directors to be elected to the Board of Directors is first made by the Corporation. In no event shall the public announcement of an adjournment of a shareholder meeting commence a new time period for the giving of timely notice as described above. A shareholder's notice to the Secretary shall set forth as to each matter the shareholder proposes to bring before the meeting (a) a brief description of the business desired to be brought before the meeting and the reasons for conducting such business at the meeting, (b) the name and address, as they appear on the Corporation's books, of the shareholder proposing such business, (c) the class and number of shares of the Corporation which are beneficially owned by the shareholder, (d) any material interest of the shareholder in such business, and (e) any such further information as shall be reasonably requested by the -6- 7 Corporation. Additionally, a shareholder's notice of the nomination of persons for election to the Board of Directors shall set forth as to each person whom the shareholder proposes to nominate for election or reelection to the Board of Directors (a) all information relating to such person that is required to be disclosed in solicitations of proxies for election of directors in an election contest, or is otherwise required in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Rule 14a-11 thereunder (including such person's written consent to being named as a nominee and to serving as a director if elected) and (b) any such further information as shall be reasonably requested by the Corporation. Notwithstanding anything in these Bylaws to the contrary, no business shall be conducted at a shareholder meeting except in accordance with the procedures set forth in this Section 10. The Chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting and in accordance with the provisions of these Bylaws, and if he should so determine, he shall so declare to the meeting and any such business not properly brought before the meeting shall not be transacted. Notwithstanding the foregoing provisions of this Section 10, a shareholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section. Nothing in the -7- 8 Section shall be deemed to affect any rights of (a) shareholders to request inclusion of proposals in the Corporation's proxy statement pursuant to Rule 14a-8 under the Exchange Act or (b) the holders of any series of Preferred Stock to elect directors under specified circumstances. For purposes of these Bylaws, "publicly disclosed" or "public disclosure" shall mean disclosure in a press release reported by the Dow Jones News Service, Associated Press or a comparable national news service or in a document publicly filed by the Corporation with the Securities and Exchange Commission. -8- 9 ARTICLE II BOARD OF DIRECTORS Section 1. Number of Term of Office. The business and property of the corporation shall be managed and controlled by the Board of Directors, and subject to restrictions imposed by law, by the articles of incorporation, or by these bylaws, they may exercise all the powers of the corporation. (a) Number. The Board of Directors shall consist of not less than nine (9) nor more than fifteen (15) Directors, as so determined from time to time by resolution of the Board of Directors. Within the above limits, the number of directors may be increased or decreased (provided that such decrease does not shorten the term of any incumbent director) from time to time by resolution of the Board of Directors. Directors need not be shareholders nor residents of Texas. (b) Election and Terms. At the 1982 Annual Meeting of Shareholders, the directors shall be divided into three classes, as nearly equal in number as possible, with the term of office of the first class to expire at the 1983 Annual Meeting of Shareholders, the term of office of the second class to expire at the 1984 Annual Meeting of Shareholders and the term of office of -9- 10 the third class to expire at the 1985 Annual Meeting of Shareholders; in each case, the term shall continue until the respective successors are elected and qualified. At each Annual Meeting of Shareholders following such initial classification and election, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the third succeeding Annual Meeting of Shareholders and until their successors have been elected and qualified. (c) Vacancies and Increases of Directors. Any vacancy (other than by an increases in number) in the Board of Directors resulting from death, resignation, retirement, disqualification, removal from office or other cause may be filled by the affirmative vote of a majority of the remaining directors though less than a quorum of the Board of Directors. Any directors so elected by the Board of Directors to fill a vacancy shall hold office for the unexpired term of the director whose place he has been elected to fill, even though that term may extend beyond the next annual meeting of shareholders. In case of any increase in the number of directors (within the above limits), the additional directors shall be elected at an annual meeting or at a special meeting of shareholders called for that purpose. (d) Removal. Any director, or the entire Board of Directors, may be removed from office at any time, with or without cause, but only by the affirmative vote of the holders of at least four-fifths of all of the outstanding shares of capital stock of -10- 11 the corporation entitled to vote on election of directors at a meeting of shareholders called for that purpose, except that if the Board of Directors, by an affirmative vote of at least four-fifths of the entire Board of Directors, recommends removal of a director to the shareholders, such removal may be effected by the affirmative vote of the holders of at least a majority of the outstanding shares of capital stock of the corporation entitled to vote on the election of directors at a meeting of shareholders called for that purpose. Section 2. Meeting of Directors. The directors may hold their meetings and may have an office and keep the books of the corporation, except as otherwise provided by statute, in such place or places in the State of Texas, or outside the State of Texas, as the Board of Directors may from time to time determine. Section 3. First Meeting. Each newly elected Board of Directors may hold its first meeting for the purpose of organization and the transaction of business, if a quorum is present, immediately after and at the same place as the annual meeting of the shareholders, and no notice of such meeting shall be necessary. Section 4. Election of Officers. At the first regularly scheduled meeting of the Board of Directors in each year at which -11- 12 a quorum shall be present, held next after the commencement of the fiscal year, the Board of Directors shall proceed to the election of the officers of the corporation. Section 5. Regular Meeting. Regular meetings of the Board of Directors shall be held at such times and places as shall be designated, from time to time, by resolution of the Board of Directors. Notice of such regular meetings shall not be required. Section 6. Special Meetings. Special meetings of the Board of Directors shall be held whenever called by the Chairman of the Board, the President or by a majority of the directors for the time being in office. Section 7. Notice. The Secretary shall give notice of each special meeting in person, or by mail or by telegraph at least two (2) days before the meeting to each director. The attendance of a director at any meeting shall constitute a waiver of notice of such meeting, except where a director attends a meeting for the express purpose of objecting to the transaction of any business on the grounds that the meeting is not lawfully called or convened. Neither the business to be transacted at nor the purpose of any regular or special meeting of the Board of Directors need be specified in the notice or waiver of notice of such meeting. At any meeting at which every director shall be present, even though without any notice, any business may be transacted. -12- 13 Section 8. Quorum. A majority of the directors fixed by these bylaws shall constitute a quorum for the transaction of business, but if at any meeting of the Board of Directors there be less than a quorum present, a majority of those present or any director solely present may adjourn the meeting from time to time without further notice. The act of a majority of the directors present at a meeting at which a quorum is in attendance shall be the act of the Board of Directors, unless the act of a greater number is required by the articles of incorporation or by these bylaws. Section 9. Order of Business. At meetings of the Board of Directors, business shall be transacted in such order as from time to time the Board may determine. At all meetings of the Board of Directors, the Chairman of the Board shall preside, and in the absence of the Chairman then the President, and in the absence of the President then a chairman shall be chosen by the Board from among the directors present. The Secretary of the corporation shall act as secretary of the meetings of the Board of Directors, but in the absence of the Secretary, the presiding officer may appoint any person to act as secretary of the meeting. -13- 14 Section 10. Compensation. Directors and members of any committee of the Board of Directors shall be entitled to such reasonable compensation for their services as directors and members of any such committee as shall be fixed from time to time by resolution of the Board of Directors, and shall also be entitled to reimbursement for any reasonable expenses incurred in attending such meetings. The compensation of directors may be on such basis as is determined in the resolution of the Board of Directors. Any director receiving compensation under these provisions shall not be barred from serving the corporation in any other capacity and receiving reasonable compensation for such other services. Section 11. Presumption of Assent. A director of the corporation who is present at a meeting of the Board of Directors at which action on any corporate matter is taken shall be presumed to have assented to the action unless his dissent shall be entered in the minutes of the meeting or unless he shall file his written dissent to such action with the person acting as secretary of the meeting before the adjournment thereof or shall forward such dissent by registered mail to the Secretary of the corporation immediately after the adjournment of the meeting. Such right to dissent shall not apply to a director who voted in favor of such action. -14- 15 Section 12. Executive Committee and other Committees. (a) Designation of Executive Committee. The Board of Directors, by resolution adopted by a majority of the entire number of directors, from time to time may designate two or more directors to constitute an Executive Committee. The designation of such Executive Committee, and the delegation of authority thereto, shall not operate to relieve the Board of Directors, or any member thereof, of any responsibility imposed upon it or him by law. No member of the Executive Committee shall continue to be a member thereof after he ceases to be a director of the corporation. The Board of Directors shall have the power at any time to increase or decrease the number of members of the Executive Committee, to fill vacancies thereon, to change any member thereof, and to change the function or terminate the existence thereof. (b) Powers of the Executive Committee. During intervals between meetings of the Board of Directors, and subject to such limitations as may be imposed by resolutions of the Board of Directors, the Executive Committee shall have any and may exercise all of the powers and authority of the Board of Directors, including, but without limitation, the power to authorize the corporate seal to be affixed to any instruments executed on behalf of the Corporation, and the power to authorize the issuance of shares of the corporation's capital stock, except that no such -15- 16 committee shall have the authority of the Board of Directors in reference to amending the articles of incorporation, approving a plan of merger or consolidation, recommending to the shareholders the sale, lease, or exchange of all or substantially all of the property and assets of the corporation otherwise than in the usual and regular course of its business. Furthermore, in such circumstances, the Executive Committee may not recommend to shareholders a voluntary dissolution of the corporation or a revocation thereof, amend, alter, or repeal the bylaws of the corporation, or adopt new bylaws for the corporation, fill vacancies in or remove members of the Board of Directors or any such committee, elect or remove officers or members of any such committee, fix the compensation of any member of such committee, or alter or repeal any resolution of the Board of Directors which by its terms provides that it shall not be so amendable or repealable. All minutes of the meetings of the Executive Committee shall be submitted to the next succeeding meeting of Board of Directors; but failure to submit the same or to receive the approval thereof shall not invalidate any completed or incomplete action taken by the corporation upon authorization by the Executive Committee prior to the time at which the same has been, or was, submitted to the Board of Directors. (c) Procedure; Meetings; Quorum. Unless designated by the Board of Directors, the chairman of the Executive Committee shall be chosen by the Executive Committee, and the Secretary of the -16- 17 corporation, if present, shall act as Secretary of the meetings. In the absence of either, the Executive Committee shall appoint a chairman or secretary, as the case may be, of the meeting. The Executive Committee shall keep a record of its acts and proceedings. The Executive Committee shall fix its own rules of procedure (which need not be written) and shall meet from time to time on call of the President or any two or more members of the Executive Committee. Notice of each such meeting, stating the place, day and hour thereof, shall be mailed, telegraphed or telephoned to each member's business or residential address at least twenty-four hours before the meeting, but need not state the purpose of the meeting. Meetings may be held at any place within or without the State of Texas, specified in the notice of such meeting. Notice of any meeting may be waived in writing, signed by the member or members entitled to such notice, whether before or after the time stated therein, and shall be equivalent to the giving of such notice. Attendance of any members at a meeting shall constitute a waiver of notice of such meeting. A majority of the Executive Committee shall be necessary to constitute a quorum for the transaction of any business, and the act of a majority of the members present at a meeting at which a quorum is present shall be the act of the Executive Committee. The members of the Executive Committee shall act only as a Committee, and the individual members shall have no power as such, but the Executive Committee may vote the members of the Executive Committee a -17- 18 reasonable fee as compensation and remainder of expenses for attendance at meetings of such Committee. (d) Other Committees. The Board of Directors may by resolution provide for such other standing or special committees as it from time to time deems desirable, and discontinue the same at its pleasure. Each such committee shall have such powers and perform such duties, not inconsistent with law, as may be assigned to it by the Board of Directors. If provision be made for any such committee, the members thereof shall be appointed by the Board of Directors and shall serve at the pleasure of the Board. Vacancies in such committees shall be filled by the Board of Directors. Section 13. Action Without A Meeting. (a) Any action required or permitted to be taken at a meeting of the Board of Directors or any committee may be taken without a meeting if a consent in writing, setting forth the action so taken, is signed by all the members of the Board of Directors or Committee, as the case may be. Such consent shall have the same force and effect as a unanimous vote at a meeting, and may be stated as such in any document or instrument filed with the Secretary of State. (b) Members of the Board of Directors, or members of any committee designated by such board, may participate in and hold a meeting of such board or committee by means of conference telephone or similar communications equipment by means of which -18- 19 all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this Section shall constitute presence in person at such meeting, except where a person participates in the meeting for the express purpose of objection to the transaction of any business on the ground that the meeting is not lawfully called or convened. -19- 20 ARTICLE III OFFICERS Section 1. Number, Titles and Term of Office. The officers of the corporation shall be a Chairman of the Board, a Vice Chairman of the Board, a President, one or more Vice Presidents (including one or more Executive Vice Presidents and one or more Senior Vice Presidents if deemed appropriate by the Board of Directors), a Secretary, a Treasurer and such other officers as the Board of Directors may from time to time elect or appoint. Each officer shall hold office until his successor shall have been duly elected and qualified or until his death or until he shall resign or shall have been removed in the manner hereinafter provided. One person may hold more than one office, except that the President shall not hold the office of Secretary. None of the officers need be a director. Section 2. Removal. Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors whenever in its judgment the best interests of the corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so -20- 21 removed. Election or appointment of an officer or agent shall not of itself create contract rights. Section 3. Vacancies. A vacancy in the office of any officer may be filled by vote of a majority of the directors for the unexpired portion of the term. Section 4. Powers and Duties of the Chairman of the Board. The Chairman of the Board shall be chief executive officer of the corporation and shall preside at all meetings of the Board of Directors and shall have such other powers and duties as designated in these bylaws and as from time to time may be assigned to him by the Board of Directors. Section 5. Powers and Duties of the Vice Chairman of the Board. The Vice Chairman of the Board in the absence of the Chairman of the Board shall preside at all meetings of the Board of Directors and in the absence of both the Chairman of the Board and the President preside at all meetings of the shareholders and shall have such other powers and duties as from time to time may be assigned him by the Board of Directors. Section 6. Powers and Duties of the President. The President shall be the chief administrative officer of the corporation and, subject to the Board of Directors and the -21- 22 Chairman of the Board, he shall have general administrative charge, management and control of the properties and operations of the corporation in the ordinary course of its business with all such powers with respect to such properties and operations as may be reasonably incident to such responsibilities; he shall preside at all meetings of the shareholders and in the absence of both the Chairman of the Board and the Vice Chairman of the Board at all meetings of the Board of Directors; he may agree upon and execute all bonds, contracts and all other obligations in the name of the corporation; and he may sign all certificates for shares of capital stock of the corporation. Section 7. Vice Presidents. Each Vice President shall have such powers and duties as may be assigned to him by the Board of Directors and shall exercise the powers of the President during that officer's absence or inability to act. Any action taken by a Vice President in the performance of the duties of the President shall be conclusive evidence of the absence or inability to act of the President at the time such action was taken. Section 8. Treasurer. The Treasurer shall have custody of all the funds and securities of the corporation which come into his hands. When necessary or proper, for collection he may, on behalf of the corporation, endorse checks, notes and other obligations and shall deposit the same to the credit of the -22- 23 corporation in such bank or banks or depositories as shall be designated in the manner prescribed by the Board of Directors, and he may sign all receipts and vouchers for payments made to the corporation, either alone or jointly with such other officer as is designated by the Board of Directors. Whenever required by the Board of Directors, he shall render a statement of his cash account; he shall enter or cause to be entered regularly in the books of the corporation to be kept by him for the purpose full and accurate accounts of all moneys received and paid out on account of the corporation; he shall perform all acts incident to the position of Treasurer subject to the control of the Board of Directors; and he shall, if required by the Board of Directors, give such bond for the faithful discharge of his duties in such form as the Board of Directors may require. Section 9. Assistant Treasurer. Each Assistant Treasurer shall have the usual powers and duties pertaining to his office, together with such other powers and duties as may be assigned to him by the Board of Directors. The Assistant Treasurers shall exercise the powers of the Treasurer during that officer's absence or inability to act. Section 10. Secretary. The Secretary shall keep the minutes of all meetings of the Board of Directors and committees thereof and the minutes of all meetings of the stockholders, in books -23- 24 provided for that purpose. He shall attend to the giving and serving of all notices; he may sign with the President, in the name of the corporation, all contracts of the corporation and affix the seal of the corporation thereto; he may sign with the President all certificates for shares of the capital stock of the corporation; he shall have charge of the certificate books, transfer books and stock ledgers, and such other books and papers as the Board of Directors may direct, all of which shall at all reasonable times be open to inspection of any director upon application at the office of the corporation during business hours; and he shall in general perform all duties incident to the office of Secretary, subject to the control of the Board of Directors. Section 11. Assistant Secretaries. Each Assistant Secretary shall have the usual powers and duties pertaining to his office, together with such other powers and duties as may be assigned to him by the Board of Directors or the Secretary. The Assistant Secretaries shall exercise the powers of the Secretary during that officer's absence or inability to act. -24- 25 ARTICLE IV INDEMNIFICATION Section 1. Each director and officer of the Company and any person who may have served at the request of the Company as a director or officer of another corporation in which it owns shares or of which it is a creditor shall be indemnified by the Company against any costs and expenses, including counsel fees, actually and necessarily incurred in connection with the defense of any civil, criminal, administrative, or other claim, action, suit, or proceeding, whether by or in the right of the Company or otherwise, in which he may become involved or with which he may be threatened by reason of his being or having been a director or officer of the Company or by reason of his serving or having served at the request of the Company as a director or officer of another corporation as aforesaid, provided that, in connection with such matter, the said director or officer acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company and, with respect to any criminal action or proceedings, had no reasonable cause to believe his conduct was unlawful. Costs and expenses indemnified shall include payments in settlement or in satisfaction of any judgment, fine or penalty. -25- 26 The termination of any action, suit, or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or equivalent shall not, of itself, create a presumption that the director, officer, or representative did not act in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company, or with respect to any criminal action or proceeding that he had reasonable cause to believe his conduct was unlawful. Section 2. Any indemnification provided for herein, unless ordered by a court, shall be made by the Company only as authorized in the specific case upon a determination that indemnification of the director or officer is proper in the circumstances because he had met the applicable standard of conduct set forth in Section 1 hereof. Such determination shall be made (a) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit, or proceeding, or (b) if such quorum is not obtainable, or, even if obtainable, and a quorum of disinterested directors so directs, by independent legal counsel (who may be of counsel to the corporation) in a written opinion, or (c) by the shareholders. Section 3. It is specifically intended to provide indemnification with regard to acts or omissions on the part of -26- 27 directors or officers which may be or are adjudged to constitute negligence, misrepresentations, slander, libel, misconduct, or other breach of duty, but only to the extent that such indemnification may be provided for under law, and only upon a determination under Section 2 hereof that such conduct was in good faith and reasonably believed to be in or not opposed to the best interest of the Company and, with respect to any criminal action or proceeding, that there was not reasonable cause for belief that the conduct was unlawful. Section 4. The Company shall have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee, or agent of the Company, or is or was serving at the request of the Company as a director, officer, employee, or agent of the Company, or is or was serving at the request of the Company as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise, against any liability asserted against him and incurred by him in any such capacity or arising out of his status as such, whether or not the corporation itself would have the power to indemnify him against such liability under law. Section 5. To the extent permitted by law, expenses incurred in connection with a civil, criminal, administrative or investigative action, suit or proceeding, or threat thereof, may -27- 28 be paid by the corporation in advance of the final disposition of such action, suit or proceeding as authorized in the manner provided in Section 2 of this Article, upon receipt of an undertaking by or on behalf of the director or officer to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the corporation as authorized in this Article. Section 6. Should any of the indemnification rights provided for herein be declared invalid, such declaration shall not invalidate the indemnification provisions generally, and such of the indemnification rights provided for herein as are permissible under law shall remain effective. Section 7. The foregoing right of indemnification shall not be deemed exclusive of any other rights to which any director, officer, or representative may be entitled under any other bylaw, agreement, or vote of shareholders or disinterested directors, as a matter of law or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, or representative and shall inure to the benefit of the heirs, executors, and administrators of such a person. -28- 29 Section 8. (a) In addition, and not in lieu of, any indemnity provided under the preceding sections of this Article IV, the Company shall indemnify each director, officer or employee and each former director, officer or employee of the Company against any costs and expenses, including counsel fees, actually and necessarily incurred in connection with the defense of any civil, criminal, administrative or other claim, action, suit or proceeding, whether by or in the right of the Company or otherwise, in which he may become involved or with which he may be threatened with regard to any error or omission or breach of duty committed or alleged to have been committed in the discharge of his fiduciary duties, obligations or responsibilities with respect to any employee pension, deferred compensation, welfare benefit or other benefit plan, including specifically, but without limitation, plans covered under the Employee Retirement Income Security Act of 1974 (which plans are herein collectively called "employee benefit plan"), of the corporation or any other corporation in which it owns shares of capital stock, or of which it is a creditor (which entities are herein collectively called the "Company") provided, that in connection with such matter, the said director, officer or employee acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Company and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. -29- 30 The Company shall be deemed to have requested a director, officer or employee of the Company to serve an employee benefit plan where the performance by such person of his duties to the Company also imposes duties on or otherwise involves services by such person to such employee benefit plan or participants or beneficiaries thereof; excise taxes assessed on a person with respect to an employee benefit plan pursuant to said Act of Congress shall be deemed "fines"; and action taken or omitted by such a person with respect to an employee benefit plan in the performance of such person's duties for a purpose reasonably believed by such person to be in the interest of the participants and beneficiaries of the employee benefit plan shall be deemed to be for a purpose which is not opposed to the best interest of the Company. Costs and expenses indemnified shall include payments in settlements or in satisfaction of any judgement, fine or penalty. The termination of any action, suit, or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the director, officer, or employee did not act in good faith. (b) Any indemnification provided for herein, unless ordered by a court, shall be made by the Company only as authorized in the specific case upon a determination that indemnification of the director, officer or employee is proper in the circumstances because he had met the applicable standard of conduct set forth in -30- 31 Section 8 (a) hereof. Such determination shall be made (a) by the Board of Directors by a majority vote of a quorum consisting of directors who were not parties to such action, suit, or proceeding, or (b) if such quorum is not obtainable, or even if obtainable, and a quorum of disinterested directors so directs, by independent legal counsel (who may be of counsel to the corporation) in a written opinion, or (c) by the shareholders. (c) It is specifically intended to provide indemnification with regard to acts or omissions on the part of directors, officers or employees which may be or are adjudged to constitute negligence, misrepresentations, slander, libel, misconduct, or other breach of duty, but only to the extent that such indemnification may be provided for under law, and only upon a determination under Section 8 (b) hereof that such conduct was in good faith. (d) The Company shall have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee, or agent of the Company, or is or was serving at the request of the Company as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise (and "other enterprise" shall in this Section 8 be deemed to include an employee benefit plan), against any liability asserted against him and incurred by him in any such capacity or arising out of his status as such, whether or -31- 32 not the corporation itself would have the power to indemnify him against such liability under law. (e) To the extent permitted by law, expenses incurred in connection with a civil, criminal, administrative or investigative action, suit or proceeding, or threat thereof, may be paid by the corporation in advance of the final disposition of such action, suit or proceeding as authorized in the manner provided in Section 8 (b) hereof, upon receipt of an undertaking by or on behalf of the director, officer or employee to repay such amount unless it shall ultimately be determined that he is entitled to be indemnified by the corporation as authorized in this Article. (f) Should any of the indemnification rights provided for herein be declared invalid, such declaration shall not invalidate the indemnification provisions generally, and such of the indemnification rights provided for herein as are permissible under law shall remain effective. (g) The foregoing right of indemnification shall not be deemed exclusive of any other rights to which any director, officer, employee or representative may be entitled under any other bylaw, agreement, or vote of shareholders or disinterested directors, as a matter of law or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office or performing such of his duties and shall continue as to a person who has ceased to be a director, officer, -32- 33 employee or representative and shall inure to the benefit of the heirs, executors, and administrators of such a person. -33- 34 ARTICLE V CAPITAL STOCK Section 1. Certificates of Shares. The certificates for shares of the capital stock of the corporation shall be in such form as shall be approved by the Board of Directors. The certificates shall be signed by the President or a Vice President, and also by the Secretary or an Assistant Secretary or by the Treasurer or an Assistant Treasurer and may be sealed with the seal of this corporation or a facsimile thereof. Where any such certificate is countersigned by a transfer agent, or registered by a registrar, either of which is other than the corporation itself or an employee of the corporation, the signatures of any such President or Vice President and Secretary or Assistant Secretary may be facsimiles. They shall be consecutively numbered and shall be entered in the books of the corporation as they are issued and shall exhibit the holder's name and the number of shares. Section 2. Transfer of Shares. The shares of stock of the corporation shall be transferable only on the books of the corporation by the holders thereof in person or by their duly authorized attorneys or legal representatives, upon surrender and cancellation of certificates for a like number of shares. -34- 35 Section 3. Closing of Transfer Books. For the purpose of determining shareholders entitled to notice of or to vote at any meeting of shareholders, or any adjournment thereof, or entitled to receive payment of any dividend, or in order to make a determination of shareholders for any other proper purpose, the Board of Directors of the corporation may provide that the stock transfer books shall be closed for a stated period but not to exceed, in any case, fifty (50) days. If stock transfer books shall be closed for the purpose of determining shareholders entitled to notice of or to vote at a meeting of shareholders, such books shall be closed for at least ten (10) days immediately preceding such meeting. In lieu of closing the stock transfer books the Board of Directors may fix in advance a date as the record date for any such determination of shareholders, such date in any case to be not more than fifty (50) days and, in case of a meeting of shareholders, not less than ten (10) days prior to the date on which the particular action requiring such determination of shareholders is to be taken. If the stock transfer books are not closed and no record date is fixed for the determination of shareholders entitled to notice of or to vote at a meeting of shareholders, or stockholders entitled to receive payment of a dividend, the date on which the notice of the meeting is mailed or the date on which the resolution of the Board of Directors declaring such dividend is adopted, as the case may be, shall be the record date for such determination of shareholders. -35- 36 Section 4. Regulations. The Board of Directors shall have power and authority to make all such rules and regulations as they may deem expedient concerning the issue, transfer and registration or the replacement of certificates for shares of the capital stock of the corporation. -36- 37 ARTICLE IV MISCELLANEOUS PROVISIONS Section 1. Offices. Until the Board of Directors otherwise determines, the registered office of the corporation required by the Texas Business Corporation Act to be maintained in the State of Texas shall be the principal place of business of the corporation, but such registered office may be changed from time to time by the Board of Directors in the manner provided by law and need not be identical to the principal place of business of the corporation. Section 2. Fiscal Year. The fiscal year of the corporation shall be such as the Board of Directors shall, by resolution, establish. Section 3. Seal. The seal of the corporation shall be such as from time to time may be approved by the Board of Directors. Section 4. Notice and Waiver of Notice. Whenever any notice whatever is required to be given under the provisions of these bylaws, said notice shall be deemed to be sufficient if given by depositing the same in a post office box in a sealed postpaid wrapper addressed to the person entitled thereto at his post -37- 38 office address, as it appears on the books of the corporation, and such notice shall be deemed to have been given on the day of such mailing. A waiver of notice, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. Section 5. Resignations. Any director or officer may resign at any time. Such resignations shall be made in writing and shall take effect at the time specified therein, or, if not time be specified, at the time of its receipt by the President or Secretary. The acceptance of a resignation shall not be necessary to make it effective, unless expressly so provided in the resignation. Section 6. Securities of Other Corporation. The Chairman of the Board, the President or any Vice President of the corporation shall have power and authority to transfer, endorse for transfer, vote, consent or take any other action with respect to any securities of another issuer which may be held or owned by the corporation and to make, execute and deliver any waiver, proxy or consent with respect to any such securities. -38- 39 ARTICLE VII AMENDMENTS Except as set forth below, bylaws may be altered, amended or repealed, or new bylaws may be adopted, by the affirmative vote of the holders of a majority of the outstanding shares of capital stock entitled to vote thereon at any annual meeting, or at any special meeting if notice of the proposed amendment is contained in the notice of said special meeting, or by the affirmative vote of a majority of the full Board of Directors at any regular or special meeting, provided notice of said proposed amendment is contained in the notice of the meeting. Notwithstanding the provisions of the preceding paragraph, the affirmative vote of the holders of at least four-fifths of the outstanding shares of capital stock of the Corporation entitled to vote thereon at a meeting called for that purpose shall be required to amend or repeal, or to adopt any provisions inconsistent with, Section 1, Article II or Article VII of the corporation's Bylaws. -39- EX-12.1 3 RATIO OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12.1 SERVICE CORPORATION INTERNATIONAL RATIO OF EARNINGS TO FIXED CHARGES
Nine Months Ended September 30, 1999 1998 - ----------------------------------------------------------------------------------------------------- (Thousands, except ratio amounts) Pretax income from continuing operations ....................... $ 234,799 $ 437,119 Undistributed income of less than 50% owned equity investees ... (1,337) (5,814) Minority interest in income of majority owned subsidiaries with fixed charges ............................................ 257 320 Add fixed charges as adjusted (from below) ..................... 201,360 146,651 --------- --------- $ 435,079 $ 578,276 --------- --------- Fixed charges: Interest expense: Corporate ............................................ $ 173,359 $ 126,386 Financial service .................................... 8,689 7,372 Capitalized .......................................... 1,250 2,431 Amortization of debt costs .................................... 254 (396) 1/3 of rental expense ......................................... 19,058 13,289 --------- --------- Fixed charges .................................................. 202,610 149,082 Less: Capitalized interest ................................... (1,250) (2,431) --------- --------- Fixed charges as adjusted ...................................... $ 201,360 $ 146,651 ========= ========= Ratio (earnings divided by fixed charges) ...................... 2.15 3.88 ========= =========
EX-27.1 4 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET OF SERVICE CORPORATION INTERNATIONAL AS OF SEPTEMBER 30, 1999 AND THE RELATED STATEMENT OF INCOME FOR THE NINE MONTHS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 205,837 1,232,108 2,315,426 129,358 209,445 1,092,604 2,537,265 580,790 14,972,437 788,327 4,111,305 0 0 272,060 3,436,067 14,972,437 2,330,545 2,511,137 1,853,749 1,984,036 267,321 16,973 182,302 234,799 84,848 149,951 0 1,885 0 151,836 .56 .56
EX-99.1 5 CONSOLIDATED CLASS ACTION COMPLAINT 1 EXHIBIT 99.1 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION In re: SERVICE CORPORATION INTERNATIONAL Civil Action No. H-99-280 JURY DEMANDED ------------- CONSOLIDATED CLASS ACTION COMPLAINT Plaintiffs sue individually and on behalf of all those similarly situated. Their allegations are upon personal knowledge as to their own acts. Other matters are alleged based upon the investigation conducted by counsel as detailed below. This class action against Service Corporation International ("SCI" or the "Company") and certain of its present and former officers and directors is prosecuted on behalf of all members of the class certified by the Court on August 25, 1999 (the "Class") who were damaged by defendants' violations of the federal securities laws. JURISDICTION AND VENUE 1. This action arises under Sections 11,12(a)(2) and 15 of the Securities Act of 1933 (the "Securities Act"), 15 U.S.C. Sections 77(k), 77(l)(2) and 77(o); Sections 10(b), 20(a) and 20A of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. Sections 78j(b), 78t(a) and 78t-1, and the rules and regulations promulgated thereunder, including Securities and Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. 240.10b-5. 2. Jurisdiction exists under 15 U.S.C. Section 77v, 15 U.S.C. Section 78aa; and 28 U.S.C. Section 1331. Page 1 2 3. Venue is proper in this district under 28 U.S.C. Sections 1391 (b) and (c) as acts, transactions and wrongful conduct alleged herein, including the dissemination to the investing public of the materially false and misleading statements at issue, occurred in substantial part in this District. In addition, the principal offices of SCI are located in this District. 4. Defendants, directly or indirectly, used the mails and instrumentalities of interstate commerce in connection with the acts and conduct alleged in the Complaint. THE PARTIES 5. Rujira Srisythep, Carl Helwig, and Allan Lisse were appointed as Lead Plaintiffs by this Court's order dated June, 9, 1999. On August 25, 1999, the Court certified them as Class representatives. Each Lead Plaintiff purchased SCI common stock during the Class Period (July 17, 1998 through January 26, 1999) and was damaged thereby. 6. Defendant SCI is a corporation organized and existing under the laws of the State of Texas. Its principal executive offices are at 1929 Allen Parkway, Houston, Texas. SCI purports to be the world's largest provider of death care services. At December 31, 1998, SCI operated 3,442 funeral service locations, 433 cemeteries, and 191 crematoria located in 20 countries on five continents. 7. At all relevant times, defendant R.L. Waltrip ("Waltrip") was SCI's Chairman of the Board and Chief Executive Officer. Waltrip signed the materially false and misleading Amendment No. 1 to Form S-4 Registration Statement containing a Proxy Statement/Prospectus, filed with the SEC on or about November 19, 1998 (the "Registration Statement/Prospectus"). The Registration Statement/Prospectus was declared effective on November 20, 1998. Waltrip Page 2 3 also made numerous materially false and misleading statements to the public via media reports and press releases issued by the Company during the Class Period as alleged herein. 8. At all relevant times, defendant George R. Champagne ("Champagne") was SCI's Senior Vice President and Chief Financial Officer. Champagne signed the materially false and misleading: (i) Form 10-Q Quarterly Report Pursuant to Section 13 or 15(D) of the Securities Exchange Act of 1934 for the Quarterly Period Ended June 10, 1998, filed with the SEC on August 14, 1998 (the "1998 Q2 10-Q"); (ii) Form 10-Q Quarterly Report pursuant to Section 13 or 15 (D) of the Securities Exchange Act of 1934 for the Quarterly Period Ended September 30, 1998, filed with the SEC on November 16, 1998 (the "1998 Q3 10-Q"); and Registration Statement/Prospectus. Champagne also made numerous materially false and misleading statements to the public via media reports and press releases issued by the Company during the Class Period as alleged herein. 9. At all relevant times, defendant L. William Heiligbrodt ("Heiligbrodt") was SCI's President and Chief Operating Officer. Heiligbrodt signed the materially false and misleading Registration Statement/Prospectus. Heiligbrodt also made numerous materially false and misleading statements to the public via media reports and press releases issued by the Company during the Class Period as alleged herein. Heiligbrodt left the employment of the Company shorty after the disclosure of the adverse information alleged herein. 10. Defendants Waltrip, Champagne and Helligbrodt are sometimes collectively referred to as the "Individual Defendants." 11. The Individual Defendants, by reason of their stock ownership, management positions, and/or membership on the Company's Board of Directors and committees thereof, had Page 3 4 control over the operations of the Company and had the power and/or ability to control each of the wrongful acts and practices complained of herein. The Individual Defendants exercised such power and control to commit the wrongful acts complained of herein, including making materially false and misleading statements and material omissions in statements to the media, the Company's press releases, quarterly SEC filings, and the Registration Statement/Prospectus. The Individual Defendants were, "control persons" of SCI within the meaning of Section 15 of the Securities Act and Section 20(a) of the Exchange Act. 12. As a result of their positions with SCI, the Individual Defendants had access to undisclosed adverse information throughout the Class Period about SCI's multi-million dollar backlog of unprofitable preneed funeral business and the impact this backlog had, and would continue to have, on SCI's profitability. They had access to such information through: (a) internal corporate documents; (b) corporate profit/loss information conveyed directly to corporate headquarters from each of the Company's domestic funeral homes on a next-day basis, via, the Company's proprietary "Falcon" computer system; (c) conversations and communications with other corporate officers and employees; (d) attendance at management and/or meetings of the Board and committees thereof; and (e) daily, weekly and monthly reports such as SCI's "Call In Reports" which provided them with profit and loss information on each of SCI's domestic funeral homes, and other information provided in connection therewith. 13. It is appropriate to treat the Individual Defendants as a group for pleading purposes and to presume that the materially false, misleading and incomplete information conveyed in the company's public filings, press releases and other publications as alleged herein are the collective actions of the Individual Defendants identified above. Page 4 5 14. The Individual Defendants made and were involved in drafting, reviewing and/or disseminating the materially false and misleading statements and information alleged herein. Each of the Individual Defendants was provided with copies of the documents alleged herein to be misleading prior to their issuance and or had the ability and/or opportunity to prevent their issuance or cause them to be corrected. Accordingly, each of the Individual Defendants is responsible for the accuracy of the public reports, press releases, and statements detailed herein and is therefore primarily liable for the materially false representations and omissions contained therein. 15. As officers and/or directors and controlling persons of a public company whose securities were registered with the SEC and governed by the federal securities laws, the Individual Defendants each had a duty to disseminate promptly accurate and truthful information with respect to the Company's business, operations, financial condition, management, earnings, and present and future business prospects, and to correct any previously issued statements that had become materially false and misleading so that the market price of the Company's publicly traded securities would be based upon truthful, accurate and complete information. The Individual Defendants' material misrepresentations and omissions, and failures to correct, during the Class Period violated these specific requirements and obligations as alleged below. SUBSTANTIVE ALLEGATIONS SCI'S FUNERAL HOME CONSOLIDATOR BUSINESS MODEL 16. Throughout the 1990s, thousands of locally-owned family operated independent funeral homes have been acquired by major corporations known in the funeral industry as "funeral home consolidators." The three largest publicly traded funeral home consolidators are SCI, Page 5 6 Loewen Group Inc. ("Loewen"), and Metarie, Louisiana-based Stewart Enterprises Inc. ("Stewart"). 17. All funeral home consolidators employ a relatively standard business model. SCI's model consists of acquiring several independently owned and locally managed funeral homes in one geographic area and then sharing labor and equipment among this "cluster" to cut costs. As reported in SCI's Form 10-K for the fiscal year ended December 31, 1998, filed with the SEC on March 31, 1999 (the "SCI 1998 Form 10-K"): the majority of the Company's funeral service locations and cemeteries are managed in groups called clusters. Clusters are established primarily in metropolitan areas to take advantage of operational efficiencies, including the sharing of [operating expenses such as] service personnel, vehicles, preparation services, clerical staff and certain building facility costs. 18. Once SCI acquires a funeral home, the public often is unaware of any change in ownership. By SCI's own design, the original family owners and employees usually remain and continue to operate the SCI-acquired funeral home under the original family name. This semblance of continuity is essential to SCI retaining the goodwill and future business of a client base largely loyal to the funeral homes' original family owners. SCI ACQUIRES THOUSANDS OF INDEPENDENT FUNERAL HOMES 19. According to SCI's 1998 Form 10-K, "[SCI] is the largest provider of death care services in the world. At December 31, 1998, the Company operated 3,442 funeral service locations, 433 cemeteries and 191 crematoria located in 20 countries on five continents." However, SCI was not always this large. Page 6 7 20. SCI's funeral empire is a creature of an acquisition campaign SCI has waged since the early 1990s. The following table illustrates the annual growth in the number of funeral homes owned by SCI throughout the 1990s:
NUMBER OF FUNERAL HOMES YEAR ACQUIRED 1990 45 1991 164 1992 54 1993 124 1994 674 1995 1,263 1996 210 1997 294 1998 308 Total 2,873
21. In acquiring a funeral home, SCI typically acquires all assets and assumes all liabilities of the acquired funeral home while paying the funeral home owner in cash, SCI securities, or some combination thereof. PRE-NEED FUNERAL SERVICES 22. The assets purchased by SCI in a typical funeral home acquisition transaction included "preneed" or "guaranteed price" funeral contracts entered into by the independent funeral homes during the years those homes were independently operated. Preneed funeral contracts generally govern an arrangement where individuals purchase their funeral arrangements prior to their death, and funeral homes agree to perform the funeral service in the future for Page 7 8 payment of a fixed sum that is paid at the time the contract is entered into, or over time pursuant to an installment payment schedule. The contractual obligation to perform these guaranteed price funerals in the future was typically reflected as a liability on the books of the independent funeral homes prior to their acquisition by SCI. Once acquired SCI assumed this future liability. 23. In connection with each acquisition, SCI also acquired the mortuary trust assets that eventually are used to pay for the preneed funerals. At the time the preneed funeral contracts were sold to prospective clients, the independent funeral homes typically established mortuary trusts, funded with payments from the prospective clients. The total funds, or trust principal, generally were less than the then-current cost of providing the funeral service because preneed funeral services were often sold at a discount. The trust principal was routinely invested in a certificate of deposit issued by a bank and redeemable only upon the death of the prospective client. To the extent that the principal and income generated by the trust equals or exceeds the ultimate cost of performing the funeral service, the funeral home will either break-even or realize a profit. If, on the other hand, the mortuary trust assets do not grow to equal or exceed the future cost of performing the service, then the funeral service will be performed at the contractually agreed upon price, resulting in a loss for the funeral home performing the service. 24. The practice of selling preneed funeral contracts began to gain increasing acceptance in the late 1980s. At this time and throughout the 1990s, the vast majority of the nation's funeral homes were independently owned and operated and lacked the financial sophistication to perform any meaningful analysis aimed at determining whether the assets invested in the mortuary trusts would generate a real rate of return in excess of the amount necessary to cover future increases in the cost of providing a price guaranteed funeral service. As a result, the Page 8 9 funds invested in these mortuary trusts were often not actively managed - if they were managed at all - and the answer to whether such funds would grow sufficiently to equal or exceed the cost of providing a price guaranteed funeral service at some future date was left to happenstance. Industry sources have confirmed that the financial management of these mortuary trust assets often consisted of little more than opening a certificate of deposit at a local bank and then throwing the preneed contract into a drawer where it remained essentially untouched until the prospective client passed away. 25. While the financial impact of such a laissez-faire approach to mortuary trust asset management may have been relatively insignificant during periods of high prevailing interest rates and relatively low funeral home cost inflation, these practices have had a severely negative impact on funeral home profit margins during the protracted period of declining interest rates and escalating funeral home costs, such as those experienced throughout the 1990s. 26. By way of example, interest rates on 24 month certificates of deposit stood as high as 8.21% in 1990, however, by 1998 they had fallen to as low as 4.22%. Conversely, the costs associated with providing funeral services increased at an average annual rate of 8.5% during this same time period. As a result, funeral homes that entered into guaranteed price funeral contracts, but failed to actively manage their mortuary trust assets during this time period, amassed multi-million dollar preneed funeral backlogs that would eventually be performed at break-even - or a loss - resulting in a drastic, negative impact on profit margins. Page 9 10 SCI FAILS TO DISCLOSE THAT IT HAS AMASSED A MULTI-MILLION DOLLAR BACKLOG OF UNPROFITABLE PRENEED FUNERALS BY ACQUIRING THOUSANDS OF INDEPENDENT FUNERAL HOMES THAT FAILED TO MANAGE THESE PRENEED FUNDS 27. It is well known in the death services industry that the failure to actively manage preneed contract trust funds can have disastrous effects on a company's financial position. As one industry analyst recognized as early as March 1997: You see there is one basic problem with preneed - the money. Regardless of how you finance prearranged funerals - trusts, insurance or some combination - the amount of the funeral at-need and the amount available to finance it will never be exactly the same. Sometimes the difference may be only a few dollars or it could be several hundred dollars. Trusts and insurance will naturally grow at a different rate than funeral prices. Therefore, there will always be only two possibilities. Either there will be too little money to finance the service at current prices, or there will be an overage. If there is a shortfall, it is the funeral home that must absorb that shortage. No trust or insurance company will be willing to make up the difference. We can rationalize it in any number of ways, but a shortage is a shortage and must be accounted for somewhere, either through an increase of at-need prices or decreased profit. BUT WHAT WOULD HAPPEN TO YOUR FUNERAL HOME IF EVERY FUNERAL YOU DID THIS YEAR HAD BEEN FUNDED 10 YEARS AGO? THERE IS NO WAY TO RECOVER THE SHORTAGES. HOW WOULD YOU SURVIVE? While it may be unrealistic to think that someday all funerals will be prefunded, isn't that the direction we are encouraging through our preneed marketing efforts? [Emphasis added]. Curtis Rostad, Preneed: Here Today, Gone Tomorrow, The Director (March 1997). 28. The "direction" that Mr. Rostad found the industry "encouraging" is precisely the direction taken by SCI during the 1990s. Significantly, by 1998, SCI had acquired ownership of more than 2,873 independent funeral homes during the preceding eight years. In doing so, SCI amassed a multi-billion dollar backlog of preneed funeral contracts. Indeed, between 1992 and 1998, in just a six-year period, SCI's prearranged funeral contract backlog increased three-fold, from $1.2 billion to $3.7 billion. The chart that follows depicts the explosive growth in the dollar Page 10 11 value of prearranged funeral contracts acquired and sold by SCI, as well as SCI's preneed funeral contract backlog between 1992 and 1998:
Value of Prearranged Prearranged Funeral Prearranged Funeral Year Contracts Acquired Funeral Contracts Backlog Services-Sold 12/31/92 $ 24 million $119 million $1.2 billion 12/31/93 $ 60 million $159 million $1.3 billion 12/31/94 $127 million S245 million $1.5 billion 12/31/95 $656 million $371 million $2.3 billion 12/31/96 $ 72 million $512 million $2.7 billion 12/31/97 $102 million $529 million $3.3 billion 12/31/98 $138 million $490 million $3.7 billion TOTAL $1.179 billion $2.425 billion --
29. Undisclosed to the Class was the fact that a material number of independent funeral homes acquired by SCI throughout the 1990s were among those that had failed to actively manage their mortuary trust assets to insure that such assets would equal or exceed the cost of providing the guaranteed price funerals in the future. As a result, each time SCI acquired ownership of another independent funeral home, SCI had, unbeknownst to the Class, also acquired countless numbers of unprofitable guaranteed price funeral contracts that had long-ago been entered into by the independent funeral homes. Significantly, all of these unprofitable funerals would eventually have to be performed by SCI. Page 11 12 30. Also undisclosed to the Class throughout the Class Period was the fact that SCI failed to establish any means of actively managing the mortuary trust assets that would eventually be used to pay for these acquired preneed funeral contracts. Defendants never disclosed that SCI's failure to take such measures had already caused, and would continue to cause, SCI to perform a material number of these prearranged funerals unprofitably, and that this ultimately would have a severe adverse impact on SCI's profit margins. DEFENDANTS CONCEAL THE RESULTS OF THE PRENEED STUDY 31. During 1995 alone, SCI purchased 1,263 independent funeral homes and acquired a staggering $656 million in preneed funeral contracts in connection with these purchases. These purchases resulted in SCI increasing its preneed funeral backlog by more than 40% in a single year and created an unprecedented need to determine the projected profitability - or lack thereof - of these preneed funeral contracts. 32. During 1996, SCI undertook what it termed "a review of the prearranged trust investment process which included an asset/liability study" (the "Preneed Study"). The results of the Preneed Study confirmed that SCI had amassed ownership of a material number of independent funeral homes with significant preneed contract inventories throughout the 1990s. The Preneed Study also confirmed for the defendants that a significant number of the independent funeral homes acquired by SCI had failed to actively manage their mortuary trust assets. As a result, a material number of SCI's funeral services had been, and would continue to be, performed at significant losses. 33. Although defendants publicly disclosed the fact that the Preneed Study had been conducted in the Company's Form 10-K for the fiscal year ended December 31, 1996 filed with Page 12 13 the SEC on March 28, 1997 (the "SCI 1996 Form 10-K"), they never disclosed the clearly material factual findings of the Preneed Study to Class members. In this vein, the SCI 1996 Form 10-K reported only that: THE COMPANY HAS RECENTLY COMPLETED A REVIEW OF THE PREARRANGED TRUST INVESTMENT PROCESS WHICH INCLUDED AN ASSET/LIABILITY STUDY. This has resulted in a NEW INVESTMENT PROGRAM which entails the consolidation of multiple trustees, the use of institutional managers with differing investing styles and consolidated performance monitoring and tracking. THIS NEW PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE AMOUNT NECESSARY TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. THIS IS ACCOMPLISHED BY ALLOCATING THE PORTFOLIO MIX TO THE APPROPRIATE INVESTMENTS THAT MORE ACCURATELY MATCH THE ANTICIPATED MATURITY OF THE POLICIES. THIS HAS RESULTED IN A NEW ASSET ALLOCATION POLICY OF APPROXIMATELY 65% EQUITY AND 35% FIXED INCOME WHICH THE COMPANY INTENDS TO IMPLEMENT IN THE FIRST HALF OF 1997. [Emphasis added]. 34. Defendants again referred to the Preneed Study in the Company's Form 10-K for the fiscal year ended December 31, 1997 filed with the SEC on March 30, 1998 (the "SCI 1997 Form 10-K"). Defendants again failed to disclose the results of the study and instead stated only that: During 1997, the Company completed a review of the prearranged trust investment process which included an asset/liability study. THIS HAS RESULTED IN A NEW INVESTMENT PROGRAM WHICH ENTAILS THE CONSOLIDATION OF MULTIPLE TRUSTEES, THE USE OF INSTITUTIONAL MANAGERS WITH DIFFERING INVESTMENT STYLES AND CONSOLIDATED PERFORMANCE MONITORING AND TRACKING. THIS NEW PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE AMOUNT NECESSARY TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. This is accomplished by allocating the portfolio mix to the appropriate investments that more accurately match the anticipated maturity of the policies. The Company is currently reallocating the portfolio to achieve a new asset allocation of approximately 65% equity and 35% fixed income. [Emphasis added.] 35. While SCI, and the Individual Defendants disclosed the fact that the Preneed Study had been conducted and boasted of the "new [preneed] investment program" that was to be implemented, they misled investors by failing to disclose the material information they had learned Page 13 14 as a result of the Preneed Study - namely that a significant number of independent funeral homes acquired by SCI had failed to actively manage their mortuary trust assets and, as a result, a material number of SCI's funeral services had been, and would continue to be, performed at significant losses to SCI. 36. Equally misleading was SCI's disclosure concerning the steps the Company was purportedly taking in connection with the implementation of its "new investment program." While the Company's public filings proclaim that this program "targets a real rate of return in excess of the amount necessary to cover future increases in the cost of providing a price guaranteed funeral service as well as any selling costs," the filings did not disclose that this "new investment program" would only be utilized to manage preneed assets acquired by SCI in the future. Nor did defendants disclose the absence of any effective program to manage the assets associated with the previously acquired preneed funeral service contracts. Significantly, the vast majority of the preneed assets that SCI had previously acquired in connection with its purchases of independent funeral homes were not, and would not be, invested in accordance with the terms of the "new investment program." This clearly material fact, as well as the reasons why this was so, were not publicly disclosed. By 1998, SCI's failure to actively manage its mortuary trust assets was having an increasingly negative impact on SCI's profit margin as reflected in the following graph: Page 14 15 FUNERAL SERVICE GROSS MARGIN FY 19 [GRAPH] 37. Rather than disclose the fact that SCI's funeral margins had been, and would continue to be, severely negatively impacted as a result of SCI continually having to perform the non-profitable preneed funerals in its backlog, defendants misled the Class by instead blaming the margin contraction throughout 1998 on a number of other factors including "increased costs," "lower funeral service volume," and "higher personnel and facility costs." Defendants did so in hopes that they could execute their plan to conceal the true cause of the margin squeeze by "burying" the impact of these non-profitable funerals in a "one time charge" as discussed in detail below. Page 15 16 SCI'S NEED TO SECRET ITS IDENTITY RESTRICTS THE COMPANY'S ABILITY TO ACTIVELY MANAGE THE PRENEED ASSETS SCI ACQUIRED WHEN IT PURCHASED THOUSANDS OF INDEPENDENT FUNERAL HOMES 38. In order to profit from the goodwill and long standing reputations of the family-owned independent funeral homes, it was necessary for SCI to refrain from advertising its acquisitions to the public. As an article in the August 28, 1995 edition of The Boston Globe reported, large funeral operators, like SCI, were so successful in hiding their ownership of the formerly independent family-run funeral homes from the public that most consumers failed to notice a change in ownership. The August 28 article stated, "chains prefer to keep the owners on, usually with good pay and benefits, to preserve the operation's family image... Most consumers would never even notice that their local funeral home is now owned by an outside firm." 39. The December 8, 1996 edition of The Boston Globe reported that, although SCI handled roughly one in every 10 funeral arrangements in the United States at this time, its expanding presence had generally gone unnoticed by the public. "When it buys a funeral home, SCI keeps the same name and usually the same management in place. What changes are the backroom operations; vehicle fleets, embalming operations, casket purchases and management are all centralized. " While a December 11, 1996 Seattle Times article entitled, "Big Corporations Shove Aside Mom and Pop" reported SCI and Loewen have been accused of hiding local buyouts hoping to cash in on the good feelings that a locally owned funeral business has accumulated through the years. Thus, with the old name still on the building, family portraits of the founders still in the lobby and the old manager still in his post, many customers won't know they're dealing with a chain. 40. Negative press on the aggressive sales practices engaged in by SCI provided further impetus to conceal SCI's ownership from the local clientele. For example, the July 6, 1996 Page 16 17 edition of The Ledger (Lakeland, FL) reported on the abuse of the elderly by an SCI-owned funeral home. According to this report, two months after performing the funeral service for Mr. Russell Carriere, a salesman from the SCI-operated Glen Abbey Memorial Gardens ("Glen Abbey") repeatedly approached Mr. Carriere's 81-year-old widow and cajoled her into purchasing her own prepaid funeral for an astonishing $132,439, which included a $39,000 casket, and a $52,000 mausoleum. As Mrs. Carriere's niece stated, "They truly preyed on a lonely, weak old woman." A civil suit against SCI and Glen Abbey was filed on behalf of Mrs. Carriere, charging them with coercing Mrs. Carriere, who had been disabled by a stroke, into buying burial services she did not want. 41. Included among the myriad examples of negative publicity were: a. A report in The Arizona Daily Star on January 14, 1996 stated that SCI was singled out by consumers as "providing for minimum disposal without regard for the emotional needs of the family." The report also quoted a source as saying, "Some of the policies put in place locally by SCI decrease the amount of service while maintaining a status quo on cost." b. In a story in the February 15, 1996 Las Vegas Review Journal, it was reported that an SCI-owned funeral home attempted to bury a prominent local businessman in the mausoleum of an unrelated family because, although there was insufficient space for the businessman to have his own mausoleum, the funeral home operator wanted the publicity of having the prominent businessman buried on the premises. c. The Chicago Sun Times reported on April 28, 1996 that two SCI-owned funeral homes employed sales personnel who attempted to persuade bereaved consumers Page 17 18 to buy more expensive caskets by describing more affordable caskets as "public aid" caskets, instead of providing the consumer a price list, as required by law. The reference by the salesperson to "public aid" was designed to create the image that only persons with limited or no assets were buried in the public aid caskets and induce the purchase of a higher-priced casket. According to the report, "Psychology plays an important role in choices made by survivors. Many buyers would feel guilty purchasing a less expensive casket." d. An August 6, 1998 report in The Fort Worth Star Telegram stated that the Texas Funeral Service Commission would consider a recommendation that SCI be fined $450,000 for allowing unsupervised trainees to embalm bodies and failing to advise consumers that the price being charged for embalming was higher than the cost to the funeral home. 42. Because of such criticisms, and SCI's fear of losing clients who learned that the local funeral home was no longer locally owned, SCI's ability to actively manage the preneed trust assets it had acquired was severely hampered. The Company was hampered because it would have been required to disclose its ownership of the funeral homes and control of the preneed trust assets it acquired to future clients in order to advise these clients that these assets would now be actively managed. Doing so meant risking the loss of millions of dollars worth of potentially profitable preneed funeral business. 43. Defendants feared that undertaking such a process would lead to countless contract terminations when customers realized that an organization tarnished by allegations of the outrageous conduct described above was responsible for something as highly sensitive as the customers' future burial services. Moreover, an admission by defendants that customers' funds had long been inactively managed by the local funeral home would serve to criticize the Page 18 19 independent funeral home operators who were well regarded by their clients and thus could lead to even more contract cancellations and loss of business. SCI Attempts To Conceal its Plunging Profit Margins 44. The undisclosed results of the Preneed Study confirmed for the defendants that a significant number of the independent funeral homes acquired by SCI had failed to actively manage their mortuary trust assets and, as a result, a material number of SCI's future funeral services had been, and would continue to be, performed at significant losses, severely cutting into SCI profit margins. 45. Rather than disclosing this clearly material adverse information, defendants embarked upon a campaign to conceal the truth about increasing number of unprofitable prearranged funerals SCI was performing, the Company's growing backlog of inadequately funded acquired preneed funeral contracts, and the increasingly adverse impact these factors were having, and would continue to have, on SCI's profit margins and earnings. The first step in this campaign was the public dissemination of materially misleading and incomplete information falsely representing that SCI was actively managing its preneed mortuary trust assets to ensure sufficient funds to cover or exceed costs for performing contractually prearranged funerals. In fact, there was no active management by SCI of the vast majority of the preneed trust assets it had amassed through its aggressive acquisitions of funeral homes over the last decade. 46. As part of its scheme to conceal the true facts about the adverse impact of SCI's multi-billion dollar backlog of preneed funeral contracts on SCI profit margins, the defendants misleadingly touted the implementation of their so-called "new investment program," described in detail above, without disclosing that the "new investment program" did not address the Page 19 20 enormous and growing backlog of preneed mortuary trust assets acquired in SCI's purchases of funeral private homes, which were laying virtually dormant in CD's, unable to grow sufficiently to cover the costs to SCI of providing the associated contractually prearranged funeral services. 47. Defendants' false and misleading representations that SCI was, in fact, actively managing its backlog of acquired preneed trust assets was reinforced when, at the beginning of the Class Period in July, 1998, the defendants publicly announced the creation of SCI Financial Services, Inc., a subsidiary which would purportedly actively manage SCI's preneed trust assets. 48. Because defendants could not afford the time and expense involved in building this new subsidiary from the ground up, SCI sought quickly to establish this new organization and did so by purchasing two operating businesses, each of which had extensive experience in preneed asset management. The first acquisition involved SCI's purchase of American Memorial Life Insurance Company ("AML" or "American Memorial") and the second acquisition involved the purchase of Equity Corporation International ("ECI"). 49. The purchase of these two organizations provided SCI for the first time with an organizational infrastructure for managing the Company's preneed business. 50. The purchase of ECI is of particular significance because ECI, unlike SCI, already had established, and fully disclosed the existence of, a financial management system which ensured that its customers' preneed investments, or the funeral insurance coverage obtained, would be sufficient to cover adequately the costs of prearranged funeral services. In its Form 10-K for the fiscal year ending December 31, 1997 filed with the SEC on or about March 30, 1998 (the "ECI 1997 Form 10-K"), ECI reported: Page 20 21 Insurance policies intended to fund preneed funeral contracts cover the original contract price AND GENERALLY INCLUDE BUILT-IN ESCALATION CLAUSES DESIGNED TO OFFSET FUTURE INFLATIONARY COST INCREASES. [Emphasis added.] Moreover, the ECI 1997 Form 10-K stated: Earnings on trust funds increase the amount of cash to be received by the Company at the time the funeral service is performed AND HISTORICALLY HAVE ALLOWED THE COMPANY TO ADEQUATELY COVER THE INFLATIONARY INCREASE IN COSTS OF FUNERAL SERVICES. [Emphasis added.] 51. ECI also recognized the high financial risk posed by the preneed funeral business and took protective measures accordingly. In its Form 10-K for fiscal year ending December 31, 1996, filed with the SEC on or about March 27, 1997 (the "ECI 1996 Form 10-K"), ECI succinctly recognized the risk of overextending preneed funeral sales absent careful financial management of the mortuary trusts: Aggressive preneed funeral sales are frequently associated with highly competitive market areas or are utilized to rapidly build market share and generally require that funeral contracts be sold at a discount to at need sales prices. 52. In response to the risks, ECI employed independent financial institutions to manage this risk. Both the ECI 1996 Form 10-K and ECI's Form 10-K for fiscal year ending December 31, 1995, filed with the SEC on or about March 25, 1996 (the "ECI 1995 Form 10-K") stated that ECI had: ...established a variety of trusts in connection with its funeral home and cemetery operations as required under applicable state law. Such trusts include (i) preneed funeral trusts, (ii) preneed cemetery merchandise trusts and (iii) perpetual care trusts. These trusts are typically administered by independent financial institutions selected by the Company. The Company also uses independent professional managers to advise the Company on investment matters. 53. The lack of disclosure regarding the Preneed Study in SCI's public filings is striking when compared to the disclosures made by ECI. While ECI disclosed that its insurance Page 21 22 policies included "built-in escalation clauses" and that earnings on its trust funds "have allowed [it] to adequately cover the inflationary increase in costs of funeral services," SCI remained silent on these points. The reason for SCI's omissions is clear: the Preneed Study confirmed that SCI's trust funds had not been managed to grow at a rate equal to or greater than the increase in the costs of funeral services. 54. Neither the establishment of SCI Financial Services, Inc. nor the so-called "new investment program," however, addressed SCI's multi-million dollar backlog of unprofitable preneed funeral contracts whose related mortuary trust assets lay virtually dormant in certificates of deposit, and other under-performing investments unable to grow sufficiently to cover the costs of performing funeral services in the future. 55. Defendants had been able to deceive the Class as to the primary - and continuing - reason for SCI's funeral service gross margin contraction during the first three quarters of 1998 by pointing to declining death rates in North America, higher costs and lower volumes of funerals throughout the industry. In addition, defendants were able to carefully "manage" SCI's reported 1998 second and third quarter earnings by, inter alia, their aggressive acquisition program which provided SCI fresh sources of revenue, including, for example, the purchase of American Memorial Life Insurance in the third quarter of 1998. However, defendants knew that SCI's deteriorating funeral service profit margins would inevitably impact reported earnings, the all important indicia of SCI's financial condition for the investing public; and that SCI's fiscal year end would soon bring about a day of reckoning. Accordingly, defendants desperately needed to find and a new way to conceal the impact that the continued performance of these unprofitable funerals was having on the Company's profitability. Page 22 23 56. According to knowledgeable former employees, by November 1998, the Individual Defendants knew that SCI's fourth quarter 1998 earnings would fall at least between $.08 to $.10 below analysts' estimates. The Individual Defendants were also aware, by virtue of their receipt of daily, weekly and monthly profit/loss reports via the Company's "Falcon" system from each of the Company's domestic funeral homes, that this shortfall resulted from SCI's performance of a material number of unprofitable preneed funerals, as well as undisclosed changes in SCI's costs. Other senior executives were also aware of this impending shortfall and the reasons for it, and openly discussed how to hide the shortfall from investors and how they and the Individual Defendants planned to "bury" this shortfall in a one-time charge that SCI planned to take in connection with its acquisition of ECI. All were well aware that the success of their plan hinged on their ability to close the ECI acquisition during the fourth quarter of 1998 so that SCI could take this one-time charge in the fourth quarter and close the ECI transaction without having to disclose the true reasons for the Company's earnings shortfall. 57. Defendants' scheme was foiled, however, when the United States Federal Trade Commission (the "FTC"), which was required to approve SCI's purchase of ECI, refused to allow SCI to close the ECI transaction until SCI had divested itself of certain funeral homes in numerous locations around the country. 58. In particular, the FTC conditioned its approval on SCI's sale of 19 funeral homes and cemetery properties located in 14 markets, primarily in the southern, western and mid-western parts of the United States, to Carriage Service Inc., another Texas-based funeral home consolidator. Under the consent agreement reached with the FTC, SCI would be permitted to acquire ECI, but only after divesting specified properties within seven days of the FTC's order. Page 23 24 59. SCI was unable to divest itself of these properties in time to obtain FTC approval to close the ECI transaction in the fourth quarter of 1998. As a result, SCI was unable to "bury" the earnings shortfall, which by the end of the fourth quarter had nearly doubled to $.19 to $.20 per share, in an acquisition charge as defendants had planned because the Merger did not close until after the end of the fourth quarter. 60. Evidencing the degree of scienter with which defendants acted, defendants nonetheless proceeded to close the ECI transaction without ever disclosing to ECI or the Class that SCI would report a drastic shortfall in its 1998 fourth quarter earnings. 61. Defendants did so despite the fact that the Agreement and Plan of Merger By and Among Service Corporation International, SCI Delaware Funeral Services, Inc. and Equity Corporation International, dated August 6, 1998 (the "Merger Agreement") required SCI to disclose to ECI its poor performance during the fourth quarter of 1998 at any time at which it could reasonably be anticipated that such poor performance could have an adverse financial impact on SCI. Under the Merger Agreement, ECI would have had the right to terminate the Merger Agreement if SCI's poor fourth quarter results had been disclosed prior to the closing of the Merger. The fourth quarter results constituted material adverse information known to defendants which defendants had a duty to disclose in connection with the Merger. 62. The Registration Statement/Prospectus SCI filed with the SEC incorporated the entire executed Merger Agreement. The Registration Statement/Prospectus at page 6 stated: "The Merger Agreement is attached hereto as Appendix A and incorporated herein by reference." 63. Article IV of the Merger Agreement is entitled "Representations and Warranties of Parent and Merger Sub." Section 4.7 of Article IV is entitled "Absence of Certain Changes Page 24 25 Or Events" and provides, with respect to SCI, that "there has not been any event, occurrence, development or state of circumstances or facts which has had, or could reasonably be anticipated to have, individually or in the aggregate, a Material Adverse Effect." 64. Section 10.10 of the Merger Agreement, entitled "Certain Definitions," defines Material Adverse Effect as: any event, occurrence, fact, condition, change, development or effect that is or could reasonably be anticipated to be materially adverse to the business, assets (including intangible assets), liabilities, financial condition, results of operations, properties (including intangible properties) or business prospects of the Company and all of its Subsidiaries or the Parent and all of its Subsidiaries, as applicable, taken as a whole.... 65. Section 8.2 of the Merger Agreement, entitled "Conditions To Obligation Of [ECI] To Effect The Merger," establishes as a condition for consummating the Merger that the representations and warranties made by SCI in the Merger Agreement shall continue to be true up to and including the day on which SCI's shares are exchanged for ECI's shares. Section 8.2(a) provides: the representations and warranties of [SCI] and Merger Sub contained in this Agreement shall be true and correct in all material respects (or in all respects in the case of any representation or warranty containing any materiality qualification) on and as of the date made and on and as of the Closing Date as if made at and as of such date, and the Company shall have received a certificate executed on behalf of Parent by the President or a Vice President of Parent and on behalf of Merger Sub by the President and Chief Executive Officer or a Vice President of Merger Sub to that effect. 66. Under the terms of the Merger Agreement, ECI had the right to terminate the Merger Agreement at any time prior to January 19, 1999 if a Material Adverse Event existed at SCI. Article IX of the Merger Agreement, entitled "Termination, Amendment And Waiver," provides: Page 25 26 [t]his Agreement may be terminated at any time prior to the Effective Time, whether before or after approval by the stockholders of the Company...if the representations and warranties of Parent and Merger Sub shall fail to be true and correct in all material respects (or in all respects in the case of any representation or warranty containing any materiality qualification) on and as of the date made or, except in the case of any such representations and warranties made as of a specified date, on and as of any subsequent date as if made at and as of subsequent date and such failure shall not have been cured in all material respects (or in all respects in the case of any representation or warranty containing any materiality qualification) within 30 days after written notice of such failure is given to [SCI] by [ECI]. 67. Defendants were well aware that disclosure of the adverse financial conditions at SCI related to its unprofitable preneed business would lead to the termination of the Merger by ECI or to a renegotiation of the transaction so that SCI would potentially have to double the number of shares issued in order to acquire ECI. This was a risk the defendants were not willing to take. 68. Under the terms of the Merger Agreement, SCI would acquire all of ECI's common stock through a stock-for-stock transaction that would result in ECI shareholders receiving $27 per share in SCI common stock. The number of shares of SCI stock to be issued to ECI shareholders was to be determined based on the average trading price of SCI common stock for the ten day trading period ending on the third day prior to the closing of the Merger, provided that such price was not less than $34 and not more than $41.50 per share. The Merger Agreement provided that if the average trading price of SCI's common stock was less than $34 per share, then 0.79412 shares of SCI common stock would be exchanged for each share of ECI common stock. The Merger Agreement provided that if the average trading price of SCI's common stock was greater than $41.50 per share, then 0.65050 shares of SCI common stock would be exchanged for each share of ECI stock declined, provided, however, that if SCI's common stock was trading at Page 26 27 a price above or below the price "collar" identified in the Merger Agreement SCI shares would be exchanged for the outstanding ECI shares at fixed floor and ceiling ratios. 69. The original Merger Agreement provided that if the average trading price for a share of SCI common stock fell below $34, then SCI would exchange 0.79412 SCI shares for each ECI share. In exchange for raising the asset divestiture limit, SCI required an amendment to the Merger Agreement that provided that if the average trading price for a share of SCI stock prior to the closing was below $38 per share, then SCI would exchange 0.71053 SCI shares for each ECI share. This reduced the maximum number of SCI shares payable to ECI shareholders from 17,298,472 to 15,477,614. 70. Defendants' audacity, however, is perhaps best highlighted by the fact that, at some point after the FTC began its review of the Merger, representatives from SCI started to discuss raising the Merger Agreement's limit on assets that SCI would be required to divest as a condition for the Merger. SCI used this opportunity to negotiate for a lower purchase price to be paid to ECI in exchange for agreeing to divest assets having aggregate 1997 revenue of up to $20 million, by demanding that ECI agree to lower the maximum number of SCI shares to be exchanged for ECI's outstanding shares. 71. On December 14, 1998, SCI and ECI amended the Merger Agreement to raise the asset divestiture revenue limit to $20 million and to reduce the maximum SCI shares exchangeable for ECI shares. When the Merger closed on January 19, 1999, the average trading price of a share of SCI was below $38, triggering the re-negotiated maximum exchange ratio. Remarkably, defendants renegotiated the consideration to be received by ECI shareholders with knowledge of SCI's impending earnings shortfall and never disclosed it, despite having warranted that there had Page 27 28 been no such adverse development at the Company. Indeed, December 14 was only 12 business days prior to the end of SCI's fourth quarter for 1998, by which time the Individual Defendants were well aware that SCI's preneed business would lead to a material earnings shortfall for the fourth quarter. They were made aware, in part, by the SCI proprietary computer systems known as the "Falcon" system, which provided profit and loss information for every domestic funeral home owned by SCI directly to SCI corporate headquarters electronically on a next-day basis. However, this information was never disclosed to ECI shareholders and the Class until after the Merger was completed. DEFENDANTS' MATERIALLY FALSE AND MISLEADING STATEMENTS AND MATERIAL OMISSIONS DURING THE CLASS PERIOD 72. Throughout the Class Period, defendants acted negligently, recklessly or intentionally by omitting to disclose material information concerning SCI and by issuing a series of materially false and misleading statements concerning the Company's financial condition and preneed funeral business. Defendants' misconduct caused the price of the Company's securities to become and remain artificially inflated (artificially depressed in the case of put options) throughout the Class Period, and ultimately resulted in millions of dollars in damages being incurred by Class members. Defendants' materially false and misleading statements, and the reasons why such statements were materially false and misleading, are set forth below. 73. On July 17, 1998, SCI issued a materially false and misleading press release that bore the headline, Service Corporation International Buys Pre-need Insurance Division of American Annuity Group and Forms New Financial Services Subsidiary. Defendant Champagne was listed as the "contact" person for the press release. The release stated in relevant part: Page 28 29 Service Corporation International (NYSE: SRV) ("SCI"), the world's largest funeral and cemetery company, announced today that it will acquire the pre-need funeral services division of American Annuity Group Inc. (NYSE: AAG) ("AAG") of Cincinnati, Ohio for $164 million cash. * * * SCI HAS FORMED A NEW FINANCIAL SERVICES SUBSIDIARY, SCI FINANCIAL SERVICES, INC., TO FACILITATE THE EXPANSION OF SCI'S PRE-NEED BUSINESSES AND FINANCIAL ACTIVITIES WORLDWIDE. The new company's operations will include prearranged funeral marketing, funeral and cemetery trust administration, investment management, life insurance operations and the lending activities of Provident Services, Inc., an existing SCI subsidiary which provides capital financing for independent funeral home and cemetery operations. SCI FINANCIAL SERVICES WILL COORDINATE THE INVESTMENT OF OVER $3 BILLION OF PRE-NEED FUNERAL TRUST AND INSURANCE ASSETS AND OVER $1 BILLION IN CEMETERY TRUST ASSETS, DIRECT THE MARKETING FOR OVER $700 MILLION IN ANNUAL FACE AMOUNTS OF PREARRANGED FUNERAL SALES, ADMINISTER OVER ONE MILLION PRE-NEED FUNERAL TRUST AND INSURANCE CONTRACTS AND OVERSEE A FINANCE OPERATION WITH A LOAN PORTFOLIO IN EXCESS OF $250 MILLION. [Emphasis added.] 74. The foregoing statements were intended to, and did, misrepresent to the investing public the false and misleading information that the formation of SCI Financial Services, Inc. would result in the active and effective investment of SCI's existing and future pre-need funeral trust assets to ensure SCI's revenues and earnings from its pre-need funeral business, which the statements also falsely implied was financially healthy and profitable. The Company and the Individual Defendants failed, however, to disclose the following facts, known to or recklessly disregarded by the defendants when the press release was issued, that rendered the statements in the press release materially false and misleading when made: (a) the Individual Defendants knew from the Preneed Study that a material number of the independent funeral homes acquired by SCI throughout the 1990s had failed to actively manage their mortuary trust assets to ensure that such assets would equal or exceed the Page 29 30 cost of providing the prearranged guaranteed price funerals SCI was contractually obligated to provide, and, as a result, a material number of SCI's funeral services had been, and would continue to be, performed at significant losses; (b) SCI's funeral profit margins were being, and were going to continue to be severely eroded as a result of having to perform prearranged funeral services at costs not covered by the mortuary trust assets dedicated to those funeral services as a result of the failure by SCI to establish any means to actively or effectively invest its existing mortuary trust assets, including those from funeral homes acquired by SCI, to improve the rates of return on or growth of those assets, and, as a result, SCI had performed, and would continue to perform, a material number of prearranged funeral services at significant losses; (c) far from establishing SCI Financial Services, Inc. "to facilitate the expansion of SCI's pre-need business and financial activities worldwide," as defendants claimed, the creation of this subsidiary marked the first time in SCI's history that the Company had implemented any concrete steps to actively manage at least a portion of its preneed trust assets. Prior to the creation of this subsidiary, and notwithstanding defendants' earlier representations about a "new investment program," no individual or organization at SCI had been responsible for actively managing those assets; (d) SCI Financial Services, Inc. would not be involved in managing of the vast majority SCI's existing multi-billion dollar backlog of preneed mortuary trust assets acquired in SCI's funeral home acquisitions, which would continue to be invested in dormant, underperforming interest bearing vehicles, such as bank CD's; Page 30 31 (e) American Memorial was being acquired to provide SCI with a vehicle to begin to actively manage preneed assets going forward, in order to blunt the ongoing drastic adverse impact that the under-performance of SCI's preexisting mortuary trust assets was having on SCI's profitability, but (f) SCI's "new investment program," which was purportedly implemented in 1997 in order to "target a real return in excess of the amount necessary to cover future increases in the cost of providing a price guaranteed funeral service as well as any selling costs," was not actively managing the vast majority of the preneed trust assets SCI had acquired by purchasing independent funeral homes. Indeed, SCI was unable to actively manage these preneed trust assets because doing so would have required SCI to step out of the shadows and identify itself as the true owner of thousands of funeral homes across the country and internationally and would cause existing and future customers to seek out other locally-owned funeral homes when they learned that what they believed was a locally-owned funeral home was actually owned by SCI, the world's largest funeral home conglomerate. 75. On July 18, 1998, the Houston Chronicle published an article entitled, SCI To Get Into Funeral Insurance; Houston Giant To Buy 'Final Expense' Business. This article discussed SCI's acquisition of American Memorial and quoted defendant Waltrip as stating: "SCI is a world leader in the provision of high-quality funeral and cemetery services," said R.L. Waltrip, SCI chairman and chief executive officer. "This acquisition enables SCI to directly respond to the increased demand for alternative methods for paying for these services." * * * "SCI's longstanding relationship with American Memorial makes them the logical choice to drive our expansion into the preneed insurance business," Waltrip said. The way SCI sees it, the acquisition is a way for it to expand its profit Page 31 32 base. Not only will it make money arranging funerals, but it will also collect the insurance premiums people pay for final-expense insurance, Heiligbrodt said. "Our goal is to pick up two profits," he said. "The money we're spending is buying new profits and generating new future profits." "WE'RE ADDING ANOTHER DIMENSION TO MAKE SURE WE'RE PICKING UP ALL THE VALUE WE CAN FOR OUR SHAREHOLDERS," Heiligbrodt said. SCI sells about $700 million of prearranged funerals a year worldwide, he said. [Emphasis added). 76. The foregoing statements were materially false and misleading at the time they were made and were intended to, and did, convey to the investing public the false impression that SCI was in the midst of a profitable "expansion into the pre-need insurance business," and that SCI's acquisition of American Memorial was undertaken to build on and increase the profitability of its existing preneed "profit base." In fact, as defendant Waltrip knew, or recklessly disregarded, SCI's profitability was being severely undercut by its existing backlog of preneed funeral contracts, and the acquisition of American Memorial and planned expansion into preneed insurance was not "a way to expand [SCI's] profit base," nor an effort to "make sure we're picking up all the value we can for our shareholders." Instead, the acquisition of American Memorial was an attempt to obtain new sources of revenue to mask the growing reductions in SCI's overall profit margins caused by having to provide unprofitable prearranged funerals pursuant to SCI's existing and acquired preneed contracts, and to ensure that going forward SCI would not be saddled with even more dormant and underperforming mortuary trust assets that could not cover the costs of prearranged funerals. 77. The foregoing statements by defendant Waltrip were also false and misleading because of the failure to disclose the facts set forth in Paragraph 74(a)-(f) above, which were necessary to Page 32 33 make the statements Waltrip made about SCI's acquisition of American Memorial and expansion into the preneed insurance business not false and misleading. 78. On July 23, 1998, SCI issued a materially false and misleading press release that bore the headline, Service Corporation International Reports Net Income up 15% and EPS up 13% for Second Quarter. Defendant Champagne was listed as the "contact" person on the press release. The release stated in relevant part: Service Corporation International (NYSE: SRV) ("SCI"), the world's largest funeral and cemetery company, today reported record second quarter revenues and earnings. For the three months ended June 30, 1998, the company reported revenues of $671.9 million, net income of $90.9 million and diluted earnings per share of $.35 ($.36 basic). This represents a 11.8 percent increase in revenues, a 15.4 percent increase in net income and a 12.9 percent increase in diluted earnings per share (9.1 percent basic) when compared to the second quarter of 1997. "Strong North American cemetery results contributed impressively to our quarterly earnings growth, MORE THAN OFFSETTING THE EFFECT ON THE FUNERAL SEGMENT OF LOWER THAN EXPECTED NORTH AMERICAN MORTALITY RATES. FUNERAL VOLUMES IMPROVED IN JUNE AFTER EXPERIENCING UNUSUALLY WEAK VOLUMES IN APRIL AND MAY," said R. L. Waltrip, SCI's Chairman and Chief Executive Officer. *** Commenting on the results, L. William Heiligbrodt, SCI's President and Chief Operating Officer said, "FLUCTUATIONS IN MORTALITY RATES PRESENT OPERATIONAL CHALLENGES OVER CERTAIN TIME PERIODS; however, THE FUNDAMENTALS OF THE FUNERAL SERVICE INDUSTRY REMAIN STRONG. Our properties include MANY OF THE PREMIER FUNERAL BUSINESSES IN MAJOR METROPOLITAN MARKETS around the world, providing excellent opportunities for growth. OUR NEWLY FORMED FINANCIAL SERVICES GROUP AND ITS ACQUISITION OF AMERICAN MEMORIAL LIFE INSURANCE COMPANY WILL INCREASE OUR PREARRANGED FUNERAL MARKETING EFFORTS, PROVIDING FOR FUTURE FUNERAL VOLUME TO MAINTAIN OUR CONSISTENT PERFORMANCE." *** During the second quarter of 1998, sales of prearranged funeral contracts were approximately $138.9 million, WHICH EXPANDED THE BACKLOG OF PREARRANGED Page 33 34 FUNERAL CONTRACTS TO BE SERVICED IN FUTURE PERIODS TO APPROXIMATELY $3.3 BILLION. [Emphasis added.] 79. The foregoing statements were materially false and misleading at the time they were made because, as defendants SCI, Waltrip, Heiligbrodt and Champagne knew, or recklessly disregarded, and failed to disclose: (a) the financial results of SCI's funeral segment was being adversely effected by the increasing number of unprofitable prearranged funeral services SCI was performing, not by "lower . . . mortality rates" or "weak volumes;" (b) the principal operational "challenge" facing SCI was not "[f]luctuations in mortality rates," but the multi-million dollar backlog of passive underperforming preneed mortuary trust assets; (c) SCI's "newly formed financial services group [SCI Financial Services, Inc.]" was not addressing the known and growing deterioration in SCI's funeral services profit margins caused by its backlog of preneed mortuary trust assets invested in passive, low return bank CDs and similar investment vehicles; and (d) SCI Financial Services, Inc. and the acquisition of American Memorial were part of SCI's attempt to begin to actively manage the investment of future preneed mortuary assets, not the "expanded ... backlog" of existing preneed funeral contracts, nor was SCI in any manner seeking to "maintain [the] consistent performance" of its multi-billion dollar backlog of preneed funeral contracts, but, to the contrary, was actively concealing the increasingly unprofitable performance of that segment of its business. 80. On August 6, 1998, SCI issued a materially false and misleading press release that bore the headline, Service Corporation International Announces Definitive Agreement for Merger Page 34 35 With Equity Corporation International. Defendant Champagne was listed as a "contact" person on the press release. The release stated in relevant part: Service Corporation International (NYSE: SRV)("SCI"), the world's largest funeral and cemetery company, announced today that it has reached a definitive agreement with Equity Corporation International (NYSE: EQU)("ECI") to form a business combination between the two companies. ECI, the nation's fourth largest publicly traded death care company, based in Lufkin, Texas, currently owns and operates 326 funeral homes and 81 cemeteries in 35 states and one Canadian province. The combination would occur through a stock-for-stock transaction that would result in ECI shareholders receiving $27 per share in SCI stock. The actual number of shares of SCI stock to be issued to the ECI shareholders will be determined based on the average SCI stock price for the ten (10) consecutive trading days ending on the third trading day prior to the closing of the merger. The average price of SCI stock used in computing the exchange will not be less than $34.00 and no more than $41.50 per share. *** In explaining the transaction, Robert L. Waltrip, Chairman of the Board and Chief Executive Officer of SCI said, "The merger will create a combined North American operation with unparalleled resources servicing both the metropolitan and rural markets throughout the country. The addition of ECI and its exceptional revenue growth rate should further enhance SCI's leading domestic market position." *** L. William Heiligbrodt, President and Chief Operating Officer of SCI noted, "The addition of ECI's properties opens SCI and its newly formed financial services division to the North American rural market, providing an expanded network and infrastructure through which we can better service both out prearranged and at-need families. Additional synergies should result from consolidating our operations and through further leveraging our cost structure." *** 81. The foregoing statements were materially false and misleading at the time they were made because defendants SCI, Waltrip and Heiligbrodt knew, or were reckless in not knowing, and failed to disclose that: Page 35 36 (a) the acquisition of ECI was part of SCI's attempt to establish, belatedly, a means to actively manage its preneed mortuary trust assets in order to ensure that its own future sales of preneed funeral contracts would not result in the kind of unprofitable funeral services increasingly generated by a substantial portion of SCI's existing multi-billion dollar preneed backlog; and (b) SCI's "leading domestic market position" was largely the result of SCI's acquisition of private funeral homes, and of their poorly invested preneed mortuary trust assets, which, at the time the statements were made, were severely cutting into SCI's profit margins. 82. On August 7, 1999, the Houston Chronicle published an article entitled, SCI Will Buy Rural-Market Equity Corp.; $588 Million Deal a Reunion For The Two Firms. This article discussed SCI's acquisition of ECI, quoted defendants Waltrip and Heiligbrodt, and stated in relevant part: Service Corporation International, the world's largest funeral company and one of the largest firms in Houston, is buying a Lufkin-based company [ECI] specializing in buying and operating funeral homes in rural areas and small cities. *** "The merger will create a combined North American operation with unparalleled resources servicing both the metropolitan and rural markets throughout the country," Service Corp. Chairman Robert L. Waltrip said in a written statement. "The addition of ECI and its exceptional revenue growth rate SHOULD FURTHER ENHANCE SCI'S LEADING DOMESTIC MARKET POSITION." *** "THEY HAVE A VERY GOOD MANAGEMENT TEAM. THEY OPERATE THEIR BUSINESS VERY WELL," Heiligbrodt said. "THEY SEE THINGS LIKE WE DO. THEIR OPERATIONAL SYSTEMS ARE VERY SIMILAR TO OURS. WE KNOW EACH OTHER VERY WELL. IT IS ONE OF THE SAFEST ACQUISITIONS A COMPANY LIKE SCI COULD DO." [Emphasis added.] Page 36 37 83. The foregoing statements were materially false and misleading at the time they were made because defendants SCI, Waltrip and Heiligbrodt knew, or were reckless in not knowing, and failed to disclose: (a) the facts set forth in Paragraph 81(a) and (b), above; and (b) that ECI's "operational systems" were fundamentally different from SCI's systems in that ECI, unlike SCI, had an established program to actively manage its preneed mortuary assets to ensure that the funds available from those assets would cover or exceed the cost of providing guaranteed price preneed funeral services in the future. 84. On August 11, 1998, a death care industry journal entitled Death Care Business Advisor published an article entitled SCI Acquires American Annuity Group, Moves Into Preneed Services. This article, which discussed SCI's acquisition of American Memorial, contained extensive quotes from defendant Champagne that echoed many of the false and misleading representations about SCI's business and plans which began with the July 17, 1998 announcement of SCI's acquisition of American Memorial. Defendant Champagne was quoted as commenting on the American Memorial acquisition as follows: "It's a new focus on our part," confirmed SCI Senior VP/CFO George Champagne. He called the acquisition a "logical fit," citing SCI's history in the prearranged funeral business. "WE'VE LONG BEEN THE LEADERS IN THE PREARRANGED FUNERAL BUSINESS," he claimed. SCI has been seeking ways, to increase its market share, according to Champagne. "THE MOST COMPELLING WAY TO DO THAT IS TO INCREASE THE LEVEL OF THE PREARRANGED FUNERAL BUSINESS," HE OFFERED. "THE ACQUISITION OF AMERICAN MEMORIAL GIVES US THE ABILITY TO FUND OUR PREARRANGED BUSINESS." *** "YOU'RE EFFECTIVELY BUILDING YOUR BACKLOG OF FUNDING FOR PREARRANGED FUNERALS," WHICH HAS THE EFFECT OF EXPANDING OR MAINTAINING SCI'S Page 37 38 PREARRANGED FUNERAL BUSINESS, EXPLAINED CHAMPAGNE. "THAT IS A VERY IMPORTANT ASPECT TO A COMPANY LIKE SCI. THERE IS A LOT OF COMPETITION FOR PREARRANGED FUNERAL BUSINESS." Thus the acquisition of AAG's funeral services division, he said, will allow SCI to better compete for and serve customers. [Emphasis added.] 85. The foregoing statements made by Champagne were materially false and misleading because they failed to disclose facts that Champagne knew or recklessly disregarded, and that were necessary to make the statements accurate and truthful when made, including that: (a) the acquisition of American Memorial was part of defendants' scheme to conceal the sharply adverse effects on SCI's profit margins caused by the multi-million dollar backlog of inadequately funded and/or dormant and underperforming mortuary trust assets; (b) SCI's position as a "leader in the prearranged funeral business" was gained through the acquisition of small, private funeral homes that brought with them dormant and underperforming mortuary trust assets that were, and continued to be, inadequate to cover the costs of the related guaranteed price prearranged funerals SCI was obligated to provide; (c) SCI's acquisition of American Memorial did not, and would not give it "the ability to fund [its] prearranged business" because that business included large numbers of preneed funeral contracts funded by inadequate and/or dormant and underperforming mortuary trust assets; and (d) SCI's "competition for prearranged funeral business," such as ECI, had taken steps to actively manage their mortuary trust assets and were thus not subject to the drastic decreases in profit margins plaguing SCI. 86. In that August 11, 1998 article, Champagne was also quoted as stating: Lastly, Champagne reminded that in the early 1980s SCI was in the insurance business. "We owned Family Services Life Insurance Company.... At the time," he continued, "SCI WAS A MUCH Page 38 39 SMALLER COMPANY. WE DID NOT HAVE THE INFRASTRUCTURE OF FUNERAL HOMES ACROSS THE COUNTRY." Then, in 1989, SCI made "a strategic decision to exit that portion of the business," said Champagne. "We couldn't support the insurance organization that was predominantly selling insurance for independent funeral homes." TODAY, THOUGH, AS THE DOMINANT FUNERAL SERVICES PROVIDER IN THE INDUSTRY, "WE'VE GOT THE INFRASTRUCTURE ACROSS THE COUNTRY," Champagne said. *** Citing the company's record [1998] second-quarter earnings, with net income reportedly up 15 percent and earnings per share up 13 percent, CHAMPAGNE SAID SCI IS PLEASED WITH THE RESULTS "IN THE FACE OF WHAT HAS COME TO BE WEAK FUNERAL VOLUMES CAUSED BY A LOWER DEATH RATE SCENARIO IN NORTH AMERICA IN THE SECOND QUARTER." BUT THE COMPANY DOESN'T EXPECT THAT TREND TO CONTINUE. "WE DON'T THINK IT'S A CONTINUING PHENOMENON," CHAMPAGNE SAID. "THAT'S ONE THING ABOUT THE FUNERAL BUSINESS. IT'S PREDICTABLE, CONSISTENT AND SUSTAINABLE OVER A LONG PERIOD OF TIME. IN ANY THREE-MONTH PERIOD YOU'RE GOING TO HAVE FLUCTUATIONS. THE CHALLENGE IS TO MANAGE THROUGH THOSE FLUCTUATIONS." *** "OUR ACQUISITION ACTIVITY CONTINUES AT A VERY STRONG PACE RIGHT NOW," SAID CHAMPAGNE. "WE'RE ON TARGET TO ACQUIRE BETWEEN 280 MILLION AND 300 MILLION OF ANNUALIZED REVENUES, of which probably 50 percent to 60 percent of that will be from international sources." [Emphasis added.] 87. These additional statements were also materially false and misleading at the time they were made because defendant Champagne, knew, or was reckless in not knowing, and failed to disclose that: (a) SCI's "infrastructure of funeral homes around the country" included a material number of formerly privately owned funeral homes that brought with them inadequately funded and/or dormant and underperforming mortuary trust assets; Page 39 40 (b) SCI's position as the "dominant funeral services provider" was obtained through the acquisition of a material number of formerly private funeral homes with inadequately funded and/or dormant and underperforming mortuary trust assets; (c) SCI's weakness in the second quarter was the result of the unprofitability of prearranged guaranteed price funeral services performed pursuant to inadequately funded and/or dormant and underperforming mortuary trust assets, and not "weak volumes caused by a lower death rate scenario"; and (d) SCI's acquisition activities were continuing "at a very strong pace" because of the urgent need to "purchase" revenue to disguise the fundamental and growing problems caused by the Company's enormous backlog of inadequately funded and/or dormant and underperforming mortuary trust assets. 88. On August 14, 1998, SCI filed its Form 10-Q for the quarter ended June 30, 1998 with the SEC (the "1998 Q2 Form 1O-Q"). The 1998 Q2 Form 10-Q was also incorporated by reference into the Registration Statement/Prospectus for SCI's acquisition of ECI, filed on November 19, 1998. The 1998 Q2 Form 10-Q was signed by defendant Champagne and contained the following materially false and misleading statements in Note 4 to the Consolidated Financial Statements: Prearranged Funeral Activities The Company sells price guaranteed prearranged funeral contracts through various programs providing for future funeral services at prices prevailing when the agreements are signed. Payments under these contracts are generally placed in trust accounts (pursuant to applicable law) or are used to pay premiums on life insurance policies [issued by third party insurers] ... Trust earnings and increasing insurance benefits are accrued and deferred until the service is performed, at which time these funds are also recognized in funeral revenues Page 40 41 and are intended to cover future increases in the cost of providing a price guaranteed funeral service.... [Emphasis added.] 1998 Q2 Form 10-Q at 7-8. 89. The foregoing statements were materially false and misleading when made because SCI and the Individual Defendants knew, or were reckless or negligent in not knowing, and failed to disclose that: (a) SCI's backlog of prearranged funeral contracts included a material number of contracts that were not sold "at prices prevailing when the agreements [were] signed," but at discounts to those prices; and (b) The funds from many of SCI'S mortuary trusts did not "cover" or exceed the cost of their related price guaranteed funeral services, and, as a result, SCI was and would continue to experience drastically deteriorating profit margins in its funeral service business. 90. The 1998 Q2 Form 10-Q also stated in the Management's Discussion and Analysis of Financial Condition ("MD&A") section, that: Prearranged Funeral Services The Company has a marketing program to sell prearranged funeral contracts and the funds collected are generally held in trust or are used to purchase life insurance or annuity contracts. The principal amount of each such prearranged funeral contract will be received in cash by a Company funeral service location at the time the funeral is performed. EARNINGS ON TRUST FUNDS AND INCREASING BENEFITS UNDER INSURANCE AND ANNUITY FUNDED CONTRACTS ALSO INCREASE THE AMOUNT OF CASH TO BE RECEIVED UPON PERFORMANCE OF THE FUNERAL AND ARE INTENDED TO COVER FUTURE INCREASES IN THE COST OR PROVIDING A PRICE GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. DURING 1997, THE COMPANY COMPLETED A REVIEW OF THE PREARRANGED TRUST INVESTMENT PROCESS WHICH INCLUDED AN ASSET/LIABILITY STUDY. THIS HAS RESULTED IN A NEW INVESTMENT PROGRAM WHICH ENTAILS THE CONSOLIDATION OF MULTIPLE TRUSTEES, THE USE OF INSTITUTIONAL MANAGERS WITH DIFFERING INVESTMENT STYLES AND CONSOLIDATED PERFORMANCE MONITORING AND TRACKING. THIS NEW PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE AMOUNT NECESSARY TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. ...[Emphasis added.] Page 41 42 1998 Q2 Form 10-Q at 19-20. 91. The foregoing statements were materially false and misleading at the time they were made because SCI and the Individual Defendants knew, or were reckless or negligent in not knowing, and failed to disclose that: (a) SCI's backlog of prearranged funeral contracts included a material number of contracts that were backed by mortuary trusts that were inadequately funded and/or had assets that were not actively invested to ensure growth adequate to cover "the cost of providing a price guaranteed funeral service"; (b) The Preneed Study showed that a material number of funeral homes acquired by SCI failed to actively manage their mortuary trust assets, and, as a result, a material number of SCI's funeral services had been, and would continue to be, performed at significant losses, resulting in an increasingly sharp erosion in SCI's profit margins for funeral services; and (c) SCI's "new investment program" was not actively managing the vast majority of the preneed trust assets SCI had acquired by purchasing independent private funeral homes, and was not obtaining "a real return in excess of the amount necessary to cover" the costs to SCI of providing a material number of prearranged guaranteed price funeral services. 92. On September 30, 1998, SCI issued a materially false and misleading press release that bore the headline, Service Corporation International Completes Strategic Acquisition of Pre-need Insurance Division of American Annuity Group. The release stated in relevant part: Service Corporation International (NYSE: SRV), the world's largest funeral and cemetery company, announced today that it has completed its previously announced acquisition of the pre-need funeral services division of American Annuity Group Inc. (NYSE: AAG) of Cincinnati, Ohio for $164 million cash. * * * Page 42 43 AMERICAN MEMORIAL WILL BE PART OF A NEW FINANCIAL SERVICES SUBSIDIARY, SCI FINANCIAL SERVICES, INC., FORMED TO FACILITATE THE EXPANSION OF SCI'S PRE-NEED BUSINESSES AND FINANCIAL ACTIVITIES WORLDWIDE. The new company's operations include prearranged funeral marketing, funeral and cemetery trust administration, investment management, life insurance operations and the lending activities of Provident Services, Inc., an existing SCI subsidiary which provides capital financing for independent funeral home and cemetery operations. [Emphasis added.] 93. The foregoing statements were materially false and misleading at the time they were made because SCI and the Individual Defendants knew, or were reckless in not knowing, and failed to disclose that: (a) the acquisition of American Memorial was an attempt by SCI to conceal its deteriorating funeral service profit margins resulting from its backlog of inadequately funded and/or dormant and underperforming preneed mortuary trust assets; and (b) SCI Financial Services, Inc. and SCI's acquisition of American Memorial was part of SCI's attempt to begin to actively manage the investments of future preneed mortuary assets, and did not and would not address the continually more acute and drastic deterioration in profit margins caused by the existing backlog of inadequately funded and/or dormant and underperforming assets SCI acquired pursuant to its purchases of privately owned funeral homes. 94. On October 22, 1998, SCI issued a materially false and misleading press release that bore the headline, Service Corporation International Reports 14.4% Increase in Net Income and 14.3% Increase in EPS for Third Quarter 1998. Defendant Champagne was listed as a "contact" person for the press release. The release stated in relevant part: Strategic Highlights -- Completed the acquisition of American Memorial Life Insurance Company (AML) for $164 million. Page 43 44 -- Announced the business combination with Equity Corporation International for $830 million, including assumed indebtedness. -- Formed a new financial services subsidiary, SCI Financial Services, Inc. to facilitate expansion of preneed businesses and financial activities worldwide. Commenting on the results, Robert Waltrip, Chairman and Chief Executive Officer, said: "I AM PLEASED TO REPORT ANOTHER QUARTER OF INCREASED PROFITABILITY FOR SCI DESPITE THE WIDELY PUBLICIZED REDUCED NUMBER OF DEATHS REPORTED BY OUR INDUSTRY. WHILE SCI WAS NOT INSULATED FROM THIS EXPERIENCE, THE STRATEGIC ACQUISITIONS AND INITIATIVES ANNOUNCED THIS SUMMER WILL ADD VALUE TO SCI TODAY AND LONG-TERM." SCI's President and Chief Operating Officer, L. William Heiligbrodt, added: "SINCE 1990, SCI'S NORTH AMERICAN MARKET SHARE HAS NEARLY DOUBLED TO APPROXIMATELY 11% TODAY, MAINLY THROUGH ACQUISITIONS, NEW CONSTRUCTION AND PREARRANGED FUNERALS. SCI'S MARKET SHARE IS EXPECTED TO INCREASE AS WE ACCELERATE THE SALES OF PREARRANGED FUNERALS. WE PLAN TO DOUBLE THE ANNUAL SALES OF PREARRANGED FUNERALS WITHIN FIVE YEARS...." Acquisition Activity Effective July 1, 1998, SCI acquired AML, the pre-need funeral services division of American Annuity Group Inc., for $164 million cash. AML offers a variety of pre-need and final expense life insurance and annuity products to finance prearranged funerals. TO FACILITATE THE EXPANSION OF SCI'S PRE-NEED BUSINESSES AND FINANCIAL ACTIVITIES WORLDWIDE, SCI FORMED A NEW FINANCIAL SERVICES SUBSIDIARY, SCI FINANCIAL SERVICES, INC. In August, SCI reached an agreement with Equity Corporation International (ECI) to enter into a business combination between the two companies. The combined company will have operations throughout metropolitan and rural North America and will consist of approximately 3,600 funeral homes, 500 cemeteries and 200 crematoria worldwide, with annualized revenues approaching $3 billion. [Emphasis added.] 95. The foregoing statements made by SCI and the Individual Defendants were materially false and misleading at the time they were made because these defendants knew, or were reckless in not knowing, and failed to disclose that: Page 44 45 (a) the profitability of SCI's funeral services business was and continued to deteriorate materially as a result of the increasing number of unprofitable funeral services being performed pursuant to preneed funeral service contracts backed by inadequately funded and/or dormant and underperforming preneed mortuary trusts; (b) SCI's nearly doubling of its market share since 1990 "mainly through acquisitions, new construction and prearranged funerals" resulted in the accumulation of an enormous backlog of preneed contracts backed by inadequately funded and/or dormant and underperforming mortuary trust assets, resulting in drastically decreasing profits margins; (c) far from establishing SCI Financial Services, Inc. "to facilitate the expansion of SCI's pre-need business and financial activities worldwide," as defendants claimed, the creation of this subsidiary marked the first time in SCI's history that the Company had implemented any concrete steps to manage actively at least a portion of its preneed trust assets. Prior to the creation of this subsidiary, and notwithstanding defendants' earlier representations about a "new investment program," no individual or organization at SCI had been responsible for actively managing those assets; (d) SCI's new investment management operations through the establishment of SCI Financial Services, Inc. would not be involved in managing of the vast majority of SCI's existing multi-billion dollar backlog of preneed mortuary trust assets acquired in SCI's funeral home acquisitions, which would continue to be invested in underperforming interest bearing vehicles, such as bank CDs; and (e) the acquisition of ECI was part of SCI's attempt to establish, belatedly, a means to actively manage its preneed mortuary trust assets in order to ensure that its future sales Page 45 46 of preneed funeral contracts would not result in the kind of unprofitable funeral services increasingly generated by a substantial portion of SCI's existing multi-billion dollar preneed backlog. 96. On November 10, 1998, Death Care Business Advisor published an article entitled SCI Reports 14 Percent Gains in Income, Share Earnings. This article discussed SCI's third quarter 1998 financial results, quoted defendants Waltrip and Champagne, and stated in relevant part: A slowdown in the number of deaths in North America did not stop Service Corporation International from racking up double-digit gains in net income and earnings per share for the third quarter of 1998 (see detailed results on p4). THE COMPANY USED ITS STRATEGY OF ACQUISITIONS COMBINED WITH A CONSCIOUS EFFORT TO CUT COSTS TO, AS SCI CHAIRMAN ROBERT WALTRIP SAID, "ADD VALUE TO SCI TODAY AND LONG TERM." Commenting on future plans, SCI, which holds an 11 percent market share in the funeral industry, has aggressive plans to grow its business operations. * * * SCI Takes on More Preneed RESPONDING TO CONCERNS THAT THE DEATH RATE WAS FALLING, SCI TOUTED THE MOVES IT HAS MADE IN THE PRENEED FUNERAL MARKET, INCLUDING THE RECENT ACQUISITION OF AMERICAN MEMORIAL LIFE, THE PRENEED INSURANCE DIVISION OF AMERICAN ANNUITY GROUP, INC. ON JULY 1. THE COMPANY PAID 164 MILLION. TO FACILITATE SCI'S GROWTH IN THIS AREA, THE COMPANY FORMED A NEW SUBSIDIARY, SCI FINANCIAL SERVICES INC. TO HANDLE PRENEED AND OTHER COMPANY FINANCIAL ACTIVITIES. IN THAT AREA, THE COMPANY SHOWED BOOMING GROWTH, WITH REVENUES GROWING FROM 21.5 MILLION IN THE THIRD QUARTER OF 1997 TO 65.8 MILLION FOR THE THIRD QUARTER OF 1998, INCORPORATING THE ACQUISITION OF AML INTO ITS FINANCIAL RESULTS. "IN 1997, DOMESTICALLY, JUST OVER 25 PERCENT OF THE ATNEED SERVICES WE PROVIDED WERE THE CULMINATION OF A PRE-ARRANGED CONTRACT. THAT MEANS ONE-QUARTER OF OUR FUNERALS CAME FROM THE BACKLOG, UP TWO PERCENTAGE POINTS FROM 1996," SAID SCI CHIEF FINANCIAL OFFICER GEORGE CHAMPAGNE. "FOR THE FIRST NINE MONTHS Page 46 47 OF 1998, THAT PERCENTAGE IS JUST BELOW 27 PERCENT. PRENEED IS PROVIDING AN INCREASING AMOUNT OF OUR ATNEED SERVICES, AND THERE IS POTENTIAL TO EXPAND MARKET SHARE." * * * Expenses Drop in Quarter DESPITE THE GROWTH THE COMPANY ACHIEVED THROUGH ACQUISITION, THE FLAT DEATH RATE DOMESTICALLY CAUSED IT TO BECOME AGGRESSIVE IN THE AREA OF EXPENSE REDUCTION. For the third quarter of 1998, general and administrative expenses were 15.4 million, a decrease from the 16.7 million SCI spent last year. Champagne said that SCI has made an effort to reduce those expenses, but they should see a reasonable upswing in the fourth quarter as most executive compensation and bonuses accrue during that time. Following that, he said they can be expected to increase reasonably, as expected, based on expansion and market conditions. [Emphasis added]. 97. The foregoing statements made by defendants Waltrip and Champagne were materially false and misleading at the time they were made because these defendants knew, or were reckless in not knowing, and failed to disclose that: (a) far from enjoying a unique advantage over its competitors in addressing the slowdown in North American deaths by virtue of acquisition and cost cutting, SCI was continuing to experience drastic deterioration in its funeral services profit margins as a result of its backlog of inadequately funded and/or dormant and underperforming preneed mortuary trust assets; (b) the acquisition of American Memorial and the formation of SCI Financial Services, Inc. did not address SCI's backlog of unprofitable preneed funeral service contracts; and (c) the "booming growth" and increased revenues from SCI's new financial activities were part of SCI's scheme to mask its increasingly deteriorating profit margins in its preneed funeral services business, and the touted increase in the number of funerals "from the Page 47 48 backlog" of preneed contracts was, in fact, fueling the profit margin deterioration, and was not, as represented, a positive development for SCI. 98. On November 16, 1998, SCI filed its Form 10-Q for the quarter ended September 30, 1998 with the SEC (the "1998 Q3 Form 10-Q"). The 1998 Q3 Form 10-Q was also incorporated by reference into the Registration Statement/Prospectus for SCI's acquisition of ECI, filed on November 19, 1998. The 1998 Q3 Form 10-Q was signed by defendant Champagne and contained the following materially false and misleading statements in Note 4 to the Consolidated Financial Statements: Prearranged Funeral Activities The Company sells price guaranteed prearranged funeral contracts through various programs providing for future funeral services at prices prevailing when the agreements are signed. Payments under these contracts are placed in trust accounts (pursuant to applicable law) or are used to pay premiums on life insurance policies. ... TRUST EARNINGS AND INCREASING INSURANCE BENEFITS ARE ACCRUED AND DEFERRED UNTIL, THE SERVICE IS PERFORMED, AT WHICH TIME THESE FUNDS ARE ALSO RECOGNIZED IN FUNERAL REVENUES AND ARE INTENDED TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED FUNERAL SERVICE.... The total value of unperformed prearranged funerals at September 30, 1998 was $3,395,916 ($3,163,357 at December 31, 1997). [Emphasis added.] 1998 Q3 Form 10-Q at 7-8 * * * 99. The foregoing statements were materially false and misleading when made because SCI and the Individual Defendants knew, or were reckless or negligent in not knowing, and failed to disclose that: (a) SCI's backlog of prearranged funeral contracts included a material number of contracts that were not sold "at prices prevailing when the agreements were signed," but at discounts to those prices; and Page 48 49 (b) The funds from many of SCI's mortuary trusts did not "cover" or exceed the cost of their related "price guaranteed" funeral services, and as a result, SCI was and would continue to experience drastically deteriorating profit margins for its funeral service business. 100. The 1998 Q3 Form 10-Q also stated in the MD&A section, that: Prearranged Funeral Services The Company has a marketing program to sell prearranged funeral contracts and the funds collected are generally held in trust or are used to purchase life insurance or annuity contracts. The principal amount of each such prearranged funeral contract will be received in cash by a Company funeral service location at the time the funeral is performed. EARNINGS ON TRUST FUNDS AND INCREASING BENEFITS UNDER INSURANCE AND ANNUITY FUNDED CONTRACTS ALSO INCREASE THE AMOUNT OF CASH TO BE RECEIVED UPON PERFORMANCE OF THE FUNERAL AND ARE INTENDED TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS. During 1997, the Company completed a review of the prearranged trust investment process which included an asset/liability study. THIS HAS RESULTED IN A NEW INVESTMENT PROGRAM WHICH ENTAILS THE CONSOLIDATION OF MULTIPLE TRUSTEES, THE USE OF INSTITUTIONAL MANAGERS WITH DIFFERING INVESTMENT STYLES AND CONSOLIDATED PERFORMANCE MONITORING AND TRACKING. THIS NEW PROGRAM TARGETS A REAL RETURN IN EXCESS OF THE AMOUNT NECESSARY TO COVER FUTURE INCREASES IN THE COST OF PROVIDING A PRICE GUARANTEED FUNERAL SERVICE AS WELL AS ANY SELLING COSTS.... * * * Prearranged funeral service sales afford the Company the opportunity to both protect current market share and mix as well as expand market share in certain markets. The Company believes this will stimulate future revenue growth. Prearranged funeral services fulfilled as a percent of the total North American funerals performed annually approximates 25% and is expected to grow, thereby making the total number of funerals performed more predictable. [Emphasis added.] 1998 Q3 Form 10-Q at 19-20. 101. The foregoing statements were materially false and misleading at the time they were made because SCI and the Individual Defendants knew, or were reckless or negligent in not knowing, and failed to disclose that: Page 49 50 (a) SCI's backlog of prearranged funeral contracts included a material number of contracts that were backed by mortuary trusts that were inadequately funded and/or had assets that were not actively invested to ensure growth adequate to cover "the cost of providing a price guaranteed funeral service"; (b) The Preneed Study showed that a material number of funeral homes acquired by SCI failed to actively manage their mortuary trust assets, and, as a result, a material number of SCI's funeral services had been, and would continue to be, performed at significant losses, resulting in an increasingly sharp erosion in SCI's profit margins for funeral services; (c) SCI's "new investment program" was not actively managing the vast majority of the preneed trust assets SCI had acquired by purchasing independent private funeral homes, and was not obtaining "a real return in excess of the amount necessary to cover" the costs to SCI of providing a material number of prearranged guaranteed price funeral services; and (d) the increasing percentage of "at need" funerals attributable to "prearranged funeral services fulfilled" was, far from being the positive development represented in the 1988 Q3 Form 10-Q, a reflection of the increasing number of unprofitable funeral services being performed pursuant to preneed contracts backed by underfunded and/or dormant and underperforming mortuary trust assets, which was fueling SCI's drastically deteriorating profit margins. 102. On or about November 19, 1998, defendants Waltrip, Champagne and Heiligbrodt, caused SCI to file the materially false and misleading Registration Statement/Prospectus with the SEC in connection with SCI's acquisition of ECI. The Registration Statement/Prospectus was Page 50 51 signed by each of the foregoing defendants, declared effective by the SEC on November 20, 1998, and incorporated SCI's 1998 Q2 Form 10-Q, and 1998 Q3 Form 1O-Q by reference. 103. The Registration Statement/Prospectus contained numerous materially false and misleading statements and omitted to disclose numerous material facts that were required to be disclosed in order to render the statements made therein not materially misleading at the time it was declared effective, including, by incorporation, the materially misleading statements contained in SCI's 1998 Q2 Form 10-Q and in SCI's 1998 Q3 Form 10-Q, which are set forth in detail above. 104. The Registration Statement/Prospectus at pages 40-41 also contained the following materially false and misleading statements: SCI's strategy is to: o continue to expand through the acquisition and construction, both domestically and internationally of funeral homes, cemeteries and crematoria in areas with demographics that SCI believes to be favorable; o increase the operating margins of its existing and acquired facilities by having those facilities share resources pursuant to SCI's cluster strategy; o increase revenue per location through the merchandising of a broad line of funeral and cemetery products and services, both on a preneed and at-need basis; and o increase future volume and revenues through the sale of prearranged funeral services. 105. The foregoing statements were materially false and misleading at the time they were made because SCI and the Individual Defendants knew, or were reckless or negligent in not knowing, and failed to disclose that: (a) SCI had been, and would continue to, suffer from materially deteriorating profit margins as a result of its enormous backlog of preneed funeral service contracts that were backed by inadequately funded and/or dormant and underperforming mortuary trust assets; and Page 51 52 (b) those deteriorating profit margins and the material adverse impact they had on SCI's overall profits and earnings would not be reversed by SCI's touted strategies of: continued expansion through "acquisition and construction"; having facilities "share resources pursuant to SCI's cluster strategy"; increased "merchandising"; or increased sales of "prearranged funeral services." 106. The Merger Agreement, which was made an exhibit to the Registration Statement/Prospectus and incorporated therein by reference, contained the following statement at pages A15-16, in the form of a representation by SCI: there has not been any event, occurrence, development or state of circumstances or facts which has had, or could reasonably be anticipated to have, individually or in the aggregate, a Material Adverse Effect. 107. The Merger Agreement provided that this statement "shall be true and correct in all material respects... as of the Closing Date" as a condition to the consummation of the merger. 108. On January 19, 1999, the merger was consummated, and, as of that date, SCI, by virtue of, inter alia, its increasingly deteriorating funeral service profit margins, had suffered a Material Adverse Effect, as reflected by its poor earnings per share in the fourth quarter of 1998, which ended almost three weeks prior to the closing of the merger. 109. SCI and the Individual Defendants' failure to disclose the existence of Material Adverse Effects which they knew, or were reckless or negligent in not knowing, at the time that the Registration Statement/Prospectus was filed with the SEC and declared effective and, as a result the Registration Statement/Prospectus was materially false and misleading. Further, on or about January 19, 1999, by announcing in a press release that the merger had been completed, SCI Page 52 53 and the Individual Defendants impliedly told investors that the representation that there had been no material adverse changes was true as of the closing of the merger when, in fact, they knew or recklessly disregarded the true and undisclosed facts regarding the adverse earnings and causes thereof. ADDITIONAL SCIENTER ALLEGATIONS DEFENDANTS' MOTIVES TO MISREPRESENT SCI'S FINANCIAL CONDITION 110. Defendants were highly motivated to conceal the true reasons behind SCI's funeral margin contraction and the negative impact that SCI's unprofitable multi-million dollar preneed funeral backlog had already had, and was continuing to have, on SCI's profit margins and earnings. By doing so, defendants were able to cause the market price of SCI's to become and remain materially artificially inflated (artificially depressed in the case of put options) throughout the Class Period. Because the consideration paid by SCI to ECI stockholders was SCI common stock, SCI was able to effectively purchase ECI with "watered stock," thereby saving SCI millions. 111. As alleged above, the ECI acquisition was critical to the Company's ability to turn around its unprofitable preneed business and therefore represented significant motivation to defraud Class members. 112. Under Section 9.1 of the Merger Agreement, ECI had the right to terminate the Merger Agreement "if the representations and warranties of [SCI] shall fail to be true and correct in all material respects...." Thus, prior to negotiating the deal with ECI, SCI was motivated to maintain SCI's stock price in an effort to acquire ECI in a stock-for-stock transaction for less than ECI's true value. After the Merger Agreement was executed, but before the deal closed, Page 53 54 SCI was motivated to conceal the adverse developments from ECI to prevent ECI from terminating the Merger Agreement. Disclosure of SCI's unprofitable preneed business would have constituted a Material Adverse Effect, as contemplated by the Merger Agreement. Had SCI admitted the existence of the Company's problems, ECI would have been able to terminate the Merger Agreement under Section 9.1. 113. In addition, defendants were motivated to conceal the truth concerning SCI's funeral margin contraction in order to obtain and maintain favorable ratings on the debt securities that SCI had registered with the SEC but not yet issued. 114. In particular, in a prospectus filed with the SEC on May 29, 1998, SCI registered to sell up to $1 billion of debt, common stock and warrants to the public from "time-to-time." Similarly, in a prospectus filed with the SEC on October 15, 1998, SCI registered to sell an additional $500 million in SCI preferred stock. The debt and equity securities were issued pursuant to shelf registration statements that were declared effective by the SEC on June 10, 1998 and October 29, 1998, respectively. As a result of filing the shelf registration statements, SCI was able to avail itself of much-needed funds to finance the Company's acquisitions and operations. 115. The omissions concerning SCI's unprofitable preneed business ensured that the debt securities would be priced as attractively as possible to SCI upon issuance. Favorable pricing allowed SCI to save millions of dollars in interest payments that would otherwise have been paid to bondholders had SCI's debt instruments been assigned lower ratings by credit rating agencies such as Standard & Poor's. Also, the omissions would ensure that SCI stock and warrants would be sold to the investing public at the highest possible prices. Page 54 55 116. The defendants' omissions about the unprofitable preneed business had the desired effect on the public, particularly Standard & Poor's ("S&P"). On October 27, 1998, shortly after defendants announced SCI's favorable third quarter results which omitted from disclosure facts about the unprofitable preneed business, S&P issued a press release praising SCI's "well-established and diverse geographic market positions, and strong industry characteristics [which] should enable the company to generate predictable cash flow." Most importantly, S&P affirmed its triple-B plus corporate credit, unsecured debt, and bank loan ratings as well as its triple B plus subordinated debt rating and it's A-2 commercial paper rating on SCI. S&P also assigned its preliminary triple B plus/triple B rating to the Company's debt registered pursuant to the shelf registration statement. 117. Thus, SCI's ability to sustain growth through continued acquisition activity was intimately tied to its ability to maintain favorable credit ratings and also periodically issue equity for cash flow purposes. By publicly making materially false and misleading statements and omitting from disclosure material facts, defendants had been able to artificially increase and maintain the inflated price of SCI common stock, maintain favorable credit ratings, and increase SCI's shelf registration for a announcement of a combined debt and equity offering of $1.5 billion. THE INDIVIDUAL DEFENDANTS KNEW THE TRUE FINANCIAL CONDITION OF SCI 118. SCI's earnings shortfall for the fourth quarter 1998 was an extraordinary event in the financial history of SCI. Prior to the fourth quarter of 1998, SCI's management repeatedly forecasted current quarterly financial performance with extraordinary accuracy. Page 55 56 119. SCI's quarterly results are particularly easy for management to estimate prior to a quarter's end because of a number of factors generally applicable to companies in the death care field and because of certain factors particularly applicable to SCI. Initially, death care providers have an extremely high level of recurring, budgeted, fixed costs that generally do not fluctuate greatly with demand for a company's services. Unlike companies in other industries, death care providers cannot respond to increased demand by delaying the period in which a service will be provided; obviously, a death care provider cannot promise to fill an order "in a week or two" and still retain a customer. The SCI 1998 Form 10-K explains, "[t]he funeral business has a high fixed cost structure (approximately 80%-90% of funeral costs) that does not easily lend itself to reduction during periods of slower revenue growth." 120. Additionally, demand for death services is steadier than almost any other industry. Demand for death care services may fluctuate somewhat as a result of disease patterns or seasonal changes, but demand is not affected by changes in consumer taste or technological developments. 121. SCI is also able to accurately measure its current quarterly performance because SCI's Falcon system reports North American cemetery and funeral home sales on a daily basis. This enables SCI to determine accurately the level of funeral and cemetery sales at any point during a quarter. 122. Further, it reasonably could have been anticipated that the declining profitability caused by SCI's undisclosed backlog of inadequately funded and/or dormant and underperforming preneed trust assets would continue into the fourth quarter. Indeed, as a result of the increasingly deteriorating profitability caused by inadequately funded preneed contracts, costs had been steadily increasing as a percentage of revenue throughout the entire 1998 year. In the first quarter 1998, Page 56 57 SCI's costs were approximately 68% of revenue; in the second quarter 1998 costs were approximately 72% of revenue; in the third quarter 1998 costs were approximately 76% of revenue; and in the fourth quarter 1998 costs were approximately 82% of revenue. THE TRUTH IS REVEALED 123. On January 26, 1999, just five business days after SCI and ECI jointly announced the completion of the Merger, SCI shocked the investment community by issuing a press release which stated: [SCI], the world's largest funeral and cemetery company, announced today that it expects diluted earnings per share for the fourth quarter of 1998 to be lower than current analyst expectations. SCI's fourth quarter 1998 gross profits were $141,246,000. This represented a 19% decline from SCI's third quarter 1998 gross profits and a 24% decline from SCI's fourth quarter 1997 gross profits. SCI's earnings per share for fourth quarter 1998 were $.23. This was 28% below EPS for third quarter 1998; 36% below SCI's EPS for the fourth quarter 1997; and 45% below the average forecast or "consensus estimate" for fourth quarter EPS by analysts who followed SCI. These "consensus estimates" were based on misleading information given directly by SCI to professional market analysts. Defendants deceptively failed to disclose to analysts, the market, or to ECI or its shareholders in connection with the negotiation and closing of its acquisition of ECI, the grave and worsening losses in its preneed funeral business. 124. The market's reaction to the January 26, 1999 disclosure was swift and severe. The price of SCI common stock plunged from $34 7/16 on January 25 to $19 1/8 on trading of over 36 million shares, a one-day decline of $15.3125 or 44%. This price decline also effectively cut the consideration paid for each share of ECI common stock in the merger virtually in half. Page 57 58 Pursuant to the Merger Agreement, ECI shareholders received SCI common stock that was worth $25.53 when the deal closed, in exchange for each share of ECI common stock they owned. Following SCI's January 26, 1999 disclosure, that same SCI common stock was worth only $12.79, effectively reducing the total consideration paid for ECI from $556 million to $278 million. As of September 1, 1999, SCI's common stock was trading at or about $14.00 per share. 125. On February 9, 1999, the Company issued a press release purporting to explain the earnings shortfall. The primary reasons cited for the shortfall were decreased revenues and increased costs. However, the true reason for the earnings surprise was revealed later by defendant Heiligbrodt. 126. Indeed, the Company and defendant Heiligbrodt have admitted that the earnings shortfalls reported for fiscal year 1998 resulted from losses on SCI's preneed business which was information known to defendants throughout the Class Period. A story published by the Death Care Business Advisor on February 23, 1999 stated in part: Because the company said that it is now selling preneed at prices which, combined with its investment strategy should lead to increased at-need earnings, SCI is understandably bullish on preneed. Especially when it estimates that only 30 percent of the people who buy preneed through an SCI facility would be an SCI atneed customer. For the time being, though, preneed is hurting company profit margins. Because SCI does not count preneed funds in its earnings until services are delivered, many of the 27 percent of SCI calls in 1998 that were the result of a preneed sale were from policies sold 12-15 years ago. According to SCI, many of those policies were sold by third parties, such as companies later purchased by SCI. ACCORDING TO [DEFENDANT) HEILIGBRODT, THE AT NEED VALUE OF MANY OF THE PRENEED PLANS SOLD IN THE 1980S IS ABOUT 20 PERCENT LESS THAN THE COMPANY PRESENTLY CHARGES FOR ITS SERVICES. [Emphasis added.] Page 58 59 127. Following up on its February 23, 1999 article, Death Care Business Advisor published another story on August 12, 1999 entitled "SCI Looking For Comeback In 2000; Company Results Miss Targets As Expected: Management Expects Flat Earnings in 1999" stating, in part: SCI has said in the past that it loses money on some of its preneed services because the contract was sold at too low a price by a funeral home or death care company later bought by SCI. When pursuing preneed, it is worth considering that a large percentage of the contracts still become at-need within 5 years of purchase, not leaving a lot of time to make up the seller's commission and inflationary price increases, to ensure the preneed seller of the same profit ordinarily achieved from an atneed funeral. While these numbers are not likely to slow the boom in the sale of preneed funeral contract, they are worth looking over. Preneed sales are supposed to ensure a successful future, not serve as a drain on company profit. PLAINTIFFS' INVESTIGATION 128. Plaintiffs' allegations set forth herein are based on a thorough investigation conducted by and through their attorneys. Such investigation included a review and analysis of: a. SCI's filings with the SEC both prior to and throughout the Class Period; b. the Company's Annual Reports to shareholders both prior to and during the Class Period; c. The Company's press releases and other publicly disseminated statements made by defendants prior to, during, and following the Class Period; d. reports, articles, and other written materials concerning the Company and the subject matter of this complaint; e. analyst reports and investor advisory service reports; and Page 59 60 f. consultations with forensic accountants, former company employees and other individuals knowledgeable about the Company's business, operations and services. INAPPLICABILITY OF STATUTORY SAFE HARBOR 129. The statutory safe harbor provided for forward-looking statements pursuant to 15 U.S.C. Section 78u-5 does not apply to any of the false statements pleaded in this Complaint. The statements alleged to be false and misleading herein all relate to then-existing facts and conditions known to defendants. In addition, to the extent that defendants may claim that certain statements alleged to be false and misleading may be characterized as forward looking, (i) such statements were not identified as "forward-looking statements" when made; (ii) there was no statement made with respect to any of those representations forming the basis of this complaint that actual results "could differ materially from those projected"; and (iii) there were no meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the purportedly forward-looking statements. Alternatively, to the extent that the statutory safe harbor does apply to any forward-looking statements pleaded herein, defendants are liable for those false forward-looking statements because at the time each of those forward-looking statements was made, the particular speaker had actual knowledge that the particular forward-looking statement was false, and/or the forward-looking statement was authorized and/or approved by an executive officer of SCI who knew that those statements were false when made. FRAUD ON THE MARKET PRESUMPTION 130. At all relevant times, the market for SCI securities was an efficient market for the following reasons, among others: Page 60 61 a. SCI common stock met the requirements for listing, and was listed and actively traded, on the New York Stock Exchange (the "NYSE"), a highly efficient market; b. As a regulated issuer, SCI filed periodic public reports with the SEC and the NYSE; C. SCI was followed by securities analysts employed by major brokerage firms who wrote reports which were distributed to the sales force and customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace. The securities firms that followed the Company during the Class Period, included, inter alia, Morgan Stanley Dean Witter, ABN AMRO; Merrill Lynch; J.P. Morgan; Nations Banc Montgomery Securities; Wasserstein Perella; and Bear, Stearns; and d. SCI regularly communicated with public investors by means of established market communication mechanisms, including through regular dissemination of press releases on the national circuits of major newswire services and through other wide-ranging public disclosures, such as communications with the financial press and other similar reporting services. Each of these releases was publicly available and entered the public marketplace. As a result, the market for SCI common stock promptly digested current information with respect to SCI from all publicly-available sources and all such information was reflected in market prices Page 61 62 of SCI common stock. Under these circumstances, all those who purchased or otherwise acquired SCI securities during the Class Period suffered similar injury through their acquisition of such securities at artificially inflated prices and a presumption of reliance applies. COUNT I AGAINST ALL DEFENDANTS FOR VIOLATION OF SECTION 11 OF THE SECURITIES ACT 131. Plaintiffs incorporate each of the foregoing paragraphs as if fully set forth herein, except to the extent such allegations charge the defendants with intentional or reckless conduct. For the purposes of this Count, plaintiffs expressly do not allege that any defendant acted with scienter or fraudulent intent, which is not an element of a Section 11 claim. 132. This Count is asserted against all defendants for violations of Section 11 of the Securities Act, 15 U.S.C. Section 77(k). 133. This count is brought on behalf of those Class members who exchanged shares of ECI common stock for shares of SCI common stock in connection with the Merger or held employee options to purchase ECI common stock under a stock plan of ECI that became options to purchase SCI common stock as a result of the Merger. 134. SCI is the issuer of the stock via the Registration Statement/Prospectus filed with the SEC in connection with the Merger. The Individual Defendants are signatories of the Registration Statement/Prospectus. 135. The Registration Statement/Prospectus contained untrue statements of material fact and/or omitted to disclose material facts required to be stated therein or necessary to make the statements made therein not misleading as alleged herein. Page 62 63 136. Defendants participated in the preparation of, issued, caused to be issued and participated in the issuance of the materially false and misleading Registration Statement/Prospectus, which was inaccurate and misrepresented or failed to disclose, inter alia, material facts concerning SCI's business and prospects, as set forth above. 137. The Individual Defendants as directors and/or officers of SCI and as signatories of the Registration Statement/Prospectus that was filed with the SEC were responsible for the preparation of the Registration Statement/Prospectus and failed to make a reasonable investigation or possess reasonable grounds for believing that the representations contained in the Registration Statement/Prospectus, were true and that they disclosed all material facts. 138. The Individual Defendants are primarily liable under Section 11 of the Securities Act and are also secondarily liable as controlling persons of SCI under Section 15 of the Securities Act. 139. As a direct and proximate result of the false and misleading statements in the Registration Statement/Prospectus, plaintiffs and the Class acquired SCI securities issued pursuant to the defective Registration Statement/Prospectus. 140. Accordingly, plaintiffs and the Class have sustained damages as a result of the violations of Section 11 of the Securities Act by defendants and are entitled to recover damages therefore pursuant to Section 11(e) of the Act. 141. At the time they approved the Merger and acquired SCI common stock, plaintiffs and the class were without knowledge of the untruths and omissions alleged herein. 142. The action was brought within one year after the discovery of the untrue statements and omissions and within three years after SCI stock was offered to the public in the Merger. Page 63 64 COUNT II AGAINST SCI FOR VIOLATION OF SECTION 12(a)(2) OF THE SECURITIES ACT 143. Plaintiffs incorporate each of the foregoing allegations as if fully set forth herein, except to the extent that such allegations charge the defendants with intentional or reckless misconduct. For the purposes of this Count, plaintiffs expressly do not allege that any defendant acted with scienter or fraudulent intent, which is not an element of a Section 12(a)(2) claim. 144. This count is asserted against SCI for violation of Section 12(a)(2) of the Securities Act, 15 U.S.C. Section 771. 145. This count is brought on behalf of those Class members who exchanged shares of ECI common stock for shares of SCI common stock in connection with the Merger or held employee options to purchase ECI common stock under a stock plan of ECI that became options to purchase SCI common stock as a result of the Merger. 146. SCI was a seller, offeror, and/or solicitor of sales of the SCI common stock for its financial benefit pursuant to the Registration Statement/Prospectus in connection with the Merger. 147. The Registration Statement/Prospectus contained materially false and misleading statements and omitted to state material facts necessary in order to make the statements, in light of the circumstances under which they were made, not misleading. 148. None of the defendants named in this Count made a reasonable investigation or possessed reasonable grounds for the belief that the statements contained in the Registration Statement/Prospectus were true, without omissions of any material facts and were not misleading. Page 64 65 149. Plaintiffs, individually and representatively, hereby elect to rescind and tender to SCI those securities that plaintiffs and other members of the Class continue to own, in return for the consideration paid for those securities together with interest thereon. 150. Plaintiffs and members of the Class who have sold their SCI common stock are entitled to recissory damages. 151. The action was brought within one year after the discovery of the untrue statements and omissions and within three years after SCI common stock was offered to the public. COUNT III AGAINST THE INDIVIDUAL DEFENDANTS FOR VIOLATION OF SECTION 15 OF THE SECURITIES ACT 152. Plaintiffs repeat and reallege each and every allegation contained above as if fully set forth herein, except to the extent that such allegations charge the Individual Defendants with intentional or reckless conduct. For purposes of this Count, plaintiffs do not allege than any Individual Defendant acted with scienter or fraudulent intent, which is not an element of controlling persons' liability under Section 15. 153. Count III is brought pursuant to Section 15 of the Securities Act, 15 U.S.C. Section 77o, against the Individual Defendants. SCI is liable to plaintiffs and the Class as an issuer under Section 11 and as a seller under Section 12(a)(2) of the Securities Act, as previously set forth in Counts I and II above. 154. This count is brought on behalf of those Class members who exchanged shares of ECI common stock for shares of SCI common stock in connection with the Merger or held employee options to purchase ECI common stock under a stock plan of ECI that became options to purchase SCI common stock as a result of the Merger. Page 65 66 155. The Individual Defendants were controlling persons of SCI by virtue of their positions as senior officers and directors of the Company. As a result, the Individual Defendants are jointly and severably liable with and to the same extent as SCI under Section 15 of the Securities Act for SCI's primary violations of Sections 11 and 12(2)(a) of the Securities Act. COUNT IV AGAINST ALL DEFENDANTS FOR VIOLATIONS OF SECTION 10(b) OF THE EXCHANGE ACT AND RULE 10b-5 156. Plaintiffs incorporate the foregoing allegations as if fully set forth herein. This claim is asserted against SCI and the Individual Defendants. 157. These defendants, and each of them, carried out a plan, scheme and course of conduct which was intended to and did: (i) deceive the investing public, including plaintiffs and other Class members, as alleged herein; and (ii) artificially inflate (artificially deflate in the case of put options) and maintain the market price of SCI securities. In furtherance of this unlawful scheme, plan and course of conduct, these defendants, and each of them, took the actions set forth herein. 158. Defendants employed devices, schemes, and artifices to defraud; made untrue statements of material fact and/or omitted to state material facts necessary to make the statements made not misleading; and engaged in acts, practices and a course of business which operated as a fraud and deceit upon Class members in an effort to maintain artificially high market prices for SCI's common stock in violation of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. These defendants are sued either as primary participants in the wrongful and illegal conduct charged herein or as controlling persons. Page 66 67 159. In addition to the duties of full disclosure imposed on defendants as a result of their making of affirmative statements and reports, or participation in the making of affirmative statements and reports to the investing public, the defendants had a duty to promptly disseminate truthful information that would be material to investors so that the market prices of the Company's publicly traded common stock would be based on truthful, complete and accurate information. 160. Defendants, individually and in concert, directly and indirectly, by the use of means and instrumentalities of interstate commerce and/or of the mails, engaged and participated in a continuous course of conduct to conceal adverse material information about the Company's financial results, business, operations, and future outlook as specified herein. These defendants employed devices, schemes and artifices to defraud, while in possession of material adverse non-public information and engaged in acts, practices, and a course of conduct as alleged herein in an effort to mislead purchasers of SCI's securities concerning the Company's business prospects and financial condition, which included the making of, or the participation in the making of, untrue statements of material facts and omitting to state material facts necessary in order to make the statements made about the Company's financial and business operations in the light of the circumstances under which they were made, not misleading, as set forth more particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon Class members. 161. Defendants had actual knowledge of the misrepresentation and omissions of material facts set forth herein, or acted with reckless disregard for the truth in that they failed to ascertain and to disclose such facts, even though such facts were available to them. Defendants' material misrepresentations and/or omissions were done knowingly or recklessly and for the purpose and Page 67 68 effect of concealing SCI's operations and business affairs from the investing public and supporting the artificially inflated price of its securities. 162. 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 SCI securities was artificially inflated (artificially deflated in the case of put options) throughout the Class Period. In ignorance of the fact that the market price of SCI's securities were artificially inflated, and relying directly or indirectly on the false and misleading statements made by defendants, or upon the integrity of the market in which the securities trade, and the truth of any representations made to appropriate agencies as the investing public, at the times at which any statements were made, and/or on the absence of material adverse information that was known to or recklessly disregarded by defendants but not disclosed in public statements by defendants, plaintiffs and the other members of the Class purchased SCI's securities at artificially high prices and were damaged thereby. 163. At the time of said misrepresentations and omissions, plaintiffs and the other members of the Class were ignorant of their falsity, and believed them to be true. Had plaintiffs and the other member of the Class and the marketplace known of the true nature of the operations of the Company and the noncompliance with federal law, which were not disclosed by defendants, plaintiffs and the other members of the Class would not have acquired their SCI securities, or, if they had acquired such securities, they would not have done so at the artificially inflated (artificially deflated in the case of put options) prices which they paid. 164. By virtue of the foregoing, defendants have violated Section 10(b) of the Exchange Act, and Rule 10b-5 promulgated there under. Page 68 69 165. As a direct and proximate result of these defendants' wrongful conduct, plaintiffs and the other members of the Class suffered damages in connection with their purchases of SCI securities. COUNT V AGAINST THE INDIVIDUAL DEFENDANTS FOR VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT 166. Plaintiffs incorporate the foregoing allegations as if fully set forth herein. This claim is asserted against the Individual Defendants. 167. The Individual Defendants acted as controlling persons of SCI within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their stock ownership, executive positions and Board membership, as alleged above, the Individual Defendants had the power to influence and control and did influence and control, directly or indirectly, the operations of the Company, and possessed the power and/or ability to control each of the wrongful acts and practices complained of herein, including the content and dissemination of the various statements which plaintiffs contend are false and misleading. The Individual Defendants were provided with or had unlimited access to copies of the Company's internal reports, press releases, public filings and other statements alleged by plaintiffs to be misleading prior to and/or shortly after these statements were issued and had the ability to prevent the issuance of the statements or cause the statements to be corrected. 168. In particular, the Individual Defendants had direct involvement in the day-to-day operations of the Company and therefore, are presumed to have had the power to control or influence the particular transactions giving rise to the securities violations as alleged herein, and exercised the same. Page 69 70 169. As set forth above, SCI violated Section 10(b) and Rule l0b-5 by its acts and omissions as alleged in this Complaint. By virtue of their positions as controlling persons of SCI, the Individual Defendants are liable pursuant to Section 20(a) of the Exchange Act. As a direct and proximate result of defendants' wrongful conduct, plaintiffs and the other members of the Class suffered damages in connection with their purchases of SCI securities. COUNT VI AGAINST SCI FOR VIOLATIONS OF SECTION 20A OF THE EXCHANGE ACT 170. Plaintiffs incorporate the foregoing allegations as if fully set forth herein. This claim is asserted against SCI. This count is brought on behalf of those Class members who exchanged shares of ECI common stock for shares of SCI common stock in connection with the Merger or held employee options to purchase ECI common stock under a stock plan of ECI that became options to purchase SCI common stock as a result of the Merger. 171. The exchange of SCI stock for ECI stock pursuant to the Merger Agreement constituted a sale of securities within the meaning of Section 20A of the Exchange Act. 15 U.S.C. Section 78t-1. At the time of the exchange of SCI stock for ECI stock, SCI was in possession of material, non-public information concerning the financial condition of SCI. As a result of SCI's failure to disclose the material, non-public information in its possession, SCI was able to negotiate a higher ratio of exchange of SCI stock for ECI stock. 172. By virtue of the foregoing, SCI has violated Section 20A of the Exchange Act. 173. As a direct and proximate result of SCI's wrongful conduct, members of the Class suffered damages in connection with their exchange of ECI stock and ECI options for SCI stock and SCI options. Page 70 71 PRAYER FOR RELIEF WHEREFORE, plaintiffs, on their own behalf and on behalf of the other members of the Class. respectfully request that this Court enter judgment in their favor and against defendants as follows: (a) Awarding plaintiffs and the other members of the Class rescission of their shares and/or the appropriate measure of damages; (b) Awarding plaintiffs and the other members of the Class prejudgment and post-judgment interest, as well as their reasonable attorneys' fees, expert witness fees and other costs and expenses; and (c) Awarding such other relief as this Court may deem just and proper. JURY DEMAND Plaintiffs demand a trial by jury. DATED: September 3, 1999 Respectfully submitted, By: -------------------------------- ROGER B. GREENBERG Attorney-in-Charge State Bar No. 08390000 12 Greenway Plaza, 10th Fl. Houston, TX 77046 (713) 627-2720 (713) 627-7057 Fax Lead Counsel for Plaintiffs PAGE 71 72 OF COUNSEL: GREENBERG, PEDEN, SIEGMYER & OSHMAN, P.C. David E. Sharp Tenth Floor, 12 Greenway Plaza Houston, TX 77046 (713) 627-2720 (713) 627-7057 Fax WOLF POPPER LLP Robert M. Kornreich Paul O. Paradis Peter Safirstein Catherine E. Anderson 845 Third Avenue New York, NY 10022 BERMAN, DEVALERIO & PEASE LLP Glen DeValerio Michael T. Matraia One Liberty Square Boston, MA 02109 BERNSTEIN LITOWITZ BERGER & GROSSMANN, LLP Douglas M. McKeige 1285 Avenue of the Americas 33rd Floor New York, NY 10019 LAW OFFICES OF STEVEN E. CAULEY, PA Steven E. Cauley Suite 218, Cypress Plaza Little Rock, AK 72212 COHEN, MILSTEIN, HAUSFELD & TOLL, PLLC Steven J. Toll 999 Third Avenue, Suite 3600 Seattle, WA 98104 Page 72 73 MILBERG WEISS BERSHAD HYNES & LERACH LLP Abraham Rappaport Maya Saxena 5355 Town Center Road Suite 900 Boca Raton, FL 33486 ABBEY, GARDY & SQUITIERI LLP Mark S. Gardy 212 East 39th Street New York, NY 10016 BARRACK, RODOS & BACINE 2001 Market Street 33rd Floor Philadephia, PA 19103 BERGER & MONTAGUE, PC Todd S. Collins Michael L. Block 1622 Locust Street Philadelphia, PA 19103 BOIES & SCHILLER, LLP Richard Drubel 26 South Main Street Hanover, New Hampshire 03755 BRUCE G. MURPHY 265 Llywyd's Lane Veto Beach, Florida 32963 CHANDLER LAW OFFICES George Chandler P.O. Box 3400 Lufkin, TX 75901 CLAXTON & HILL, PLLC Roger F. Claxton Robert J. Hill 3131 McKinney Avenue - LB 103 700 McKinney Place Dallas, Texas 75204-2471 74 CONSTANT & VELA Anthony Constant 802 North Caranachua Suite 1570 Corpus Christi, TX 78401 CRUSE, SCOTT, HENDERSON & ALLEN, LLP Sam W. Cruse 600 Travis Street, Suite 3900 Houston, TX 77002-2910 FARUQI & FARUQI Nadeem Farqui 415 Madison Avenue New York, NY 10017 FINKELSTEIN & KRINSK Howard D. Finkelstein Jeffrey R. Krinsk 501 West Broadway, Suite 1250 San Diego, CA 92101-3579 FRANK & ROSEN Alan L. Frank David T. Shulick, 1835 Market Street, Suite 320 Philadelphia, PA 19103 HOEFFNER, BILEK & EIDMAN Thomas E. Bilek 720 Lyric Office Center 440 Louisiana, Suite 720 Houston, TX 77002 JAROSLAWICZ & JAROS David Jaroslawicz 150 William Street New York, NY 10038 Page 74 75 KAPLAN, KILSHEIMER & FOX LLP Robert N. Kaplan Peter A. Lennon Janine R. Azriliant 685 Third Avenue, 26th Floor New York, NY 10017 KENNETH A. ELAN 217 Broadway, Suite 404 New York, NY 10007 KIRBY MCINERNEY SQUIRE Jeffrey H. Squire Ira M. Press 830 Third Avenue, 10th Floor New York, NY 10022 LAW OFFICES OF CLAYTON E. DARK, JR. Clayton E. Dark, Jr. P.O. Box 2207 Lufkin, TX 75902-2207 LAW OFFICES OF DENNIS J. JOHNSON Dennis J. Johnson 1690 Williston Road South Burlington, VT 05403 LOCKRIDGE, GRINDAL, NAUEN & HOSTEIN, PLLP Richard A. Lockridge Karen M. Hanson 100 Washington Avenue South, Suite 2200 Minneapolis, MN 55401 LOWEY DANNENBERG BEMPORAD & SELINGER PC Richard Bemporad David C. Harrison The Gateway - 11th Floor One North Lexington Avenue White Plains, NY 10601-1714 Page 75 76 LYNN STODGHIIL MELCHIMER AND TILLOTSON, LLP Thomas M. McIsheimer M. Brett Johnson 750 N. Pearl Street, Suite 1400 Dallas, TX 75201 RABIN & PECKEL LLP Marvin L. Frank Joseph V. McBride 275 Madison Avenue, 34th Floor New York, NY 10016 SCHIFFRIN & BARROWAY, LLP Andrew L. Barroway David Kessler Three Bala Plaza East, Suite 400 Bala Cynwyd, Penn. 19004 SCOTT & SCOTT Neil Rothstein 108 Norwich Avenue P.O. Box 192 Cochester, CT 06415 SCOTT, DOUGLASS & MCCONNICO, LLP Stephen E. McConnico 600 Congress Avenue, 15th Floor Austin, TX 78701-2334 SPECTOR & ROSEMAN, PC Eugen A. Spector Jeffrey L. Kodroff 1818 Market Street, Suite 2500 Philadelphia, PA 19103 STULL STULL & BRODY Jules Brody Aaron Brody 6 East 45th Street New York, NY 10017 Page 76 77 SUSMAN GODFREY LLP Kenneth S. Marks 5100 First Interstate Bank Plaza 1000 Louisiana Houston, TX 77002-5096 THE OLSEN LAW FIRM Kurt Olsen 2121 K. Street, N.W. Suite 800 Washington, D.C. 20037 WEISS & YOURMAN Joseph H. Weiss 551 Fifth Avenue, Suite 1600 New York, NY 10176 WHITTINGTON, VONSTERNBERG, EMERSON & WILSHER, LLP John G. Emerson, Jr. 2600 South Gessner, Suite 600 Houston, TX 77063 WOLF, HALDENSTEIN, ADLER, FREEMAN & HERZ, LLP Fred T. Isquith Robert Abrams 270 Madison Avenue New York, NY 10016 ATTORNEYS FOR PLAINTIFFS Certificate of Service This document was served on defendants' counsel of record on September 3, 1999 pursuant to the Federal Rules of Civil Procedure. /s/ David E. Sharp ------------------ David E. Sharp Page 77 EX-99.2 6 DEFENDANTS' ANSWER TO CONSOLIDATED CLASS ACTION 1 EXHIBIT 99.2 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION ( ( IN RE SERVICE CORPORATION ( INTERNATIONAL ( CIVIL ACTION NO. H-99-0280 ( (Judge Lynn N. Hughes) ( ( DEFENDANTS' ANSWER TO THE CONSOLIDATED CLASS ACTION COMPLAINT Defendants Service Corporation International ("SCI"), R. L. Waltrip, George R. Champagne and L. William Heiligbrodt file this Answer to the Consolidated Class Action Complaint, and would show the Court as follows: RESPONSES TO ALLEGATIONS 1. Admit that this is a civil action in which Plaintiffs have brought suit under the various statutes, rules and regulations cited in Paragraph 1 of the Consolidated Class Action Complaint, but deny the truth of any of those allegations and further deny that any factual basis for cognizable claims under such statutes and laws exist as against the Defendants. 2. Admit that this Court has subject matter jurisdiction over this cause based upon application of the laws set out in Paragraph 2 of the Consolidated Class Action Complaint, but deny that the factual basis for such jurisdiction exists. 3. Admit that this Court has venue over this cause based upon application of the laws set out in Paragraph 3 of the Consolidated Class Action Complaint, but deny any factual basis for cognizable claims under such statutes and laws exist as against the Defendants. 4. Deny. 2 5. Admit the first two sentences of Paragraph 5 of the Consolidated Class Action Complaint; deny the third sentence of Paragraph 5 of the Consolidated Class Action Complaint. 6. Admit. 7. Admit that R.L. Waltrip is SCI's Chairman of the Board and Chief Executive Officer. Admit that the Registration Statement/Prospectus was declared effective on November 20, 1998. Deny the remaining allegations contained in Paragraph 7 of the Consolidated Class Action Complaint. 8. Admit that George Champagne is SCI's Senior Vice President and Chief Financial Officer. Deny the remaining allegations contained in Paragraph 8 of the Consolidated Class Action Complaint. 9. Admit that L. William Heiligbrodt was SCI's President and Chief Operating Officer. Deny the remaining allegations contained in Paragraph 9 of the Consolidated Class Action Complaint. 10. Admit. 11. Deny the first two sentences of Paragraph 11 of the Consolidated Class Action Complaint. Admit the third sentence of Paragraph 11 of the Consolidated Class Action Complaint. 12. Deny. 13. Deny. 14. Deny. 15. Admit that the Individual Defendants had an obligation to comply with applicable federal securities laws. Deny the remaining allegations. 16. Admit. -2- 3 17. Admit. 18. Admit. 19. Admit. 20. Admit that Paragraph 20 of the Consolidated Class Action Complaint correctly lists the number of funeral homes acquired worldwide by SCI, year by year, from 1990 to 1998. However, Defendants deny that the total number of funeral homes acquired by SCI is 2,873. Plaintiff has made a mathematical error. The correct number should be 3,136. 21. Admit. 22. Deny that the contractual obligations to perform guaranteed price funerals in the future were typically reflected as a liability on the books of the independent funeral homes prior to their acquisition by SCI. Admit the remaining allegations contained in Paragraph 22 of the Consolidated Class Action Complaint. 23. Admit the first, second and fifth sentences of Paragraph 23 of the Consolidated Class Action Complaint. Deny the remaining allegations contained in Paragraph 23 of the Consolidated Class Action Complaint. 24. Admit that the practice of selling preneed funeral contracts began to gain increasing acceptance in the late 1980s. Admit that financial management of some mortuary trust assets consisted of opening a certificate of deposit. Deny the remaining allegations contained in Paragraph 24 of the Consolidated Class Action Complaint. 25. Deny. 26. SCI is without sufficient knowledge to admit or deny the first sentence of Paragraph 26 of the Consolidated Class Action Complaint. Deny the remaining allegations. -3- 4 27. Admit that the block quotation is contained in the March 1997 issue of The Director. Deny the remaining allegations contained in Paragraph 27 of the Consolidated Class Action Complaint. 28. Admit that SCI acquired ownership of more than 2,873 independent funeral homes from 1990-1998. Admit that between 1992 and 1998, SCI's prearranged funeral contract backlog increased from $1.2 billion to $3.7 billion. Deny that the chart accurately reflects the prearranged funeral services sold. 29. Deny. 30. Deny. 31. Admit that during 1995 SCI purchased 1,263 independent funeral homes and acquired $656 million in preneed funeral contracts. Deny the remaining allegations contained in Paragraph 31 of the Consolidated Class Action Complaint. 32. Admit that during 1996 SCI undertook "a review of the prearranged trust investment process which included an asset/liability study." Deny the remaining allegations contained in Paragraph 32 of the Consolidated Class Action Complaint. 33. Admit that the block quotation is contained in SCI's 10-K for the year ended December 31, 1996. Deny the remaining allegations contained in Paragraph 33 of the Consolidated Class Action Complaint. 34. Admit that the block quotation is contained in SCI's 10-K for the year ended December 31, 1997. Deny the remaining allegations contained in Paragraph 34 of the Consolidated Class Action Complaint. 35. Deny. -4- 5 36. Admit that the chart in Paragraph 36 of the Consolidated Class Action Complaint accurately reflects SCI's gross profit margins for fiscal year 1998. Deny the remaining allegations contained in Paragraph 36 of the Consolidated Class Action Complaint. 37. Deny. 38. Admit that the August 28, 1995 edition of the Boston Globe included the referenced quotations. Deny the remaining allegations contained in Paragraph 38 of the Consolidated Class Action Complaint. 39. Admit that the December 8, 1996 edition of the Boston Globe and the December 11, 1996 edition of the Seattle Times included the referenced quotations. Deny the remaining allegations contained in Paragraph 39 of the Consolidated Class Action Complaint. 40. Admit that the July 6, 1996 edition of The Ledger included a story about a salesman from the SCI-operated Glen Abbey Memorial Gardens. Admit that a lawsuit was filed against SCI and Glenn Abbey Memorial Gardens on behalf of Mrs. Carriere. Deny the remaining allegations. 41. Admit that the various periodicals cited included stories about SCI. Deny the remaining allegations. 42. Deny. 43. Deny. 44. Deny. 45. Deny. 46. Deny. 47. Admit that SCI announced the creation of SCI Financial Services, Inc. in July, 1988. Deny the remaining allegations. -5- 6 48. Deny. 49. Deny. 50. Admit that the block quotations are contained in ECI's 10-K for the year ended December 31, 1997. Deny the remaining allegations contained in Paragraph 50 of the Consolidated Class Action Complaint. 51. Admit that the block quotations are contained in ECI's 10-K for the year ended December 31, 1997. Deny the remaining allegations contained in Paragraph 51 of the Consolidated Class Action Complaint. 52. Admit that the block quotations are contained in ECI's 10-K for the year ended December 31, 1997. Deny the remaining allegations contained in Paragraph 52 of the Consolidated Class Action Complaint. 53. Deny. 54. Deny. 55. Deny. 56. Deny. 57. Deny. 58. Admit. 59. Admit that SCI was unable to divest itself of these properties in time to obtain FTC approval to close the ECI transaction in the fourth quarter of 1998. Deny the remaining allegations contained in Paragraph 59 of the Consolidated Class Action Complaint. 60. Deny. -6- 7 61. Insofar as the Plaintiffs refer to the Merger Agreement, the document speaks for itself. Deny the remaining allegations contained in Paragraph 61 of the Consolidated Class Action Complaint. 62. Admit. 63. Admit. 64. Admit. 65. Admit that the block quotation is contained in the Merger Agreement. Insofar as the Plaintiffs further refer to the Merger Agreement, the document speaks for itself. 66. Admit that the block quotation is contained in the Merger Agreement. Insofar as the Plaintiffs further refer to the Merger Agreement, the document speaks for itself. 67. Deny. 68. Admit. 69. Admit. 70. Deny. 71. Admit the first two sentences of Paragraph 71 of the Consolidated Class Action Complaint. Deny the remaining allegations contained in Paragraph 71 of the Consolidated Class Action Complaint. 72. Deny. 73. Admit that the block quotation is contained in SCI's July 17, 1998 press release. Deny the remaining allegations contained in Paragraph 73 of the Consolidated Class Action Complaint. 74. Deny. -7- 8 75. Admit. 76. Deny. 77. Deny. 78. Admit that the block quotation is contained in SCI's July 23, 1998 press release. Deny the remaining allegations contained in Paragraph 78 of the Consolidated Class Action Complaint. 79. Deny. 80. Admit that the block quotation is contained in SCI's August 6, 1998 press release. Deny the remaining allegations contained in Paragraph 80 of the Consolidated Class Action Complaint. 81. Deny. 82. Admit that the block quotation is contained in SCI's August 7, 1998 press release. Deny the remaining allegations contained in Paragraph 82 of the Consolidated Class Action Complaint. 83. Deny. 84. Admit that the block quotation is contained in the August 11, 1998 edition of Death Care Business Advisor. Deny the remaining allegations contained in Paragraph 84 of the Consolidated Class Action Complaint. 85. Deny. 86. Admit. 87. Deny. -8- 9 88. Admit that the block quotation is contained in SCI's 10-Q for the quarter ended June 30, 1998. Deny the remaining allegations contained in Paragraph 88 of the Consolidated Class Action Complaint. 89. Deny. 90. Admit. 91. Deny. 92. Admit that the block quotation is contained in SCI's September 30, 1998 press release. Deny the remaining allegations contained in Paragraph 92 of the Consolidated Class Action Complaint. 93. Deny. 94. Admit that the block quotation is contained in SCI's October 22, 1998 press release. Deny the remaining allegations contained in Paragraph 94 of the Consolidated Class Action Complaint. 95. Deny. 96. Admit. 97. Deny. 98. Admit that the block quotation is contained in SCI's 10-Q for the quarter ended September 30, 1998. Deny the remaining allegations contained in Paragraph 98 of the Consolidated Class Action Complaint. 99. Deny. 100. Admit. 101. Deny. -9- 10 102. Deny. 103. Deny. 104. Admit that the block quotation is contained in SCI's Registration Statement/Prospectus. Deny the remaining allegations contained in Paragraph 104 of the Consolidated Class Action Complaint. 105. Deny. 106. Admit. 107. Admit. 108. Deny. 109. Deny. 110. Deny. 111. Deny. 112. Admit the first sentence of Paragraph 112 of the Consolidated Class Action Complaint. Deny the remaining allegations contained in Paragraph 112 of the Consolidated Class Action Complaint. 113. Deny. 114. Admit. 115. Deny. 116. Admit that Standard & Poor's issued a press release on October 27, 1998 that contained the referenced quotations. Deny the remaining allegations contained in Paragraph 116 of the Consolidated Class Action Complaint. 117. Deny. -10- 11 118. Deny. 119. Deny the first sentence of Paragraph 119 of the Consolidated Class Action Complaint. Admit the remaining allegations contained in Paragraph 119 of the Consolidated Class Action Complaint. 120. Deny. 121. Admit that the Falcon system allows SCI to determine the level of funeral and cemetery sales. Deny the remaining allegations contained in Paragraph 121 of the Consolidated Class Action Complaint. 122. Deny. 123. Admit that SCI issued a press release on January 26, 1999 that contained the referenced block quotation. Insofar as Plaintiffs further refer to the January 26, 1999 press release, the document speaks for itself. Deny the remaining allegations contained in Paragraph 123 of the Consolidated Class Action Complaint. 124. Admit. 125. Admit that SCI issued a press release on February 9, 1999. Deny the remaining allegations contained in Paragraph 125 of the Consolidated Class Action Complaint. 126. Admit that the block quotation is contained in the February 23, 1999 Death Care Advisor. Insofar as Paragraph 126 of the Consolidated Class Action further refers to the February 23, 1999 article, the article speaks for itself. 127. Admit. -11- 12 128. SCI is without knowledge or information sufficient to form a belief as to the truth of the allegations contained in Paragraph 128 of the Consolidated Class Action Complaint. Therefore, such allegations shall be treated as denied. 129. Deny. 130. SCI is without knowledge or information sufficient to form a belief as to the truth of the allegations contained in Paragraph 128 of the Consolidated Class Action Complaint. Therefore, such allegations shall be treated as denied. 131. Deny. 132. Deny. 133. Deny. 134. Admit. 135. Deny. 136. Deny. 137. Deny. 138. Deny. 139. Deny. 140. Deny. 141. Deny. 142. Deny. 143. Deny. 144. Deny. 145. Deny. -12- 13 146. Admit. 147. Deny. 148. Deny. 149. Deny. 150. Deny. 151. Deny. 152. Deny. 153. Deny. 154. Deny. 155. Deny. 156. Deny. 157. Deny. 158. Deny. 159. Deny. 160. Deny. 161. Deny. 162. Deny. 163. Deny. 164. Deny. 165. Deny. 166. Deny. 167. Deny. -13- 14 168. Deny. 169. Deny. 170. Deny. 171. Admit that the exchange of SCI stock for ECI stock pursuant to the Merger Agreement constituted a sale of securities within the meaning of Section 20A of the Exchange Act. Deny the remaining allegations in Paragraph 171 of the Consolidated Class Action Complaint. 172. Deny. 173. Deny. AFFIRMATIVE DEFENSES 174. The Consolidated Class Action Complaint fails to allege facts sufficient to state a claim upon which relief may be granted. 175. Plaintiffs are not entitled to any recovery from Defendants because the registration statement did not contain any untrue statement of material fact nor did Defendants omit to state any material fact required to be stated or necessary to make the statements made not misleading. 176. Plaintiffs are not entitled to any recovery from Defendants because the documents, filings and announcements quoted did not contain any untrue statement of material fact nor did Defendants omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. 177. Plaintiffs are not entitled to any recovery from Defendants because at all relevant times Defendants acted diligently and reasonably and had a good faith belief in the truthfulness of each of the matters alleged in the Consolidated Class Action Complaint to be inaccurate and further -14- 15 believed that there was no failure to state a material fact alleged in the Consolidated Class Action Complaint to be omitted. 178. Any increase or decrease in the market value of Plaintiffs' stock was the result of market or other factors and not the alleged wrongful conduct on the part of Defendants. 179. Plaintiffs are not entitled to any recovery from Defendants because the substance of the material information that Plaintiffs allege to have been omitted or misrepresented was in fact disclosed in SCI's public filings, prospectuses and other public releases, was otherwise publicly available and/or widely known to the market and to the investing community. 180. Plaintiffs are not entitled to any recovery from Defendants because no act or omission of SCI was the cause in fact or the proximate cause of any damage to Plaintiffs. 181. Plaintiffs are not entitled to any recovery because Plaintiffs did not exercise reasonable care to discover the facts relating to the alleged misstatements or omissions. 182. The Consolidated Class Action Complaint fails to plead fraud against Defendants with the specificity required by Rule 9(b) of the Federal Rules of Civil Procedure. 183. Every act or omission alleged in the Consolidated Class Action Complaint was done or omitted in good faith conformity with the rules and regulations of the Securities and Exchange Commission, and therefore, pursuant to Section 23(a) of the Securities Exchange Act of 1934, there is no liability for any act or omission so alleged. 184. Plaintiffs would have purchased SCI stock even with full knowledge of the facts that they allege were misrepresented or omitted. 185. Defendants lacked the requisite scienter required for liability. 186. Plaintiffs did not rely upon the misrepresentations or misleading statements alleged. -15- 16 187. The actual facts which Plaintiffs allege were misrepresented or omitted in fact were known to and entered the securities market through credible sources. 188. Plaintiffs fail to satisfy the requirements of the Private Securities Litigation Reform Act of 1995. WHEREFORE, Defendants pray as follows: 1. That Plaintiffs take nothing by the Consolidated Class Action Complaint; 2. That the complaint be dismissed with prejudice; 3. That Defendants be awarded its costs of suit, including reasonable attorneys' fees; 4. That Defendants have such other, further and different relief as this Court deems just and proper. Respectfully submitted, Bracewell & Patterson, L.L.P. By: ----------------------------------------- J. Clifford Gunter III State Bar No. 08627000 South Tower Pennzoil Place 711 Louisiana, Suite 2900 Houston, Texas 77002-2781 Telephone: (713) 223-2900 Facsimile: (713) 221-1212 -16- 17 Of Counsel: Andrew M. Edison State Bar No. 00790629 Bracewell & Patterson, L.L.P. South Tower Pennzoil Place 711 Louisiana, Suite 2900 Houston, Texas 77002-2781 Telephone: (713) 223-2900 Facsimile: (713) 221-1212 CERTIFICATE OF SERVICE I hereby certify that a true and correct copy of the foregoing document was forwarded by certified mail, return receipt requested, on the 17th day of September, 1999 to all counsel of record: Mr. Roger E. Greenberg Mr. David E. Sharp Greenberg, Peden, Siegmyer & Oshman, P.C. 12 Greenway Plaza 10th Floor Houston, Texas 77046 ---------------------------------------- Andrew M. Edison -17- EX-99.3 7 DEFENDANTS' MOTION TO DISMISS 1 EXHIBIT 99.3 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION ) ) IN RE SERVICE CORPORATION ) INTERNATIONAL ) CIVIL ACTION NO. H-99-0280 ) (Judge Lynn N. Hughes) ) ) DEFENDANTS' MOTION TO DISMISS THE CONSOLIDATED CLASS ACTION COMPLAINT J. Clifford Gunter III Andrew M. Edison Bracewell & Patterson, L.L.P. South Tower Pennzoil Place 711 Louisiana, Suite 2900 Houston, Texas 77002-2781 Telephone: (713) 223-2900 Facsimile: (713) 221-1212 COUNSEL FOR DEFENDANTS 2 TABLE OF CONTENTS
PAGE ---- INTRODUCTION......................................................................................................1 NATURE AND STAGE OF PROCEEDINGS...................................................................................3 PLAINTIFFS' ALLEGATIONS...........................................................................................4 STATEMENT OF FACTS................................................................................................5 I. GENERAL BACKGROUND..............................................................................5 II. THE PRENEED FUNERAL BUSINESS....................................................................6 III. THE "PRENEED STUDY."............................................................................7 IV. ACQUISITION, EXPANSION AND MERGER...............................................................8 V. THE SCI-ECI MERGER CLOSES AND FOURTH QUARTER EARNINGS ARE ANNOUNCED..........................................................................9 ARGUMENT AND AUTHORITIES.........................................................................................10 I. THE CONSOLIDATED CLASS ACTION COMPLAINT DOES NOT STATE THE BASIS FOR PLAINTIFFS' INFORMATION AND BELIEF.....................................................................................10 II. PLAINTIFFS FAIL TO PLEAD FRAUD WITH PARTICULARITY..............................................13 A. Plaintiffs Do Not Plead Specific Facts Showing That The SCI Defendants' Statements Were False When Made.......................................13 B. Plaintiffs' References to the Preneed Study Are Insufficient to Show That the SCI Defendants' Statements Were False When Made.............................................................................17 C. Allegations Based on Internal Corporate Documents are Insufficient to Satisfy the Reform Act................................................21 III. MANY OF THE ALLEGED MISSTATEMENTS ARE NOT ACTIONABLE AS A MATTER OF LAW..................................................................23
-i- 3
PAGE ---- A. General Statements of Optimism Do Not Support a Fraud Claim...........................23 B. Statements of Historical Fact Do Not Support a Fraud Claim............................25 C. The SCI Defendants' Forward-Looking Statements are Protected by The Safe Harbor....................................................................25 IV. PLAINTIFFS DO NOT ADEQUATELY ALLEGE SCIENTER...................................................26 A. Under the Reform Act, Plaintiffs Must Allege Specific Facts Creating a Strong Inference of Scienter that the SCI Defendants Acted Knowingly or Recklessly, Not Just That They Had a Motive and Opportunity to Commit Fraud.....................................28 B. Plaintiffs' Allegations Do Not Support a Strong Inference of Scienter...........................................................................32 1. Plaintiffs' Allegations that the SCI Defendants Made Misstatements to Maintain SCI's Bond Rating Fails to Create the Required Inference of Scienter.................................33 2. Plaintiffs' Allegation that the SCI Defendants Made Misstatements to Facilitate Consummation of the SCI-ECI Merger Fails to Create the Required Inference of Scienter..................................................................34 3. The Individual Defendants' Lack of Trading in SCI Stock Negates Any Inference of Scienter............................................35 CONCLUSION.......................................................................................................38 CERTIFICATE OF SERVICE...........................................................................................40
-ii- 4 TABLE OF AUTHORITIES
PAGE ---- CASES Bryant v. Avado Brands, Inc., 1999 WL 688050 (11th Cir. 1999)....................................................31 Duncan v. Pencer, 1996 WL 19043 (S.D. N.Y. 1996).................................................................35 Ernst v. Hockfelder, 425 U.S. 185 (1976).........................................................................27 Ferber v. Travelers Corp., 785 F. Supp. 1101 (D. Conn. 1991).....................................................12 Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42 (D.Mass. 1997)................................................30 Garcia v. United States, 469 U.S. 70 (1984).......................................................................1 Grossman v. Novell, Inc., 120 F.3d 1112 (10th Cir. 1997).........................................................24 Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186 (1974)...........................................................30 Haft v. Eastland Fin. Corp., 772 F. Supp. 1315 (D.R.I. 1991).....................................................12 Harris v. Ivax Corp., 998 F. Supp. 1449 (S.D. Fla. 1998), aff'd, 182 F.3d 799 (11th Cir. 1999)...................................................................26 Hausberg v. Comp USA, Inc., 1995 U.S. Dist. LEXIS 20333 (N.D. Tex. 1995).............................................................................2 Head v. NetManage, Inc., 1998 WL 917794 (N.D. Cal. 1998).........................................................36 In re 1993 Corning Sec. Litig., 1996 WL 257603 (S.D.N.Y. 1996)...................................................34 In re Advanta Corp. Sec. Litig., 1998 WL 387595 (E.D. Pa. 1998), aff'd, 180 F.3d 525 (3d Cir. 1999)......................................................................21 In re Advanta Corp. Sec. Litig., 180 F.3d 525 (3d Cir. 1999).....................................................31 In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3d Cir. 1997)..........................................35 In re Caere Corp. Sec. Litig., 837 F. Supp. 1054 (N.D. Cal. 1993)................................................24 In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446 (N.D. Cal. 1996)...............................................34
-iii- 5 In re Comshare Sec. Litig., 1997 WL 1091468 (E.D. Mich. 1997), aff'd, 183 F.3d 542 (6th Cir. 1999).....................................................................37 In re Comshare Sec. Litig., 183 F.3d 542 (6th Cir. 1999).........................................................31 In re Convergent Techs, Sec, Litig., 948 F.2d 507 (9th Cir.1991).................................................25 In re Credit Acceptance Corporation Securities Litigation, 50 F. Supp.2d 662 (E.D. Mich. 1999).....................................................................37 In re Crown Am. Realty Trust Sec. Litig., 1997 WL 599299 (W.D. Pa. 1997).........................................................................................34 In re Cypress Semiconductor Sec. Litig., 891 F. Supp. 1369 (N.D. Cal. 1995)........................................................................................25 In re Gleaner Technologies, Inc. Sec. Litig., 1998 WL 915907 (S.D.N.Y. 1998).........................................................................................37 In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541 (9th Cir. 1994)....................................................28 In re Health Mgmt. Sys. Sec. Litig., 1998 WL 283286 (S.D.N.Y. 1998)..........................................16, 37 In re Health Management, Inc. Sec. Litig., 970 F. Supp. 192 (E.D.N.Y.1997)..........................................................................................34 In re Mobile Telecommunication Techs. Corp. Sec. Litig., 915 F. Supp. 828 (S.D. Miss. 1995)......................................................................24 In re Oak Tech. Sec. Litig., 1997 WL 448168 (N.D. Cal. 1997).................................................13, 15 In re Paracelsus Corp. Sec. Litig., 1998 WL 1108373 (S.D. Tex. 1998)....................................................................................29, 32 In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746 (N.D. Cal. 1997) ...................................................................................10, 12 In re Silicon Graphics Sec. Litig., 183 F.3d 970 (9th Cir. 1999)......................3, 11, 22, 23, 29, 30, 31, 32 In re Stac Elecs. Sec. Litig., 89 F.3d 1399 (9th Cir. 1996), cert. denied, 117 S.Ct. 1105 (1997)..................................................................5, 13 In re Stratosphere Corp. Sec. Litig., 1997 WL 581032 (D.Nev. 1997)...............................................13
-iv- 6 In re VeriFone Sec. Litig., 784 F. Supp. 1471 (N.D. Cal. 1992), aff'd, 11 F.3d 865 (9th Cir. 1993).....................................................................24 In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994), cert. denied, 116 S.Ct. 185 (1995)...................................................................4, 38 INS v. Cardoza-Fonseca, 480 U.S. 421 (1987)......................................................................30 L.L. Capital Partners, L.P. v. Rockefeller Center Properties, Inc., 939 F. Supp. 294 (S.D.N.Y. 1996).......................................................................33 Leonard v. Netframe Sys., Inc., 1995 WL 798923 (N.D. Cal. 1995)..................................................14 Leventhal v. Tow, 48 F. Supp. 2d 104 (D. Conn. 1999).........................................................34, 35 Lovelace v. Software Spectrum Inc., 78 F.3d 1015 (5th Cir. 1996)..............................................5, 28 Malin v. Ivax, 17 F. Supp.2d 1345 (S.D. Fla. 1998)...............................................................35 McNamara v. Bre-X Minerals Ltd., 1999 WL 507441 (E.D. Tex. 1999)........................................................................................14 Melder v. Morris, 27 F.3d 1097, 1100 (5th Cir. 1994).................................................13, 17, 29, 33 Northwest Forest Resource Council v. Glickman, 82 F.3d 825 (9th Cir. 1996)..............................................................................1 Novak v. Kasaks, 997 F. Supp. 425 (S.D.N.Y. 1998)............................................................12, 15 Press v. Chemical Investment Services Corp., 166 F.3d 529 (2d Cir. 1999)..........................................................................................31 Raab v. General Physics Corp., 4 F.3d 286 (4th Cir. 1993)........................................................24 Robertson v. Strassner, 32 F. Supp.2d 443 (S.D. Tex. 1998).......................................................32 Ronconi v. Larkin, 1998 WL 230987 (N.D. Cal. 1998)...........................................................16, 17 San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Companies, 75 F.3d 801 (2d Cir. 1996)........................................................32, 33 Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124 (2d Cir. 1994)..................................................28 Snowden v. Hughes, 321 U.S. 1 (1944).........................................................................20, 21 Tuchman v. DSC Communications Corp., 14 F.3d 1061 (5th Cir. 1994)................................................27
-v- 7 Wenger v. Lumisys, Inc., 2 F. Supp.2d 1231 (N.D. Cal. 1998)..............................................14, 22, 25 Williams v. WMX Techs., Inc., 112 F.3d 175 (5th Cir.), cert. denied, 118 S.Ct. 412 (1997)......................................................................32 Zeid v. Kimberley, 930 F. Supp. 431 (N.D. Cal. 1996).........................................................14, 22 STATUTES/RULES Fed. R. Civ. P. 9(b)...........................................................................1, 2, 12, 13, 28, 33 Fed. R. Evid. 201(b)..............................................................................................2 15 U.S.C. Section 78u-4(b)(1)................................................................................10, 11 15 U.S.C. Section 78u-4(b)(1)(B).................................................................................11 15 U.S.C. Section 78u-4(b)(2)....................................................................................29 15 U.S.C. Section 78u-4(b)(3)(A)..................................................................................2 15 U.S.C. Section 78u-5(c)(1)(A)(i)..............................................................................25 OTHER H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. 31 (1995), reprinted in 1995 U.S.C.C.A.N. 730........................................................1, 2, 28, 29, 30 H.R. Doc. No. 104-150 (1995).....................................................................................30
-vi- 8 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION ) ) IN RE SERVICE CORPORATION ) INTERNATIONAL ) CIVIL ACTION NO. H-99-0280 ) (Judge Lynn N. Hughes) ) ) DEFENDANTS' MOTION TO DISMISS THE CONSOLIDATED CLASS ACTION COMPLAINT Pursuant to Fed. R. Civ. P. 9(b), 12(b)(6) and the Private Securities Litigation Reform Act of 1995, Defendants Service Corporation International ("SCI"), R. L. Waltrip, L. William Heiligbrodt and George R. Champagne (collectively "the SCI Defendants")(1) file this Motion to Dismiss the Consolidated Class Action Complaint. INTRODUCTION This securities fraud class action is governed by the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67 (the "Reform Act"). In enacting the Reform Act, Congress found "significant evidence of abuse in private securities lawsuits." H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. 31 (1995), reprinted in 1995 U.S.C.C.A.N. 730.(2) Specifically, Congress noted that these abusive practices included "the routine filing of lawsuits against issuers of securities and others whenever there is a significant change in an issuer's stock price, without regard to any underlying - -------- (1) Waltrip, Heiligbrodt and Champagne are referred to as the "Individual Defendants." (2) The Conference Report is the "authoritative source for finding the Legislature's intent." Garcia v. United States, 469 U.S. 70, 76 (1984). See also Northwest Forest Resource Council v. Glickman, 82 F.3d 825, 835 (9th Cir. 1996) ("[A] congressional conference report is recognized as the most reliable evidence of congressional intent because 'it represents the final statement of the terms agreed to by both houses'"). 9 culpability of the issuer, and with only faint hope that the discovery process might lead eventually to some plausible cause of action[.]" Id. Congress further found that the standard for pleading fraud under Fed. R. Civ. P. 9(b) "has not prevented abuse of the securities laws by private litigants." Id. at 41. Among other things, the Reform Act requires plaintiffs to state with particularity the facts -- not speculation -- that supports their belief that a fraud really has taken place. Plaintiffs now must convince the court that they have facts to support a fraud action, and not just a vivid imagination and hope that the discovery process will be fruitful. Unlike a traditional Rule 12(b)(6) motion, a motion to dismiss under the Reform Act does not permit a plaintiff to rest on presumptions or require the Court to draw inferences in plaintiffs' favor. The Reform Act authorizes courts to scrutinize complaints for the requisite factual basis at the outset, and requires dismissal of cases that are deficient. 15 U.S.C. Section 78u-4(b)(3)(A). This securities fraud class action is exactly the type of case that prompted Congress to reform the federal securities laws, for Plaintiffs have brought this action solely on the basis that SCI experienced a significant drop in its stock price during the Class Period, going from a closing price of 43-3/8 on July 17, 1998 to 19-1/2 on January 26, 1999.(3) Although Plaintiffs accuse SCI and its three highest ranking officers of engaging in a fraud of the greatest magnitude, there are no facts to substantiate this serious charge. Reminiscent of pre-Reform Act pleadings, Plaintiffs simply recite a litany of statements by the SCI Defendants covering all aspects of SCI's business - including operating challenges, - -------- (3) In rendering its decision on a motion to dismiss, the Court may consider matters of public record involving historical stock prices. Fed. R. Evid. 201(b); Hausberg v. Comp USA, Inc., 1995 U.S. Dist. LEXIS 20333, at *31 n.14 (N.D. Tex. 1995). -2- 10 acquisitions and financial results. The Consolidated Class Action Complaint ("CCAC") then summarily concludes that these statements were false or misleading when made because SCI did not disclose that its preneed funeral business was causing a sharp erosion in its profit margins. This type of pleading simply does not satisfy the Reform Act. It is noteworthy that Plaintiffs conveniently forget to mention that the Individual Defendants in this case -- the purported masterminds of this fraud -- did not sell any shares of SCI stock during the Class Period. This completely negates any inference of scienter. The CCAC should be dismissed for the following reasons: 1. The CCAC does not satisfy the Reform Act requirement that allegations made on "information and belief" state with particularity the facts on which the belief is formed; 2. The CCAC does not allege, with the particularity required by the Reform Act, that the SCI Defendants' statements concerning SCI's preneed funeral business were false when made; 3. The statements alleged to be false or misleading were in fact innocuous, non-actionable statements of general optimism or historical fact. Courts have long held that such statements cannot serve as the basis for a securities claim; and 4. The CCAC fails to allege with particularity facts giving rise to a strong inference that the SCI Defendants acted with, at a minimum, deliberate recklessness. See In re Silicon Graphics Sec. Litig., 183 F.3d 970 (9th Cir. 1999) (Silicon Graphics II). Far from meeting that standard, the CCAC even fails to meet lower scienter standards applied by other courts interpreting the Reform Act. NATURE AND STAGE OF PROCEEDINGS In January and February 1999, more than 20 virtually identical class action lawsuits were filed in the Southern District of Texas against SCI and certain of its present and former officers and directors. Two class action lawsuits were brought in the Eastern District of Texas and transferred -3- 11 to the Southern District of Texas. All of these actions have been consolidated before this Court under Cause No. H-99-0280; In Re Service Corporation International. On June 9, 1999, this Court appointed Rujira Srisythep, Carl Helwig and Allan Lisse to serve as Lead Plaintiffs. This Court also appointed Roger Greenberg to serve as Lead Plaintiffs' Counsel. On August 25, 1999, this Court certified the Lead Plaintiffs as class representatives. The Class Period is from July 17, 1998 to January 26, 1999. On September 3,1999, Plaintiffs filed the CCAC, alleging claims against the SCI Defendants under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933, Sections 10(b), 20(a) and 20A of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated by the Securities and Exchange Commission ("SEC").(4) PLAINTIFFS' ALLEGATIONS The allegations contained in the CCAC focus entirely on SCI's preneed funeral business. According to Plaintiffs, the SCI Defendants were aware that SCI's preneed funeral business was unprofitable but failed to disclose that information to the public. This elaborate ruse is alleged to have been perpetrated so that SCI could inflate its stock price in order to maintain high credit ratings on debt securities and obtain favorable terms in connection with a stock-for-stock transaction. - -------- (4) There can be no violation of Section 15 of the Securities Act of 1933 and Section 20(a) of the Securities Exchange Act of 1934 without a primary violation. See In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1428 n.9 (9th Cir. 1994), cert. denied, 116 S.Ct. 185 (1995). Because Plaintiffs have not stated a claim under Section 10(b) or Rule 10b-5, they have no claim under Sections 20(a) and 20A. Similarly, because Plaintiffs have not stated a claim under Sections 11 or 12(a)(2), they have no claim under Section 15 either. -4- 12 STATEMENT OF FACTS I. GENERAL BACKGROUND. SCI is a Texas corporation founded in 1962 by R.L. Waltrip. From a single funeral home in the Heights, SCI has grown into the largest provider of death care services and products in the world. See CCAC at Paragraph 19. As of December 31, 1998, SCI and its subsidiary and affiliate companies operated 3,442 funeral service locations, 433 cemeteries and 191 crematoria located in 20 countries on five continents. Id. SCI performs approximately 11 percent of the funeral services in North America, 28 percent of the funeral services in France, 14 percent of the funeral services in the United Kingdom and 25 percent of the funeral services in Australia. See SCI's Form 10-K for the Fiscal Year ended December 31, 1998, attached as Exhibit A, at p. 2.(5) SCI's common stock is listed on the New York Stock Exchange. Historically, SCI's growth has been largely attributable to acquisitions.(6) During the 1990s alone, SCI added more than 2,800 funeral homes worldwide. See CCAC at Paragraph 20. During the Class Period, Waltrip served as SCI's Chief Executive Officer, Heiligbrodt served as SCI's Chief Operating Officer and Champagne served as SCI's Chief Financial Officer. Id. at Paragraphs 7-9. - -------- (5) All exhibits attached to this Motion to Dismiss are referenced in the CCAC or are public documents filed with the SEC. It is well-settled that the Court may take judicial notice on a motion to dismiss of those documents which are referenced in the Complaint or are public documents filed with the SEC. See In re Stac Elecs. Sec. Litig., 89 F.3d 1399, 1405 n.4 (9th Cir. 1996), cert. denied, 117 S. Ct. 1105 (1997); Lovelace v. Software Spectrum Inc., 78 F.3d 1015, 1018 (5th Cir. 1996). (6) SCI revolutionized the funeral industry through its innovative "clustering" concept. SCI believed that by sharing facilities, vehicles, equipment and personnel, several funeral homes within a given area or "cluster" could operate more efficiently and lower combined overhead costs, thus achieving economies of scale unavailable to them as independent operators. See CCAC at Paragraph 17. -5- 13 II. THE PRENEED FUNERAL BUSINESS. Preneed funeral contracts are arrangements where individuals select and purchase their funeral arrangements prior to their death, and funeral homes agree to perform the funeral services in the future. Id. at Paragraph 22. For SCI, preneed funeral contracts provide an opportunity to protect current market share and lock-in future market share. Id. at Paragraph 126 ("only 30 percent of the people who buy preneed through an SCI facility would be an SCI at need customer"). For consumers, by planning ahead, they avoid forcing family and friends from having to make costly and difficult funeral decisions during a period of peak emotional strain. SCI's SEC filings fully disclose how its preneed funeral business operates: SCI sells price guaranteed prearranged funeral contracts through various programs providing for future funeral services at prices prevailing when the agreements are signed. Payments under these contracts are placed in trust accounts (pursuant to applicable law) or are used to pay premiums on life insurance policies. Earnings on trust funds and increasing benefits under insurance funded contracts also increase the amount of cash to be received upon performance of the funeral. See SCI's Form 10-K for the Fiscal Year Ended December 31, 1997, attached as Exhibit B, at p. 16.(7) As SCI purchased additional funeral homes, it acquired both the obligation to perform preneed funerals and the mortuary trust assets that eventually are used to pay for the preneed funerals. See CCAC at Paragraph 22. - -------- (7) SCI's SEC filings also note the accounting treatment given to prearranged funerals: Amounts paid by a customer under a prearranged funeral contract are recognized in funeral revenue at the time the funeral service is performed. Trust earnings and increasing insurance benefits are accrued and deferred until the services are performed, at which times these funds are also recognized in funeral revenues.... See Exhibit A at p.36. -6- 14 SCI's trust funds are invested to "cover future increases in the cost of providing a price guaranteed funeral service." See Exhibit A at p.18. Recent years have seen SCI's trust funds perform very well. In fact, SCI's "North American prearranged trust portfolio earned a return of 18.0% in 1998 and 12.5% in 1997 (including realized gains)." Id. As of December 31, 1998, the total value of unperformed prearranged funeral contracts expected to be recognized by SCI in future periods was $3.75 billion (up from $3.37 billion as of December 31, 1997).(8) Id. III. THE "PRENEED STUDY." To determine how to optimize the performance of trust investments, SCI undertook during 1996 and 1997 a "review of the prearranged trust investment process which included an asset/liability study." See Exhibit B at p.16. The CCAC refers to this review as the "Preneed Study." (9) See CCAC at Paragraph 32. At the time the Preneed Study was initiated, SCI invested its funeral trust funds approximately 21 percent in equity and 79 percent in fixed income. See Exhibit C-1 at SCI0009. The Preneed Study looked at five different asset allocation mixes available to SCI (including the 21 percent equity/79 percent fixed income asset allocation mix in effect at the time), and found that SCI could increase the trust rate of return through adoption of a new asset allocation mix. See Exhibit C-4 at SCI0062-63. In light of this conclusion, SCI, during 1997, reallocated its trust portfolio to - -------- (8) The total value of unperformed prearranged funeral contracts are trust funded or insurance funded and represent the original contract price plus accumulated trust earnings or increasing insurance benefits. See Exhibit A at p.36. (9) True and correct copies of the various documents comprising the Preneed Study are attached as Exhibits C-1 to C-7. The Preneed Study is authenticated by the Declaration of Mary Beth Russo, attached as Exhibit C. The "asset/liability" study referred to in SCI's Form 10-K is part of the Preneed Study and is attached as Exhibit C-1. For simplicity sake, all pages of the Preneed Study have been stamped with a "SCI" bates-stamp. -7- 15 achieve a "new asset allocation of approximately 65 percent equity and 35 percent fixed income." See Exhibit B at p.16. SCI also implemented "a new investment program which entail[ed] the consolidation of multiple trustees, the use of institutional managers with differing investment styles and consolidated performance monitoring and tracking." Id. The Preneed Study was fully disclosed in SCI's numerous SEC filings. See, e.g., Exhibit B at pp. 16-17; SCI's Form 10-K for the Fiscal Year Ended December 31, 1996, attached as Exhibit D, at p. 17. IV. ACQUISITION, EXPANSION AND MERGER. The summer of 1998 was a busy time for SCI. On July 17, 1998, SCI announced that it had acquired American Memorial Life Insurance Company, the preneed funeral services division of American Annuity Group, Inc. See CCAC at Paragraph 73. Also on July 17, 1998, SCI announced that it had formed a new financial services subsidiary, SCI Financial Services, Inc., to facilitate the expansion of SCI's preneed businesses and financial activities worldwide. Id. A week later, SCI announced its second quarter revenues and earnings. Id. at Paragraph 78. For the three months ended June 30, 1998, SCI reported revenues of $671.9 million, net income of $90.9 million and diluted earnings per share of $.35. Id. On August 6, 1998, SCI announced that it had reached a definitive agreement with Equity Corporation International ("ECI"), the nation's fourth largest publicly traded death care company, to acquire ECI in a merger transaction. Id. at Paragraph 80. In an interesting twist to the merger, urban-oriented SCI and rural-oriented ECI were part of the same company until 1990 when ECI was spun off and relocated its headquarters to Lufkin, Texas. Id. -8- 16 On October 22, 1998, SCI announced its third quarter revenues. Id. at Paragraph 94. For the three months ended September 30, 1998, SCI reported revenues of $712.5 million, net income of $83.2 million and earnings per share of $.32. Id. These results were significantly higher as compared to the same period for the year before. Id. V. THE SCI-ECI MERGER CLOSES AND FOURTH QUARTER EARNINGS ARE ANNOUNCED. The SCI-ECI merger closed on January 19, 1999 with ECI shareholders receiving .71053 of a share of SCI common stock for each share of ECI common stock. Id. at Paragraph 69. On January 26, 1999, SCI issued a press release, announcing that it expected diluted earnings per share for the fourth quarter of 1998 would be lower than analysts' expectations (10) See Exhibit E. For the three months ended December 31, 1998, SCI said it expected diluted earnings per share in the range of $.22-$.24 as compared to the First Call earnings estimate of $0.42 per share (11) Id. The stock market reacted swiftly to the news. SCI's stock price dropped from 34 7/16 to 19 1/2, a - -------- (10) SCI explained in a press release the reasons for the lower than expected earnings included: o Reduced mortality rates in the Company's major markets resulting in fewer funerals performed at the Company's locations. o Cemetery revenues below anticipated levels. o Increased operating costs and field overhead expenses associated with necessary investment in newly acquired operations, information technology systems and training programs. o Fewer acquisitions during the quarter than were previously expected due to higher than anticipated acquisition pricing. o Disappointing results from selected foreign operations. See Exhibit E. (11) While SCI did not meet analyst's expectations, it should be noted that, for the year ended December 31, 1998, SCI still earned $1.31 a share on net income of $342.1 million. See Exhibit A at p.7. -9- 17 single day loss of almost 44 percent. See CCAC at Paragraph 124. Today, SCI's common stock trades at around $8.(12) ARGUMENT AND AUTHORITIES I. THE CONSOLIDATED CLASS ACTION COMPLAINT DOES NOT STATE THE BASIS FOR PLAINTIFFS' INFORMATION AND BELIEF The Reform Act adopted several procedural requirements designed to weed out non-meritorious cases at the pleading stage. It forbids conclusory or generalized allegations of fraud, and commands that a complaint "shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. Section 78u-4(b)(1) (emphasis added). A complaint that does not meet these criteria "shall" be terminated at the pleading stage. 15 U.S.C. Section 78u-4(b)(3)(A) (emphasis added). The Reform Act's information and belief provision is a significant new requirement. In this case, Plaintiffs do not profess to have personal knowledge of their allegations; hence, they are pleading on information and belief. See In re Silicon Graphics, Inc. Sec. Litig., 970 F. Supp. 746, 763 (N.D. Cal. 1997) (Silicon Graphics I) (noting that a complaint based on "investigation of counsel" is the same as a complaint based upon "information and belief"), aff'd, In re Silicon Graphics, Inc. - -------- (12) SCI is not the only company in the death care industry to see its stock tumble in the last year. Operating challenges have severely impacted the funeral industry as a whole. Loewen Group (NYSE: LWN), the nation's second largest death care firm, is now mired in Chapter 11 bankruptcy proceedings. Its stock is currently trading at around 1/2 (52 week high: 15-3/8). Another major force in the industry, Stewart Enterprises, Inc., (NASDAQ: STEI) recently warned of lower than expected earnings for the rest of this year and its stock dropped as well. It is currently trading at around 5-1/32 (52 week high: 24-3/4). -10- 18 Graphics, Inc. Sec. Litig., 183 F.3d 970 (9th Cir. 1999). Plaintiffs must therefore "state with particularity all facts" that support their belief that the SCI Defendants committed fraud. See 15 U.S.C. Section 78u-4(b)(1). The only attempt to comply with the Reform Act -- other than Plaintiffs' specious reference to the Preneed Study, discussed more fully below - -- is a boilerplate paragraph entitled "Plaintiff's [sic] Investigation," which alleges: Plaintiff's [sic] allegations set forth herein are based on a thorough investigation conducted by and through their attorneys. Such investigation included a review and analysis of: a. SCI's filings with the SEC both prior to and throughout the Class Period; b. the Company's Annual Reports to shareholders both prior to and during the Class Period; c. the Company's press releases and other publicly disseminated statements made by defendants prior to, during, and following the Class Period; d. reports, articles, and other written materials concerning the Company and the subject matter of this complaint; e. analyst reports and investor advisory service reports; and f. consultations with forensic accountants, former company employees and other individuals knowledgeable about the Company's business, operations and services. See CCAC at Paragraph 128. Courts applying the Reform Act have held repeatedly that this type of conclusory pleading does not comply with the statutory requirement to "state with particularity all facts" that form plaintiffs' belief that the defendants committed fraud. See 15 U.S.C. Section 78u-4(b)(1)(B). Indeed, complaints with virtually identical "Basis of Allegations" paragraphs have been routinely dismissed. See, e.g., Silicon Graphics II, 183 F.3d 985 (rejecting a rote basis of allegations paragraph, stating that "a plaintiff must provide, in great detail, all the relevant facts forming the basis of her belief"); -11- 19 Novak v. Kasaks, 997 F. Supp. 425, 431 (S.D.N.Y. 1998) (virtually identical "Basis of Allegations" paragraph coupled with allegations of negative internal reports insufficient). Plaintiffs' assertion that their allegations are based in part on unspecified "consultations with forensic accountants, former company employees and other individuals knowledgeable about the Company's business, operations and services" (CCAC at Paragraph 128) is especially flawed. "If, in fact, these unnamed 'consultants' provided information forming the basis for these allegations, then the consultants should have been named in the complaint." Novak, 997 F. Supp. at 431 (dismissing complaint); see also Silicon Graphics I, 970 F. Supp. at 763 (Reform Act legislative history suggests plaintiffs must identify "confidential informants, employees, competitors, Government employees, members of the media, and others who have provided information leading to the filing of the case"). Plaintiffs do not identify any single discussion with anyone upon which they formed their supposed "belief." There are no facts in the CCAC that would suggest that Plaintiffs' allegations are derived from anything more than their counsel's surmise and speculation.(13) - -------- (13) Plaintiffs cite an August 12, 1999 article from The Death Care Business Advisor that does not even purport to quote SCI executives. Under the Reform Act, such an article does not support a claim for fraud. Ferber v. Travelers Corp., 785 F. Supp. 1101, 1108 (D. Conn. 1991) ("The strictures of Rule 9(b) are not satisfied by indirect quotes taken from a newspaper reporter's notebook"); Haft v. Eastland Fin. Corp., 772 F. Supp. 1315, 1319 (D.R.I. 1991) (news article "fail[ed] to provide the underlying factual support required by Rule 9(b)" because "[i]t is not a direct quote from the defendants, it is merely an analysts' opinion "). -12- 20 II. PLAINTIFFS FAIL TO PLEAD FRAUD WITH PARTICULARITY A. PLAINTIFFS DO NOT PLEAD SPECIFIC FACTS SHOWING THAT THE SCI DEFENDANTS' STATEMENTS WERE FALSE WHEN MADE. Despite its length and complexity, the CCAC does not satisfy the Reform Act's rigorous pleading standard.(14) The CCAC contains no facts detailing when, where, and how the SCI Defendants knew the challenged statements were false when made (15) "Apparently, plaintiffs believe that the sheer volume of their allegations gives credibility to their claims." In re Oak Tech. Sec. Litig., 1997 WL 448168, at *4 (N.D. Cal. 1997). Plaintiffs' allegations are based on the conclusory assumption that at the time statements were made concerning SCI's financial condition and preneed funeral business, the opposite of what was said was true. This type of conclusory, fraud-by-hindsight pleading was routinely rejected even under the less rigorous pre-Reform Act pleading standard: Plaintiff's conclusory attempt to plead as "facts" the converse of the positive statements made by defendants does not satisfy [the] requirement that a plaintiff identify particular facts indicating the falsity of defendants' statements. Essentially, plaintiff points to a positive statement by defendants, - -------- (14) As an aside, the CCAC also does not satisfy the requirements of Fed. R. Civ. P. 9(b). See Melder v. Morris, 27 F.3d 1097 (5th Cir. 1994). (15) These standards apply equally to securities fraud claims brought under Sections 10(b) and 20A of the 1934 Act and Sections 11 and 12(2) of the 1933 Act where, as here, the gravamen of each claim is fraud. See, e.g., In re Stac Elecs. Sec. Litig., 89 F.3d at 1404-05 (holding that "the particularity requirements of Rule 9(b) apply to claims brought under Section 11 when, as here, they are grounded in fraud"); Melder, 27 F.3d at 1100 n.6 (holding that Rule 9(b) applies to 1933 Act claims when they are grounded in fraud rather than negligence, and applying the rule to Section 11 and 12(2) claims). Here, Plaintiffs' Section 11 and 12(2) claims sound in fraud. Plaintiffs' effort to distinguish between negligence and fraud are not successful because Plaintiffs' Section 11 and 12(2) claims are based on the same predicate facts. See In re Stratosphere Corp. Sec. Litig., 1997 WL 581032 at *7-8 (D.Nev. 1997) (holding that "[p]laintiffs cannot avoid the more stringent requirements of Rule 9(b) by merely inserting boilerplate language into their Complaint stating that claims are based in negligence, not fraud, or try to plead both fraud and negligence by stating Defendants 'knew or should have known' of the alleged falsity"). -13- 21 such as, "We are very pleased with growth through the second quarter and look forward to the opportunities and challenges ahead," and, in a conclusory manner, states the opposite, such as "the Company expected a material decline in its profitability." These are not specific "facts" indicating that the first statement was false; these are simply allegations that the opposite was true without any supporting facts or circumstances. Plaintiff does not specify dates, places, amounts, transactions, etc. Plaintiff does not point to any inconsistent contemporaneous statements or information (such as internal reports) which were made by or available to defendants at the time of the positive statements which would suggest that the positive statements were false or misleading. . . . Because of this, plaintiff's allegations must be dismissed. Leonard v. Netframe Sys., Inc., 1995 WL 798923, at *6 (N.D. Cal. 1995) (citations omitted). Not surprisingly,"post-Reform Act cases have emphasized [that] without references to specific facts demonstrating that the statements at issue were false or misleading when made, allegations regarding adverse information supposedly known to defendants are merely 'speculation and conclusions drawn from hindsight.'" Wenger v. Lumisys, Inc., 2 F. Supp.2d 1231, 1250 (N.D. Cal. 1998) (citation omitted). See also Zeid v. Kimberley, 930 F. Supp. 431, 436 (N.D. Cal. 1996) (conclusory allegations insufficient to support securities fraud claim where complaint did not plead contemporaneous facts tending to show that the allegedly misleading statements were false when made); In re Oak Tech Sec. Litig., 1997 WL 448168, at *5 (insufficient for plaintiffs to merely allege that defendants made certain representations even though they were aware of contrary adverse information; plaintiffs must provide supporting contemporaneous factual allegations, including allegations of when defendants learned of adverse information); McNamara v. Bre-X Minerals Ltd., 1999 WL 507441, at *20 (E.D. Tex. 1999) (same). Here, Plaintiffs allege that the SCI Defendants "knew" that the independent funeral homes acquired by SCI had failed to actively manage their funeral trust assets (CCAC at Paragraph 44); "knew" that SCI had failed to actively invest its existing mortuary trust assets (Paragraph 74); "knew" that funeral trust -14- 22 funds were inadequately funded to cover the cost of providing a funeral (Paragraph 91); and "knew" that SCI's preneed funeral business was a drain on SCI's profitability. (Paragraphs 12, 44). These conclusory allegations are not sufficient to meet Plaintiffs' pleading burden. The CCAC does not plead what specific information the SCI Defendants knew, how they knew it, and why it rendered their statements false. Plaintiffs have failed to point to particular contemporaneous, inconsistent statements by the SCI Defendants or to show specific information available to the SCI Defendants revealed something different than what the SCI Defendants stated or failed to state. Conclusory pleadings that "'adverse material facts were in existence or known by Defendants at the time the allegedly misleading statements were made" are not enough. In re Oak Tech. Sec. Litig., 1997 WL 448168, at *4. In Novak, 997 F. Supp. 425, the court dismissed plaintiffs' securities fraud action for failing to plead "facts underlying the complaint's allegations as to the information that was available to the individual defendants" or to "direct the Court to where those facts might be found." Id. at 431. Plaintiffs' allegations here, like those in the Novak case, are based on unnamed consultants and other unspecified sources, and do not identify any basis for concluding that any SCI Defendant knew of any adverse fact concerning SCI's preneed funeral business. Throughout the CCAC's 77 pages, Plaintiffs point to a number of statements made by the SCI Defendants and claim, without providing any factual support, that the opposite of what the SCI Defendants said was true. For example: o SCI said in public filings that preneed funeral contracts are sold at prices prevailing when the agreements are signed. See CCAC at Paragraph 88. o Plaintiffs claim this is not true. Id. at Paragraph 89. -15- 23 o SCI said that its financial services subsidiary would coordinate the investment of all funeral trust assets. Id. at Paragraph 73. o Plaintiffs blithely assert this is not true. Id. at Paragraph 74. o SCI coordinated investments of all of the company's funeral trust funds. Id. at Paragraph 94. o Plaintiffs claim this is not the case. Id. at Paragraph 95. o SCI said that the operational systems of SCI and ECI were similar. Id. at Paragraph 82. o Plaintiffs claim this is not true. Id. at Paragraph 83. o SCI said in 1997 that it had implemented a new investment program for its funeral trust funds targeting "a real return in excess of the amount necessary to cover future increases in the cost of providing a price guaranteed funeral." Id. at Paragraph 90. o Plaintiffs allege this is not true. Id. at Paragraph 91. o SCI said it had purchased American Memorial Life Insurance Company to facilitate the expansion of SCI pre-need business and financial activities worldwide. Id. at Paragraph 92. o Plaintiffs say this is not true. Id. at Paragraph 93. "[T]he conclusory allegation that the opposite of a statement in a press release is true, without further factual elaboration, is insufficient." In re Health Mgmt. Sys. Sec. Litig., 1998 WL 283286, at * 6 (S.D.N.Y. 1998). Without specific factual detail, this type of pleading certainly does not satisfy the Reform Act. Ronconi v. Larkin, 1998 WL 230987 (N.D. Cal. 1998) is directly on point. In that case, the court dismissed a securities fraud claim based upon purported misstatements made in connection with an announced merger. In an observation applicable to this case, the court noted that "plaintiffs' allegations of falsity really amount to the following: defendants said X. X was false. X was false -16- 24 because the opposite of X was true. Or X was false because X did not later come true." Id. at *4. The court continued: "While such a syllogism might be a sufficient statement of falsity in ordinary expression, it is not adequate under the standards of law for pleading violations of the Securities Exchange Act of 1934." Id. The same is the case here. Plaintiffs' failure to allege a factual basis for their claims requires a dismissal. This is not a technical defect. This issue prompted securities litigation reform legislation: plaintiffs are no longer allowed to base their claims on guesswork, with the "faint hope" that discovery might prove the guess correct. B. PLAINTIFFS' REFERENCES TO THE PRENEED STUDY ARE INSUFFICIENT TO SHOW THAT THE SCI DEFENDANTS' STATEMENTS WERE FALSE WHEN MADE. Plaintiffs attempt to satisfy the Reform Act's strict pleading requirements by alleging that the SCI Defendants were aware through the Preneed Study that SCI's preneed funeral business was unprofitable. Specifically, Plaintiffs claim that the Preneed Study confirmed that: o a "significant number of independent funeral homes acquired by SCI had failed to actively manage their mortuary trust assets and, as a result, a material number of SCI's funeral services had been and would continue to be, performed at significant losses to SCI, severely cutting into SCI's profit margins." CCAC at Paragraph 44. See also CCAC at Paragraphs 32, 35, 74(a); and o "SCI's trust funds had not been managed to grow at a rate equal to or greater than the increase in the cost of funeral services." CCAC at Paragraph 53 (emphasis included in original). The problem with Plaintiffs' reliance on the Preneed Study is twofold. FIRST, THE STATEMENTS IN THE CCAC ABOUT THE ALLEGED CONTENTS OF THE PRENEED STUDY ARE OUTRIGHT FALSEHOODS.(16) The Preneed - -------- (16) As in Melder, 27 F.3d at 1101 fn. 8, "if plaintiffs' counsel had been bound under the same strictures concerning veracity as were the [defendants] under governing securities law standards, their complaint would have to be labeled misleading." -17- 25 Study simply does not in any respect say what Plaintiffs claim it says. By way of example, a thorough review of the Preneed Study will not find one sentence, chart or graph supporting Plaintiffs' baseless accusations that a "significant number of independent funeral homes acquired by SCI had failed to actively manage their mortuary trust assets" or that "SCI's trust funds had not been managed to grow at a rate equal to or greater than the increase in the cost of funeral services." SECOND, THE PRENEED STUDY ACTUALLY REBUTS EACH OF PLAINTIFFS' UNSUBSTANTIATED ALLEGATIONS, COMPLETELY UNDERMINING THE CREDIBILITY OF THE CLAIMS RAISED IN THE CCAC. For example, contrary to Plaintiffs' bald assertion that the Preneed Study demonstrates that "SCI's trust funds had not been managed to grow at a rate equal to or greater than the increase in the cost of funeral services" (CCAC at Paragraph 53), the Preneed Study shows that SCI's return on mortuary trust assets has considerably outpaced inflation. The Preneed Study indicated that the "current actual" return of SCI's mortuary trust assets was 2 percent over inflation. See Exhibit C-4 at SCI0064. The Preneed Study also estimated that a 65 percent equity/35 percent fixed income asset allocation mix would, on an annual basis, return more than five percent over inflation.(17) Id. In 1997, SCI selected the 65 percent equity/35 percent fixed income asset allocation. The fully disclosed results have been even better than expected, as SCI's "North American prearranged trust portfolio earned a return of 18.0% in 1998 and 12.5 % in 1997 (including realized gains)." See Exhibit A at p.18. Far from showing that "a material number of SCI's funeral services had been and would continue to be, performed at significant losses," the Preneed Study actually demonstrates that the preneed funeral business is profitable. Indeed, the asset/liability study (which was part of the - -------- (17) The 65 percent equity/35 percent fixed income asset allocation mix was mix #2 in the asset/liability study. See Exhibit C-1 at SCI0009. -18- 26 Preneed Study) conducted by Coopers & Lybrand, L.L.P. looked at three states - Florida, Texas and California -- and established that the preneed funeral contracts in those states alone had a present value of more than $210 million in company net income. See Exhibit C-1 at SCI0020. The Preneed Study also found that "The Five Asset Allocation Mixes Reviewed All Resulted in Significant Net Cash Flow to SCI" and "Given Any Reasonable Time Frame (Longer than One Year), The More Aggressive Asset Mixes Provide Great Upside Potential With No Measurable Downside." See Exhibit C-4 at SCI0063. The notion that the Preneed Study "confirmed" the unprofitability of SCI's preneed funeral business is belied by the clear and unequivocal charts and graphs of the Preneed Financing Option Report, which was also prepared by Coopers & Lybrand, L.L.P. and is part of the Preneed Study. See Exhibit C-3. This Report looked at the various opportunities available to fund preneed funerals such as trust funds, insurance and bonding. Id. This model forecasted cash flows forward for 40 years and discounted them back to the present using present value techniques. Id. At-need funerals were forecast in the same way in this model as a comparison point. Id. The states of Florida, Texas, California and Missouri were modeled. Id. In all four states, profits generated by preneed contracts were more profitable than the at-need contracts, even using very conservative inflation assumptions. Id. at SCI0040, SCI0051, SCI0054, SCI0056-57. Not surprisingly, the Preneed Study also demonstrates that many of the other allegations raised by Plaintiffs regarding SCI's preneed funeral business are without any merit whatsoever. For example: o While Plaintiffs claim that "the vast majority of the preneed assets that SCI had previously acquired in connection with its purchase of independent funeral homes were not, and would not be, invested in accordance with the terms of the "new investment program" (CCAC -19- 27 at Paragraph 36, 44, 45), the Preneed Study demonstrates this is not the case. The truth is that the "new investment program" included all North American funeral trust assets, whether acquired in a purchase or not. SCI had established procedures in place to quickly move the trust funds it acquired to SCI's preferred trustees for investment in accordance with the new asset allocation mix. See Exhibit C-7 (When SCI acquires a funeral home, it takes steps to "amend the trust agreement or to have the trust adopt the master agreement for that state, assignment of an account number, verification of assets, and transferring of the trust to a new trustee"); Id. ("Once the [trust] assets are moved to the new trustee...the Corporate Investment Department will forward a package reflecting the asset allocation that is designated for the trust funds they hold"). (18) o While Plaintiffs claim that SCI did not have any program to manage the assets associated with preneed funeral trusts prior to the creation of SCI Financial Services, Inc. in 1998 (See CCAC at Paragraph 95), the Preneed Study shows this is not the case. The Preneed Study expressly states that "[a]lthough SCI previously had an overall asset allocation policy for these trusts, the new allocation has been developed based upon on [sic] a more scientific, analytical approach, focused on meeting SCI's financial objectives." See Exhibit C-5 at SCI0070 (emphasis added). o While Plaintiffs claim that SCI's "backlog of prearranged funeral contracts included a material number of contracts that were not sold at prices prevailing when the agreements were signed" (CCAC at P. 89), the Preneed Study establishes the falsity of Plaintiffs' claim. See Exhibit C-5 at SCI0068 ("At the time the [preneed] contract is signed, the contract's goods and services are priced at the current retail price"). o While Plaintiffs claim that SCI failed to disclose during the Class Period that it had not "establish[ed] any means of actively managing the mortuary trust assets that would eventually be used to pay for these acquired preneed funeral contracts" (CCAC at Paragraph 30), this is - -------- (18) SCI's Form 10-Ks further demonstrate that SCI moved a considerable amount of the trust assets it acquired to its new investment program. In 1996, the year before SCI's new investment program went into effect, $276 million (or 31.8 percent) of the $866 million in funeral trust assets were in cash equivalents. By the end of 1997, after a year of SCI's new investment program, only $134 million (or 12.6 percent) of the $1.070 billion in funeral trust assets were in cash equivalents. See Exhibit B at p. 30. -20- 28 simply not true. As noted above, in 1997 SCI implemented a "new investment program which entailed the consolidation of multiple trustees, the use of institutional managers with differing investment styles and consolidated performance monitoring and tracking." See Exhibit B at p. 16. The Preneed Study details the components of this "new investment program" in great detail. See Exhibit C-5 at SCI0066-71. A district court's central task in evaluating a motion to dismiss is to determine whether the complaint alleges facts sufficient to state a cause of action. In conducting that inquiry, the court need not accept a complaint's "bald assertions" or "unsupportable conclusions." See Snowden v. Hughes, 321 U.S. 1, 10 (1944). In this case, the Preneed Study speaks for itself. Plaintiffs should not be permitted to base a complaint solely on disingenuous and false references to the Preneed Study. C. ALLEGATIONS BASED ON INTERNAL CORPORATE DOCUMENTS ARE INSUFFICIENT TO SATISFY THE REFORM ACT. Aside from the Preneed Study, the Plaintiffs allege no facts for their claim that SCI encountered troubles in its preneed funeral business.(19) Plaintiffs allege only that SCI's executives had access to unspecified internal adverse information showing the "true" state of affairs. See CCAC at Paragraph 12 (the SCI Defendants were aware of true facts through "internal corporate documents," "conversations and communications with other corporate officers and employees," and "attendance at management and/or meetings of the Board and committees"). Courts across the United States have expressly rejected allegations of fraud based on unspecified allegations of negative "internal - -------- (19) Plaintiffs claim that the Individual Defendants, as a result of their high-ranking positions with SCI, had access to "undisclosed adverse information." This is not sufficient to satisfy the Reform Act's pleading standards. See, e.g, In re Advanta Corp. Sec. Litig., 1998 WL 387595, at *7 (E.D. Pa. 1998), aff'd, 180 F.3d 525 (3d Cir. 1999) (allegations that defendants' positions within the company rendered them knowledgeable about adverse conditions is an "unsupported conclusion;" plaintiffs must point "to specific reports, circulated among defendants, which contained the adverse information defendants are charged with knowing"). -21- 29 company documents." See, e.g., Wenger, 2 F. Supp.2d at 1250-51 (rejecting unsubstantiated allegation that defendants were aware of the "true facts" and had access to "internal corporate documents"); Zeid, 930 F. Supp. at 436 (without any reference to particular corporate documents or other information, the Court can only conclude that Plaintiffs' allegations are based purely on speculation and conclusions drawn from hindsight). If the mere allegation that internal reports were "negative" were sufficient, any public company could be sued for fraud whenever its stock price dropped -- precisely what the Reform Act was intended to prevent.(20) Silicon Graphics II is instructive. In that case, plaintiffs alleged that the company ("SGI") and six of its top officers made a series of misleading statements, or withheld information, to inflate the value of SGI's stock while they engaged in massive insider trading, realizing nearly $14 million. See 183 F.3d at 982. Plaintiffs alleged that internal memorandum showed: (1) the company's product was not shipping in volume; (2) sales were slow in North America and Europe; and (3) SGI would not meet its revenue and growth targets. Id. at 984. Plaintiffs contended that these reports notified officers that SGI was suffering, but the officers did not disclose the information to the public. Id. Rather, according to the plaintiffs' allegations, the officers entered into a "conspiracy of silence" whereby they agreed to downplay the seriousness of SGI's problems while they dumped their SGI stock. Id. The Ninth Circuit ruled that where plaintiffs rely on such allegations, they must set forth "the sources of [their] information with respect to the [negative internal] reports," how plaintiffs "learned of the report[s]," "who drafted them," "which officers received them," and "an adequate description - -------- (20) In any event, the Individual Defendants' access to the Preneed Study gave them no reason to believe SCI had encountered troubles of the sort asserted by the Plaintiffs in SCI's preneed funeral business. -22- 30 of their contents" which should include "specifics." Id. at 985. As the Reform Act requires, a plaintiff must state "with particularity all facts on which [her] belief is formed." Id. The CCAC lacks any specific factual allegations. As in Silicon Graphics II, Plaintiffs here rely on the Individual Defendants' positions and allege participation in the day-to-day management and overall direction of the Company allowed them access to "undisclosed adverse information." See CCAC at Paragraph 12. Without such "corroborating details," the Court simply "cannot determine whether there is any basis for alleging that the [Individual Defendants] knew that their statements were false at the time they were made." Silicon Graphics II, 183 F.3d at 985. Plaintiffs' cursory allegation that the Individual Defendants had access to "undisclosed confidential information" through reports generated by SCI's Falcon computer system and "Call In Reports" is not sufficient. See CCAC at Paragraph 12. The problem with the CCAC is that it fails to provide details such as when these reports were allegedly generated, who prepared them, to whom they were directed, the sources from which Plaintiffs obtained this information or the contents of such reports. See Silicon Graphics II, 183 F.3d at 985.(21) In short, the CCAC does not comply with the Reform Act. It should therefore be dismissed. III. MANY OF THE ALLEGED MISSTATEMENTS ARE NOT ACTIONABLE AS A MATTER OF LAW A. GENERAL STATEMENTS OF OPTIMISM DO NOT SUPPORT A FRAUD CLAIM. The CCAC challenges numerous inactionable, vague statements of puffery and general optimism, a natural consequence of Plaintiffs' decision to include in the CCAC virtually every public statement SCI made during the Class Period. Even before the Reform Act, courts consistently held - -------- (21) Moreover, Plaintiffs' claims are contradicted by the very document which they reference -- The Preneed Study. See Exhibit C. -23- 31 that general statements of corporate optimism cannot support liability for securities fraud. Raab v. General Physics Corp., 4 F.3d 286, 290 (4th Cir. 1993) (vague statements of opinion are not actionable under the federal securities laws because they are considered immaterial and discounted by the market as mere "puffing"); In re VeriFone Sec. Litig., 784 F. Supp. 1471, 1481 (N.D. Cal. 1992) ("investors . . . know how to devalue the optimism of corporate executives"), aff'd, 11 F.3d 865 (9th Cir. 1993). As would be expected, SCI made a number of general statements concerning the growth of its business, its acquisition strategy and its potential for profitability in the future. Here are a few examples of the types of vaguely optimistic statements Plaintiffs challenge. o "The acquisition [of American Memorial Life Insurance Company] is a way for [SCI] to expand its profit base." See CCAC at Paragraph 75. o The acquisition of American Memorial Life Insurance Company "will allow SCI to better compete for and serve customers." Id. at Paragraph 84. o "We're adding another dimension to make sure we're picking up all the value we can for our shareholders." Id. at Paragraph 75. o "The fundamentals of the funeral industry remain strong". Id. at Paragraph 78. o "We've long been the leaders in the prearranged funeral business." Id. at Paragraph 84. o SCI "used its strategy of acquisitions...[to] add value to SCI today and long term." Id. at Paragraph 96. These statements are not actionable because they cannot reasonably be relied upon by an investor making an investment decision. See Grossman v. Novell, Inc., 120 F.3d 1112, 1121-22 (10th Cir. 1997) (dismissing as puffing a statement that the merger presented a "compelling set of opportunities"); In re Mobile Telecommunication Techs. Corp. Sec. Litig., 915 F. Supp. 828, 834 (S.D. Miss. 1995) (dismissing as inactionable the statement that: "[w]e are highly optimistic that we -24- 32 will be profitable in 1993 as demand for nationwide and international wireless messaging services continues to grow both in the U.S. and in the international countries we serve"); In re Caere Corp. Sec. Litig., 837 F. Supp. 1054, 1057-58 (N.D. Cal. 1993) (dismissing as inactionable the statement that the company was "well-positioned for growth"). Plaintiffs further attack certain public statements that are vague expressions of optimism about the merger between SCI and ECI. Specifically, Plaintiffs seek to hold the SCI Defendants liable for stating that the merger "should further enhance SCI's leading domestic market position" (CCAC at Paragraphs 80, 82), and that the merger "will create a combined North American operation with unparalleled resources" (CCAC at Paragraphs 80, 82). These statements are also not actionable because no reasonable investor would rely upon such obvious "puffery." B. STATEMENTS OF HISTORICAL FACT DO NOT SUPPORT A FRAUD CLAIM. Of the statements made by the SCI Defendants, a number report historical facts regarding SCI's business, such as the results of the second and third quarters of 1998. See CCAC at Paragraphs 78, 86, 96. However, Plaintiffs do not allege that these results were false or inaccurate. Moreover, the announcement of past financial results cannot in itself imply that such results will continue. See, e.g., In re Convergent Techs, Sec, Litig., 948 F.2d 507, 512-13 (9th Cir.1991); Wenger, 2 F. Supp. 2d at 1245 ("disclosure of accurate historical data does not become misleading even if less favorable results might be predictable by the company in the future"). Thus, none of these statements are actionable on the grounds they were false or misleading. See, e.g., In re Cypress Semiconductor Sec. Litig., 891 F. Supp. 1369, 1379 (N.D. Cal. 1995) (accurate statements of historical fact are not actionable). -25- 33 C. THE SCI DEFENDANTS' FORWARD-LOOKING STATEMENTS ARE PROTECTED BY THE SAFE HARBOR. The Reform Act's safe harbor provides that a person "shall not be liable" for any forward-looking statement accompanied by a "meaningful cautionary statement identifying important factors that could cause actual results to differ materially from those in the forward-looking statement...." 15 U.S.C. Section 78u-5(c)(1)(A)(i). This is true even if the cautionary statement fails "to include the particular factor that ultimately causes the forward-looking statement not to come true . . . ." H.R. Conf. Rep. No. 104-369, at 44. Plaintiffs have purposefully tried to mischaracterize forward-looking statements as statements of historical fact by alleging that the statements were made with knowledge of their falsity. This disingenuous effort to avoid the safe harbor should be rejected. Statements concerning a strategy yet to be fully implemented and yet to be completed are, by definition, forward looking in nature. Harris v. Ivax Corp., 998 F. Supp. 1449, 1453 (S.D. Fla. 1998) (although couched in present tense, allegations regarding business conditions were forward looking because "[r]epresentations regarding the state of a business' position in a changing market or the soundness of its growth strategies are necessarily forward-looking"), aff'd, 182 F.3d 799 (11th Cir. 1999). Plaintiffs assert that the SCI Defendants failed to warn investors of various factors -- including an allegedly unprofitable preneed funeral business - - that could have an adverse impact on earnings. However, SCI's August 6, 1998 and October 22, 1998 press releases, both of which Plaintiffs assert contain misleading statements, are accompanied by cautionary statements and specific risk factor disclosures. See Exhibits F and G.(22) Plaintiffs also complain that statements - ----------------- (22) SCI's cautionary statement under the Reform Act provides as follows: (continued...) -26- 34 contained in the Forms 10-Q filed by SCI on August 14, 1998 and November 16, 1998 misled investors about the expected growth in revenues and profitability of SCI. The Forms 10-Q, however, also contained safe harbor language. See Exhibit H at p.21 and Exhibit I at pp.22-23. In light of these ample risk disclosures, the Reform Act's safe harbor provision renders it impossible for Plaintiffs to claim that SCI's forward looking statements were misleading. IV. PLAINTIFFS DO NOT ADEQUATELY ALLEGE SCIENTER "Scienter is a crucial element" in claims of securities fraud. Tuchman v. DSC Communications Corp., 14 F.3d 1061, 1067 (5th Cir. 1994).(23) This is so "because not every misstatement or omission in a corporation's disclosures gives rise to a Rule 10b-5 claim." Id. Only when a plaintiff can show that the defendant acted with "a mental state embracing intent to deceive, manipulate, or defraud" does an alleged misstatement or omission raise a legitimate claim of securities fraud. Id. (quoting Ernst v. Hockfelder, 425 U.S. 185, 193 n.12 (1976)). - -------- (22) (...continued) Certain matters discussed in this release are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include, but are not limited to, the following: The company maintaining its high level of acquisition activity and achieving expected performance from these acquired businesses, and the ability to manage internal growth of existing operations; the economy, competition and death rates in the company's geographic areas of operations; and sufficient availability of capital resources to fund future acquisitions and planned levels of capital expenditures which will depend on prevailing market conditions, interest rates, and the financial condition of the company. See Exhibits F and G (emphasis added). (23) To establish a securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, a plaintiff must plead and prove a (1) material misstatement or omission (2) of material fact (3) made with scienter (4) on which the plaintiff relied (5) that proximately caused the plaintiff's injury. Tuchman, 14 F.3d. at 1067. Scienter is not an element of Plaintiffs' Section 11 and 12(a)(2) claims. -27- 35 Plaintiffs attempt to satisfy the heightened scienter requirement of the Reform Act in two ways. First, Plaintiffs contend that the SCI Defendants made false and misleading statements "to obtain and maintain favorable ratings on the debt securities that SCI had registered with the SEC but not yet issued." See CCAC at Paragraph 113. Second, Plaintiffs allege that the SCI Defendants made misstatements to facilitate the consummation of the SCI-ECI merger. See CCAC at Paragraphs 110, 112. As shown below, neither of these scienter allegations pass muster. A. UNDER THE REFORM ACT, PLAINTIFFS MUST ALLEGE SPECIFIC FACTS CREATING A STRONG INFERENCE OF SCIENTER THAT THE SCI DEFENDANTS ACTED KNOWINGLY OR RECKLESSLY, NOT JUST THAT THEY HAD A MOTIVE AND OPPORTUNITY TO COMMIT FRAUD. Before the Reform Act, the courts used a range of standards governing the degree of specificity needed to plead a defendant's state of mind for a securities fraud claim. Some circuits found a general allegation of scienter sufficient under Fed. R. Civ. P. 9(b), e.g., In re Glenfed, Inc. Sec. Litig., 42 F.3d 1541, 1545 (9th Cir. 1994), while others, including the Fifth Circuit, held that plaintiffs "must set forth specific facts to support an inference of fraud." Lovelace, 78 F.3d at 1018. The Second Circuit employed a standard requiring plaintiffs to plead specific facts that would support "a strong inference of fraud." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994). Under this "strong inference" standard, a plaintiff had to allege specific facts that would either "constitute strong circumstantial evidence of conscious misbehavior or recklessness" or "show that defendants had both motive and opportunity to commit fraud." Id. In enacting the Reform Act, Congress sought to reduce the volume of abusive federal securities litigation by erecting procedural barriers to prevent plaintiffs from asserting baseless securities fraud claims. See H.R. Conf. Rep. 104-369, at 31. An important component of the Reform Act's new standard is its heightened pleading requirement for scienter. Under this heightened -28- 36 standard, plaintiffs must "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," and do so "with respect to each act or omission alleged." 15 U.S.C. Section 78u-4(b)(2) (emphasis added). This new standard augments and reinforces the Fifth Circuit's existing mandate under Fed. R. Civ. P. 9(b) that the circumstances allegedly constituting fraud must be spelled out in great detail. See Melder, 27 F.3d at 1100 (setting forth Rule 9(b) requirements for pleading securities fraud). The Reform Act's new standard no longer permits plaintiffs to plead scienter by merely alleging facts showing defendants' "motive and opportunity" to commit fraud. See, e.g., Silicon Graphics II, 183 F.3d at 977-79. Congress soundly rejected Second Circuit case law that allegations of "motive and opportunity" could suffice to provide the required strong inference of scienter.(24) In fact, the Conference Report, which is the authoritative source for finding the Legislature's intent, expressly stated that Congress declined to adopt the "motive and opportunity" test: The Conference Committee language is based in part on the pleading standard of the Second Circuit. . . .Regarded as the most stringent pleading standard, the Second Circuit requirement is that the plaintiff state facts with particularity, and that these facts, in turn, must give rise to a "strong inference" of the defendant's fraudulent intent. Because the Conference Committee intends to strengthen existing pleading requirements, it does not intend to codify the Second Circuit's case law interpreting this pleading standard. FN 23/ FN 23/ For this reason, the Conference Report chose not to include in the pleading standard certain language relating to motive, opportunity, or recklessness. - -------- (24) The legislative history of this provision of the Reform Act is set out in great detail in In re Paracelsus Corp. Sec. Litig., 1998 WL 1108373, at *5-6 (S.D. Tex. 1998) (Werelin, J.). -29- 37 H.R. Conf. Rep. 104-369, at 41 n.23. See also S. Rep. 104-98, at 15 ("The Committee does not intend to codify the Second Circuit's case law interpreting [the strong inference] pleading standard, although courts may find this body of law instructive"). Congress also rejected an amendment that would have codified the Second Circuit standard, making "motive and opportunity" part of the statutory language. See H.R. Conf. Rep. 104-369, at 41; 141 Cong. Rec. S9199, S9201. Several courts have considered Congress' rejection of such proposed statutory language to be persuasive evidence that Congress did not intend to leave alive the "motive and opportunity" test. See, e.g., Friedberg v. Discreet Logic, Inc., 959 F. Supp. 42, 48-9 (D.Mass. 1997). Indeed, "[f]ew principles of statutory construction are more compelling than the proposition that Congress does not intend sub silentio to enact statutory language that it has earlier discarded in favor of other language." INS v. Cardoza-Fonseca, 480 U.S. 421, 442-43 (1987). See also Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186, 200 (1974) (by expressly declining to adopt proposed statutory language, Congress' action "strongly militates against a judgment that Congress intended [the] result that it expressly declined to enact"). "Congress further provided very strong evidence of its intent to go beyond the Second Circuit standard when it overrode President Clinton's veto of the [Reform Act]." Silicon Graphics II, 183 F.3d 979. President Clinton vetoed the Reform Act, in part, because "the conferees make crystal clear...their intent to raise the [pleading] standard even beyond [the Second Circuit] level," and "the conferees meant to erect a higher barrier to bringing suit than any now existing." H.R. Doc. No. 104-150 (1995). By overriding the President's veto and enacting this "higher barrier," Congress provided powerful evidence to elevate the pleading standard to a level beyond that in the Second Circuit. -30- 38 Accordingly, a number of courts addressing the issue have held that following passage of the Reform Act, allegations of motive and opportunity, without more, will no longer be presumed sufficient to support a strong inference of scienter.(25) As the Ninth Circuit has explained: [P]laintiffs proceeding under the [Reform Act] can no longer aver intent in general terms of mere motive and opportunity or "recklessness," but rather, must state specific facts indicating no less than a degree of recklessness that strongly suggests actual intent. Thus...the [Reform Act] requires plaintiffs to plead, at a minimum, particular facts giving rise to a strong inference of deliberate or conscious recklessness. - -------- (25) Three other circuit courts have agreed that the Reform Act raised the scienter pleading standard to something more than just "motive and opportunity." In In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 549 (6th Cir. 1999), the Sixth Circuit held that plaintiffs "may plead scienter in Section 10(b) or Rule 10b-5 cases by alleging facts giving rise to a strong inference of recklessness, but not by alleging facts merely establishing that a defendant had the motive and opportunity to commit fraud." Similarly, the 11th Circuit has recently held that ("[Congress] did not intend to codify the lesser-known, lesser-accepted, and certainly not well-established notion that allegations of motive and opportunity to commit fraud are sufficient to show scienter"). Bryant v. Avado Brands, Inc., 1999 WL 688050, *12 (11th Cir. 1999). The Third Circuit found that the "Reform Act establishes a pleading standard approximately equal in stringency to that of the [pre-Reform Act] Second Circuit," (including allegations of motive and opportunity), but recognized that "particularity" language in the Reform Act resulted in a "heightened standard." In re Advanta Corp. Sec. Litig., 180 F.3d 525, 534 (3d Cir. 1999). By contrast, the Second Circuit, without any analysis of the statutory language or the oft-cited legislative history, merely adopted the "motive and opportunity" test used before the enactment of the Reform Act. Press v. Chemical Investment Services Corp., 166 F.3d 529, 538 (2d Cir. 1999). -31- 39 Silicon Graphics II at *21.(26) This interpretation follows from Congress' intent as expressed in the legislative history of the Reform Act.(27) B. PLAINTIFFS' ALLEGATIONS DO NOT SUPPORT A STRONG INFERENCE OF SCIENTER. Plaintiffs' scienter allegations amount to no more than an attempt to plead motive alone and therefore fail to satisfy the Reform Act's heightened pleading standard. On this ground alone, Plaintiffs' 10(b) and 10b-5 claims should be dismissed. But whatever standard applies, the Reform Act requires "facts giving rise to a strong inference" of scienter. The CCAC's scienter allegations fall woefully short of the mark. - -------- (26) The SCI Defendants expect the Plaintiffs to cite Williams v. WMX Techs., Inc., 112 F.3d 175, 178 (5th Cir.), cert. denied, 118 S.Ct. 412 (1997) for the proposition that the Fifth Circuit has adopted the "motive and opportunity" test under the Reform Act. This argument is without merit as Judge Werlein recently noted: The Court notes the argument made by Plaintiffs that the Fifth Circuit in Williams v. WMX Techs., Inc., 112 F.3d 175, 178 (5th Cir.), cert. denied, 118 S.Ct. 412 (1997), stated that the [Reform Act] did not change the strong inference pleading standard adopted by the Second Circuit.... In Williams, however, the Fifth Circuit was not discussing the standard for pleading scienter under Section 10(b); instead, the court cited a Second Circuit case that discussed the particularity with which the elements of fraud had to be pled under Rule 9(b) (i.e., the "who, what, when, and where"). See Williams, 112 F.3d at 177-78 (citing Mills v. Polar Molecular Corp., 12 F.3d 1170 (2d Cir.1993) (setting forth the specificity with which the elements of fraud must be pled)). The Fifth Circuit in Williams did not discuss the new requirement for pleading scienter under Section 10(b), nor did it rely upon the Second Circuit's contrary decision in Shields, which had held that pleading motive and opportunity was sufficient from which to infer scienter. Maldonado v. Dominguez,137 F.3d 1, 9 n.5 (1st Cir.1998), which made a similar statement to the one in Williams, is distinguishable on the same basis as Williams. In re Paracelsus Corp., 1998 WL 1108373, at *6 fn.2. (27) The two courts in the Southern District of Texas that have construed this section of the Reform Act are divided in their interpretations. Compare In re Paracelsus Corp., 1998 WL 1108373 (holding that the Reform Act imposes a heightened pleading standard and eliminates the ability to plead scienter solely by alleging evidence of a defendant's motive and opportunity) with Robertson v. Strassner, 32 F. Supp.2d 443 (S.D. Tex. 1998) (Atlas, J.) (adopting "motive and opportunity" test). -32- 40 1. PLAINTIFFS' ALLEGATIONS THAT THE SCI DEFENDANTS MADE MISSTATEMENTS TO MAINTAIN SCI'S BOND RATING FAILS TO CREATE THE REQUIRED INFERENCE OF SCIENTER. Plaintiffs' conclusory allegation that the SCI Defendants made false and misleading statements "to obtain and maintain favorable ratings on the debt securities that SCI had registered with the SEC but not yet issued" (CCAC at Paragraph 113) fails to support an inference of motive even under the pre- Reform Act pleading standards for scienter. Applying only Rule 9(b), courts, including the Fifth Circuit, repeatedly refused to infer "motive" from similar allegations that misstatements were made to maintain a high bond or credit rating. See, e.g., Melder, 27 F.3d at 1102;(28) L.L. Capital Partners, L.P. v. Rockefeller Center Properties, Inc., 939 F. Supp. 294, 300 (S.D.N.Y. 1996) (holding under Rule 9(b) that allegations that misrepresentations were made to facilitate $21 million offering insufficient to establish motive). Post-Reform Act cases looking to motive as a relevant factor equally reject such allegations as a basis for inferring scienter. In San Leandro Emergency Med. Group Profit Sharing Plan v. Philip Morris Companies, 75 F.3d 801, 813-14 (2d Cir. 1996), for example, the plaintiffs attempted to establish motive by alleging that an inflated stock price maintained the company's bond or credit rating at the highest possible level, so as to maximize the marketability of $700 million of debt securities. The Second Circuit held: We do not agree that a company's desire to maintain a high bond or credit rating qualifies as a sufficient motive for fraud in these circumstances, because "if scienter could be pleaded on that basis alone, virtually every - -------- (28) The Fifth Circuit, in Melder, affirmed the dismissal of plaintiffs' section 10(b) claims where plaintiffs alleged that defendants engaged in securities fraud "so that they could inflate the price of the Company's common stock in order to . . . successfully bring to fruition the [initial and secondary public] offering." 27 F.3d at 1102. The Melder court held that plaintiffs' allegations "did not set out facts sufficient to allow for a proper inference of scienter." Id. -33- 41 company in the United States that experiences a downturn in stock price could be forced to defend securities fraud actions." San Leandro, 75 F.3d at 814 (citation omitted). Courts have quite correctly interpreted the San Leandro decision as an "unequivocal rejection of the concept of motive predicated upon desire to maximize the marketability of debt securities and to minimize interest rates." In re 1993 Corning Sec. Litig., 1996 WL 257603, at * 6 (S.D.N.Y. 1996) (holding that allegations of company's desire to complete bond offering and maximize ongoing marketability of debt securities insufficient to plead scienter). See also In re Crown Am. Realty Trust Sec. Litig., 1997 WL 599299, at *25 (W.D. Pa. 1997) (holding that allegations of "desire to improve [defendant's] financial picture to enhance its ability to finance further capital improvements" is insufficient to plead scienter). Accordingly, even if this Court is prepared to accept "motive and opportunity" allegations as a sufficient basis for scienter, the allegations in the CCAC of the SCI Defendants' motivation is inadequate. 2. PLAINTIFFS' ALLEGATION THAT THE SCI DEFENDANTS MADE MISSTATEMENTS TO FACILITATE CONSUMMATION OF THE SCI-ECI MERGER FAILS TO CREATE THE REQUIRED INFERENCE OF SCIENTER. Plaintiffs also allege that the SCI Defendants were motivated to commit fraud to facilitate the consummation of the SCI-ECI merger. See CCAC at Paragraph 112 ("SCI was motivated to maintain SCI's stock price in an effort to acquire ECI in a stock-for-stock transaction for less than ECI's true value"). However, it is well-settled that a "desire to consummate [a] corporate transaction does not constitute a motive for securities fraud." In re Health Management, Inc. Sec. Litig., 970 F. Supp. 192, 203-04 (E.D.N.Y.1997) (motive not established by pleading corporate acquisition using supposedly artificially inflated stock). See also Leventhal v. Tow, 48 F. Supp. 2d 104, 115 (D. Conn. -34- 42 1999) (finding that allegation that the defendants had a motive to artificially inflate stock price during the class period in order to get more favorable terms in the stock-for-stock transactions and in the issuance of the debentures was an insufficient allegation of scienter); Malin v. Ivax, 17 F. Supp.2d 1345, 1361 (S.D. Fla. 1998) (rejecting motive "maintaining the stock price...to facilitate mergers and acquisitions"); In re Cirrus Logic Sec. Litig., 946 F. Supp. 1446, 1477 (N.D. Cal. 1996) (allegation that defendants misrepresented reserves to facilitate stock-for-stock merger is insufficient to establish scienter). If all a securities fraud plaintiff had to do to sufficiently plead scienter was to allege that the defendants artificially inflated a stock's price to obtain more favorable terms in a stock-for-stock transaction "nearly every stock-for-stock transaction conducted in the United States could be subject to challenge." In re Cirrus Logic Sec. Litig., 946 F. Supp. at 1477. At that point, the scienter requirement becomes meaningless. Additionally, the Plaintiffs do not expressly or even inferentially explain how the desire to conclude the SCI-ECI merger by using inflated value of the stock as consideration for the merger, is in the economic self-interest of the Individual Defendants. Numerous courts have found that stock ownership, standing alone, is insufficient to plead scienter. See, e.g., Duncan v. Pencer, 1996 WL 19043, at * 11 (S.D. N.Y. 1996) (defendants' motive "to enhance the value of their personal holdings and options" is insufficient to plead scienter). 3. THE INDIVIDUAL DEFENDANTS' LACK OF TRADING IN SCI STOCK NEGATES ANY INFERENCE OF SCIENTER. Plaintiffs' scienter allegations contain an interesting - although unsurprising - omission. Plaintiffs fail to inform the Court that none of the Individual Defendants sold SCI stock during the -35- 43 Class Period.(29) The collective failure of the three Individual Defendants - SCI's Chief Executive Officer, Chief Operating Officer and Chief Financial Officer - to take advantage of "artificially inflated prices" and to sell stock during the Class Period negates any inference of scienter. See, e.g., In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1423 (3d Cir. 1997) (finding that no inference of scienter was established because "two of the more powerful" defendants did not sell any stock). The Individual Defendants are, without question, substantial shareholders in SCI. The chart below summarizes the Individual Defendants stock ownership as of July 17, 1998:
Total Holdings Shares of Stock(30) Vested Options(31) Available for Sale ------------------- ------------------ ------------------ Waltrip 889,645 2,235,753 3,125,398 Heiligbrodt 588,944 1,333,452 1,922,396 Champagne 63,150 510 63,660
Despite the fact that the Individual Defendants had a cumulative 5,111,454 shares available for sale, there are no allegations that the Individual Defendants sold a single share during the Class Period. It defies belief that the three presumed masterminds of the massive fraud alleged in the - -------- (29) The Individual Defendants' stock sales are publicly reported on SEC Form 4 within 10 days of the end of the month in which a transaction occurs. Form 4 requires the dates and amounts of the security purchased or sold. See SEC Rules 16a-1 to a-3 and Form 4, codified at 17 C.F.R. Section 240.16a-1 to a-3, and Official Form (1997). Form 4 is usually the only source of data on insider trades. (30) See Forms 4 and Forms 5, attached as Exhibits J, K and L. Form 5 is an Annual Statement of Changes in Beneficial Ownership. These figures include both indirect and direct holdings. (31) See 1999 Proxy Statement and 1999 Annual Meeting Notice, attached as Exhibit M, at p. 14. -36- 44 CCAC would not take advantage of that scheme and sell even a small portion of their stock holdings during the Class Period. In evaluating whether the allegations of a complaint sufficiently allege scienter, courts routinely place great importance on the complaint's lack of any allegations of stock trading by the company's high-ranking executives. In In re Gleaner Technologies, Inc. Sec. Litig., 1998 WL 915907 (S.D.N.Y. 1998), for example, the Court stated: [P]erhaps most importantly, the inference of scienter is undermined by the fact that [the company's] Chief Executive Officer ("CEO") and Chairman, Vice Chairman, Chief Financial Officer ("CFO") and Comptroller did not sell any stock before the Company publicly disclosed the [negative] impact of the FCC freeze [on the company]. Certainly one can assume that these high-ranking corporate officers, arguably the most knowledgeable of all Board members, would be part of any fraudulent scheme to benefit from insider information through pre-emptive stock sales. The absence of sales from these individuals, then, suggests that the February trading by the seven defendants does not give rise to a strong inference of scienter. Id. at *4. See also Head v. NetManage, Inc., 1998 WL 917794, at *4 (N.D. Cal. 1998) (dismissing complaint; holding that chief financial officer did not sell negated scienter and stating that it makes no sense that "the alleged masterminds of the fraudulent scheme" would not take advantage of the scheme); In re Health Mgmt. Sys. Sec. Litig., 1998 WL 283286, at * 6 (finding that no inference of scienter is created because the CFO did not sell any stock); In re Comshare Sec. Litig., 1997 WL 1091468, at * 10 (E.D. Mich. 1997), aff'd, 183 F.3d 542 (6th Cir. 1999) ("the CEO and CFO would have been essential participants in any scheme, thus, their having sold no stock, undermines any suggestion of knowledge on the part of defendants due to the other sales"); In re Credit Acceptance Corporation Securities Litigation, 50 F. Supp.2d 662, 677 (E.D. Mich. 1999) ("It seems as though the CFO would have been an essential participant in any fraudulent scheme to defraud the company. -37- 45 The fact that he did not sell any shares during the class period undermines the suggestion that the Defendants engaged in securities fraud in order to profit from their own stock sales") . The fact that the three Individual Defendants retained substantial holdings affirmatively demonstrates no scienter. See In re Worlds of Wonder Sec. Litig., 35 F.3d at 1425 (holding that there was no inference of scienter where defendants retained the bulk of their shares). Waltrip's SCI total holdings declined in value approximately $46.6 million on January 26, 1999, the day SCI announced that it expected earnings per share for the fourth quarter 1998 to be lower than analysts' expectations. That same day, Heiligbrodt's SCI total holdings declined in value approximately $28.7 million and Champagne's SCI total holdings declined in value approximately $950,000. Far from supporting a "strong inference" that the Individual Defendants had a motive to capitalize on artificially inflated stock prices, these facts suggest they had every incentive to ensure the long term growth and stability of SCI.(32) CONCLUSION Plaintiffs' allegations against the SCI Defendants epitomize the abusive claims the Reform Act was designed to prevent. For the reasons stated above, the SCI Defendants respectfully request that the Court dismiss the Consolidated Class Action Complaint in its entirety with prejudice. - -------- (32) Further refuting an inference of scienter is the fact that Heiligbrodt sold all of his holdings of SCI stock after the end of the Class Period, at $17 per share. See Exhibit M at p. 17. This is approximately 50 percent less than SCI's stock price at the beginning of the Class Period. If, as Plaintiffs assert, Heiligbrodt was responsible for committing a fraud, one would expect him to sell his stock when it was "inflated," not when it was at a 52-week low. -38- 46 Respectfully submitted, Bracewell & Patterson, L.L.P. By: ---------------------------------- J. Clifford Gunter III State Bar No. 08627000 South Tower Pennzoil Place 711 Louisiana, Suite 2900 Houston, Texas 77002-2781 Telephone: (713) 223-2900 Facsimile: (713) 221-1212 ATTORNEY-IN-CHARGE Andrew M. Edison Bracewell & Patterson, L.L.P. South Tower Pennzoil Place 711 Louisiana, Suite 2900 Houston, Texas 77002-2781 Telephone: (713) 223-2900 Facsimile: (713) 221-1212 COUNSEL FOR DEFENDANTS -39- 47 CERTIFICATE OF SERVICE I hereby certify that a true and correct copy of the foregoing document was forwarded by messenger on the 8th day of October, 1999 to Plaintiffs' Lead Counsel: Mr. Roger E. Greenberg Greenberg, Peden, Siegmyer & Oshman, P.C. 12 Greenway Plaza 10th Floor Houston, Texas 77046 ---------------------------------------- Andrew M. Edison -40- EX-99.4 8 PLAINTIFFS' OPPOSITION TO DEFENDANTS' MOTION 1 EXHIBIT 99.4 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION - ------------------------------------------- In re: SERVICE CORPORATION INTERNATIONAL Civil Action No. H-99-280 JURY DEMANDED - ------------------------------------------- PLAINTIFFS' OPPOSITION TO DEFENDANTS' MOTION TO DISMISS THE CONSOLIDATED CLASS ACTION COMPLAINT 2 TABLE OF CONTENTS PRELIMINARY STATEMENT.....................................................................................................1 THE ALLEGATIONS OF THE COMPLAINT..........................................................................................4 A. Background...............................................................................................4 B. The Preneed Study Proves A Number Of Plaintiffs' Allegations.............................................6 C. Defendants' Scheme.......................................................................................7 D. Defendants' Motives.....................................................................................10 E. The Truth Is Revealed...................................................................................11 ARGUMENT ................................................................................................................13 I. THE APPLICABLE LEGAL STANDARDS..................................................................................13 II. THE COMPLAINT STATES CLAIMS AGAINST DEFENDANTS FOR VIOLATIONS OF SECTIONS 11 AND 12(a)(2)..........................................................................14 A. Elements of Claims Under Sections 11 and 12(a)(2).......................................................15 B. The Amended Complaint Adequately Alleges the Elements of Claims Under Sections 11 and 12(a)(2) For Material Omissions and Misstatements in the Registration Statement/Prospectus................................................................17 C. Plaintiffs' Section 11 and 12(a)(2) Claims Are Not Subject to Fed. R. Civ. P. 9(b) Or To the Particularity Requirements of the PSLRA..........................................20 III. THE COMPLAINT STATES CLAIMS FOR VIOLATIONS OF SECTION 10(b) AND RULE 10b-5............................................................................................21 A. The Circumstances of Defendants' Fraud Are Stated With Sufficient Particularity Under Rule 9(b) And The PSLRA..................................................21 1. Defendants' Fraudulent Statements in Connection With the ECI Acquisition and the Fourth Quarter of 1998.........................................................22 2. The Complaint Also Alleges With Particularity the Defendants' False and Misleading Statements Throughout The Class Period........................................24
- i - 3 B. The Preneed Study, Along With Defendants' Public Statements And Admissions, Amply Support The Allegations In The Complaint..............................................25 C. Plaintiffs Are Not Required By The PSLRA Or Rule 9(b) To Identify Internal Documents Or Informants...............................................................27 IV. THE COMPLAINT ADEQUATELY ALLEGES SCIENTER.......................................................................28 A. The Legal Standards.....................................................................................28 B. The Defendants Acted With Actual Knowledge Or A Reckless Disregard For The Truth........................................................................31 C. Defendants Also Had Motive And Opportunity To Engage In The Fraudulent Scheme................................................................................33 V. THE FALSE AND MISLEADING STATEMENTS CHALLENGED IN THE COMPLAINT ARE NEITHER "PUFFERY" NOR "FORWARD LOOKING."...................................................36 A. Defendants' Statements Regarding SCI's Growth And Profitability Are More Than Mere Corporate Puffery....................................................................36 B. Defendants' Statements And Omissions Are Not Protected By The Safe Harbor Provisions of the PSLRA.................................................................................38 CONCLUSION...............................................................................................................40
- ii - 4 TABLE OF AUTHORITIES CASES Blake v. Dierdorff, 856 F.2d 1365 (9th Cir. `988)........................................................................35 Bryant v. Avado Brands, Inc., 1999 WL 688050, *12 (11th Cir. 1999).......................................................30 Coates v. Heartland Wireless Communications, Inc., 26 F. Supp. 2d 910 (N.D. Tex. 1998)............................................................................................27, 29 Cohen v. Koenig, 25 F.3d 1168 (2d Cir. 1994).............................................................................27 Conley v. Gibson, 355 U.S. 41 (1957).....................................................................................13 Cooper v. Pickett, 137 F.3d 616 (9th Cir. 1997)..........................................................................38 Cosmas v. Hassett, 886 F.2d 12 (2d Cir. 1989)........................................................................27, 35 Degulis v. LXR Biotechnology, Inc., 928 F. Supp. 1301 (S.D.N.Y. 1996)................................................16, 20 Duncan v. Pencer, No. 94 Civ. 0321, U.S. Dist. LEXIS 401, at *48-49 (S.D.N.Y. Jan. 18, 1996)........................................................................................34 Epstein v. Itron, Inc., 993 F.Supp. 1314 (E.D. Wash. 1998)...............................................................35 Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976).........................................................................16 Friedberg v. Discreet Logic Inc., 959 F. Supp. 42 (D. Mass. 1997)........................................................32 Goldman v. Belden, 754 F.2d 1059 (2d Cir. 1985)..........................................................................27 Greebel v. FTP Software, Inc., 1999 WL 902898 (1st Cir. 1999)............................................................30 Gross v. Medaphis Corp., 977 F.Supp. 1463 (N.D. Ga. 1997)........................................................33, 35, 39 Hanon v. Dataproducts Corp., 976 F.2d 497 (9th Cir. 1992)............................................................35, 38 Hartsell v. SourceMedia, Inc., 1999 WL 649645 (N.D. Texas 1999)..........................................................29 Harvey M. Jasper Retirement Trust v. Ivax Corp., 920 F.Supp. 1260 (S.D. Fla. 1995).......................................34 Herman and MacLean v. Huddleston, 459 U.S. 375 (1983)................................................................16, 20
- iii - 5 Hill York Corporation v. American International Franchises, Inc., 448 F.2d 680 (5th Cir. 1971)...........................................................................................16 Holmes v. Texas A&M Univ., 145 F.3d 681 (5th Cir. 1998)..................................................................13 In re Advanta Corp. Sec. Litig., 1999 WL 395997, at *3 (3d Cir. June 17, 1999)...........................................30 In re Bausch & Lomb, Inc. Sec. Litig., 941 F. Supp. 1352 (W.D.N.Y. 1996).............................................14, 27 In re Cephalon Sec. Litig., [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) P. 99,562, at 97,799 (E.D. Pa. Aug. 29, 1997)....................................................................14 In re Compaq Sec. Litig., 848 F. Supp. 1307 (S.D. Tex. 1993).............................................................35 In re Comshare, Inc. Sec. Litig., 183 F.3d 542 (6th Cir. 1999)...........................................................31 In re Digi Int'l Sec. Litig., 6 F. Supp. 2d 1089 (D. Minn. 1998).........................................................14 In re F & M Distributors, Inc. Sec. Litig., 937 F. Supp. 647 (E.D.Mich. 1996)............................................16 In re Health Management Sec. Litig., 970 F. Supp. 192 (E.D.N.Y. 1997)................................................14, 34 In re Home Health Corp. of America, Inc. Sec. Litig., 1999 WL 79057, *15 (E.D. Pa. 1999).....................................................................................35 In re Nationsmart Sec. Litig., 130 F.3d 309 (8th Cir. 1997)..............................................................21 In Re Silicon Graphics II, 183 F.3d at 977-79 (9th Cir. 1999)............................................................30 In re Stratosphere Corp. Sec Litig., 1 F. Supp. 2d 1096 (D. Nev. 1998)...................................................26 In re Wells Fargo, 12 F.3d 922 (9th Cir. 1993)...........................................................................35 Kensington Capital Management v. Oakley, Inc., [1999 Transfer Binder] Fed. Sec. L. Rep. (CCH) P. 90,411 (C.D.Cal. Jan. 14, 1999).............................................................21 Khurana v. Innovative Health Care Systems, Inc., 130 F.3d 143 (5th Cir. 1997)........................................13, 25 Leventhal v. Tow, 1999 WL 270089, *10-11 (D. Conn. 1999).................................................................34 Lowrey v. Texas A&M University System, 117 F.3d 242 (5th Cir. 1997)......................................................13 Marra v. Tel-Save Holdings, Inc., 1999 WL 317103 (E.D.Pa. 1999)..........................................................34
- iv - 6 McNamara v. Bre-X Minerals Ltd., 57 F. Supp. 2d 396 (E.D. Tex. 1999).....................................................29 Parcelsus, 1998 WL 1108373 (N.D. Tex. 1998)..............................................................................29 Picture Lake Campground v. Holiday Inns, Inc., 497 F. Supp. 858 (E.D. Va. 1980)..........................................14 Powers v. Eichen, 977 F. Supp. 1031 (S.D. Cal. 1997).....................................................................33 Press v. Chemical Inv. Servs. Corp., 166 F.3d 529 (2d Cir. 1999).....................................................29, 30 Rehm v. Eagle Finance Corp., 954 F. Supp. 1246 (N.D. Ill. 1997)..........................................................32 Robertson v. Strassner, 32 F. Supp. 2d 443 (S.D. Tex. 1998)...................................................13, 29-31, 36 Ross v. A.H. Robins Co., 607 F.2d 545 Cir. 1979).........................................................................14 Shaw v. Digital Equip. Corp. 82 F.3d 1194 (1st Cir. 1996).............................................................18-21 Shields v. Citytrust Bancorp, 25 F.3d 1124 (2d Cir. 1994)................................................................33 STI Classic Fund v. Bollinger Industries, Inc., 1996 U.S. Dist. Lexis 21553, *3 (N.D. Tex. 1996)...................................................................................29, 30 Virginia Bankshares v. Sandberg, 501 U.S. 1083 (1991)....................................................................38 Weiner v. Quaker Oats Co., 129 F.3d 310 (3d Cir. 1997)...................................................................35 Williams v. WMX Techs., Inc., 112 F.3d 175 (5th Cir.) cert. denied, 118 S.Ct. 412 (1997)............................................................................................21, 29-31 Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618 (N.D. Tex. 1998).............................13, 21, 25, 29-31, 35-36 STATUTES AND RULES Section 11 of the Securities Exchange Act of 1933 (15 U.S.C. Section 77(k))......................1, 2, 14, 15-18, 20-21, 23 Section 12(a)(2) of the Securities Exchange Act of 1933 (15 U.S.C. Section 77(l)(2)).................1, 2, 14-17, 20-21, 23 Section 15 of the Securities Exchange Act of 1933 (15 U.S.C. Section 77(o))..............................................40 Section 20(a) of the Securities Exchange Act of 1933 (15 U.S.C. Section 78t(a))..........................................40 Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. Section 78j(b))..........................2, 4, 20-21, 28-29
- v - 7 Section 20A of the Securities Exchange Act of 1934 (15 U.S.C. Section 78t-1).............................................35 15 U.S.C. Section 77z-1..................................................................................................20 15 U.S.C. Section 78u-4..................................................................................................20 15 U.S.C. Section 78u-4(b)(1)........................................................................................21, 28 Fed. R. Civ. P. 9(b).....................................................................................13, 14, 22, 26, 29 Fed. R. Civ. 12(b)6)..................................................................................................4, 13 Private Securities Litigation Reform Act of 1995.................................................................in passium OTHER Merriam Webster's Collegiate Dictionary 598-99 (10th ed. 1993)...........................................................26 141 Cong. Rec. S19044-45 (Dec. 21, 1995) ................................................................................28 House-Senate Conference Report, H. R. Rep. No. 104-369, at 41 (Nov. 28, 1995)............................................28
- vi - 8 Plaintiffs submit this memorandum in opposition to the defendants' motion to dismiss the Consolidated Class Action Complaint (the "Complaint").(1) PRELIMINARY STATEMENT There are two principal claims at issue in this case. The first is on behalf of former owners of the common stock and stock options of Equity Corp. International ("ECI"). These innocent shareholders were duped when, 19 days after the close of the fourth quarter of Service Corp. International's ("SCI") financial year, they exchanged their ECI stock and options for SCI stock and options. By January 19, 1999, the date of the exchange, SCI's fourth quarter results were in hand, were far below expectations, and yet were not disclosed to the ECI holders as required under the securities laws. Seven days later, on January 26, 1999, when SCI finally chose to disclose those results, its stock price was cut almost in half, and the value of the SCI shares that the ECI holders had received days before dropped from $556 million to $278 million. Pursuant to Sections 11 and 12(a)(2) of the Securities Act of 1933 (the "1933 Act"), plaintiffs need only prove that the poor 1998 fourth quarter results for SCI were in existence and rendered SCI's registration statement and prospectus (the "Registration Statement/Prospectus"), pursuant to which the ECI shares were exchanged, misleading. Plaintiffs do not have to prove defendants' scienter under these 1933 Act claims -- neither recklessness, nor knowledge, nor intent. In fact, the Registration Statement/Prospectus were patently misleading because they contained a provision requiring SCI to disclose up until the closing of the exchange any event which was having -- or could have -- a materially adverse effect on its business condition. Liability attaches strictly from the failure - ---------------- (1) All references to "P." followed by a number indicate the referenced paragraph of the Complaint. - 1 - 9 to disclose the materially adverse fourth quarter results; the reasons for these poor results are irrelevant to these claims. Defendants' Motion to Dismiss essentially ignores -- and thereby concedes -- the validity of the claims brought on behalf of the ECI stock and option holders regarding the January 19, 1999 stock exchange. Defendants' only mention of the Section 11 and 12(a)(2) claims (set forth solely in footnote 15, page 13 of their brief) asserts that plaintiffs must plead these claims with particularity because they sound in fraud. However, defendants do not contend that plaintiffs failed to plead these claims with particularity. Indeed, such an argument strains credulity: how could plaintiffs be more particular than pleading (1) the fourth quarter had ended; (2) the fourth quarter's poor results were necessarily complete; (3) defendants closed on the ECI transaction without disclosing these results; and (4) the Registration Statement/Prospectus affirmatively represented that SCI experienced no events -- up until the close of the transaction -- which would have a materially adverse effect on their business condition? These claims must be sustained. The second set of claims in this case is brought on behalf of both the former ECI stock and option holders who exchanged their ECI holdings for SCI common stock on January 19, 1999 and open-market purchasers of SCI stock and options from July 17, 1998 through January 26, 1999 (the "Class Period"). This second set of claims is brought under Section 10(b) of the Securities and Exchange Act of 1934 (the "1934 Act"). In addition to former ECI shareholders, all members of the class who bought SCI stock during the Class Period in reliance on the integrity and honesty of SCI's public statements suffered dramatic losses when the disclosure of SCI's true financial condition on January 26, 1999 drove the inflated price of SCI stock down a stunning 44%. - 2 - 10 As alleged in the Complaint, the poor fourth quarter results were no surprise to defendants. To the contrary, the exchange of grossly inflated SCI stock for ECI securities on January 19, 1999 was the culmination of defendants' longstanding scheme to conceal a growing deterioration in the business and financial condition of SCI, a deterioration that was known by the defendants throughout the Class Period. The most critical of SCI's mounting problems was the enormous backlog of unprofitable "preneed" funeral service contracts SCI had inherited from the hundreds of funeral homes it had acquired in the 1990s. Defendants concealed that crisis from the investing public during the second and third quarters of 1998 by carefully "managing" SCI's reported financial results, and schemed to continue to conceal the problem in the fourth quarter financial results. By mid-November the Individual Defendants(2) were openly discussing among themselves their scheme to "bury" what they already knew would be an $.08 to $.10 shortfall in reported earnings in a special one-time charge attributed to the ECI acquisition. The scheme was foiled, however, when the closing date for the ECI acquisition was delayed past year-end 1998 by regulatory issues and defendants were forced to reveal SCI's results. Defendants failed to disclose this information in any of the statements they made to the investing public during the Class Period, i.e., SCI's growing backlog of unprofitable acquired preneed contracts and the increasingly adverse impact those contracts had already had, and were continuing to have, on SCI's overall profit margins. In particular, the Complaint alleges that SCI woefully failed to manage its preneed funds actively to generate a rate of return in excess of actual funeral cost increases. The Complaint also specifically identifies all of the materially false and misleading statements and omissions made by defendants during the Class Period, and explains in - ------------------ (2)The Individual Defendants are R.L. Waltrip, SCI's CEO; George Champagne, SCI's CFO and L. William Heiligbrodt, SCI's President. - 3 - 11 detail how and why those statements and omissions were fraudulent. The Complaint also alleges specific facts that are more than sufficient to raise a compelling inference that defendants made those statements with knowledge -- or reckless disregard -- of their untruthfulness. The facts alleged thus state a Section 10(b) claim under the 1934 Act and more than satisfy the pleading requirements of the Private Securities Litigation Reform Act of 1995 ("PSLRA") and Federal Rules of Civil Procedure 9(b) and 12(b)(6). The Section 10(b) claims must also be sustained. THE ALLEGATIONS OF THE COMPLAINT A. BACKGROUND. SCI operates 3,442 funeral service locations, 433 cemeteries and 191 crematoria located in 20 countries on five continents. P. 19. SCI became the world's largest death care services provider by purchasing more than 3,000 locally-owned family operated independent funeral homes throughout the 1990's. P. 20. Among the assets acquired by SCI from these funeral home purchases were "preneed" (sometimes called "guaranteed price") funeral contracts that had been entered into when the acquired funeral homes were independently operated. P. 22. Preneed funeral contracts allow individuals to make and lock in the price of funeral arrangements before dying. Under such contracts, the funeral home agrees to provide funeral services and products in the future in return for a fixed sum paid at the time of the contract or under an installment schedule. P. 22. Defendants have admitted that SCI assumed the contractual obligation to perform price guaranteed funerals when it acquired the independent funeral homes. Ans. P. 22.(3) - ---------------- (3) The abbreviation "Ans." followed by a paragraph designation refers to Defendants' Answer to the Complaint. - 4 - 12 When the preneed contracts were sold, the independent funeral homes established mortuary trusts funded with the payments from the prospective clients. P. 23. The total funds, or trust principal, generally were less than the then-current cost of providing the funeral service because preneed funeral services were often sold at a discount. P. 23. SCI acquired those mortuary trust assets when it purchased the independent homes. P. 23; Ans. P. 23. To the extent that the principal and income generated by the trust equals or exceeds the ultimate cost of performing the funeral service, the funeral home either will break-even or realize a profit. P. 23. If, on the other hand, the mortuary trust assets do not grow to equal or exceed the future cost of performing the service, then the funeral service will be performed at the contractually agreed upon price, resulting in a loss. P. 23. As SCI's internal documents unequivocally recognize, "[t]he exposure to cost increases falls to SCI." Exhibits in Support of Defendants Motion to Dismiss the Consolidated Class Action Complaint (hereinafter "Exhibit"), Exhibit C-5, SCI0068. As defendants admit, SCI had amassed a multi-billion dollar preneed funeral contract backlog. Ans. P. 31 (acknowledging that "[d]uring 1995 alone, SCI purchased 1,263 independent funeral homes and acquired a staggering $656 million in preneed funeral contracts"); Ans. P. P. 24, 28 (conceding between 1992 and 1998, in just a six-year period, SCI's preneed funeral contract backlog increased three-fold, from $1.2 billion to $3.7 billion"). The vast majority of the independent funeral homes acquired by SCI lacked the financial sophistication to perform any meaningful analysis aimed at determining whether the assets invested in the mortuary trusts would generate a real rate of return in excess of the amount necessary to cover future increases in the cost of providing a price guaranteed funeral service. P. 24. The funds invested in these mortuary trusts often were not actively managed - if they were managed at all - and whether - 5 - 13 such funds would grow sufficiently to equal or exceed the cost of providing a price guaranteed funeral service at some future date was left to happenstance. P. 24. Indeed, defendants have admitted that the financial management of these mortuary trust assets often consisted of little more than opening a certificate of deposit at a local bank. Ans. P. 24. And these practices have had a severely negative impact on SCI's profit margins during the protracted period of declining interest rates and escalating funeral home costs throughout the 1990's. P. P. 25, 26. B. THE PRENEED STUDY PROVES A NUMBER OF PLAINTIFFS' ALLEGATIONS. During 1996, SCI undertook what it termed "a review of the prearranged trust investment process which included an asset/liability study" (the "Preneed Study"). P. 32. Defendants have submitted a collection of select unauthenticated internal SCI documents that they conclusorily assert constitute the Preneed Study alleged in the Complaint. Defendants' reliance on these select documents, and arguments based on self-serving interpretations of these documents, amount to a debate about the meaning and weight of evidence, inappropriate on a motion to dismiss. In all events, even the documents submitted by defendants, which have not been tested by any discovery or cross-examinations, support plaintiffs' claim that "SCI failed to establish any means of actively managing the mortuary trust assets that would eventually be used to pay for these acquired preneed funeral contracts." P. 30. Among other things, the collection of internal SCI documents defendants attached to their motion confirms that: o SCI did not have an investment program to provide "independent, objective advice and assistance, particularly in the areas of asset allocation development and investment manager evaluation and selection," Exhibit C-5, SCI0067; o SCI did not have a "scientific, analytical approach, focused on meeting SCI's financial objectives" and, at best, SCI was "in the process of developing" an "overall investment policy for the Pre-arranged Funeral trust funds." Exhibit C-5, SCI0070; - 6 - 14 o SCI lacked the ability to even identify all of the mortuary trust assets it had acquired during its funeral home acquisition campaign - let alone manage these assets. See Exhibit C-6, SCI0138 (December 1996 memorandum stated "[c]urrently there is no reliable source to determine whether all acquisitions have been loaded to the trust general ledger."); Exhibit C-5, SCI0070 ("all trust funds currently identifiable are on the FSG system.") (Emphasis added); o more than $600 million in mortuary trust assets was not even being monitored - let alone managed - as recently as June 30, 1997: "as of June 30, 1997, approximately 2000 trusts with total assets of $1.72 billion are being monitored." Exhibit C-5, SCI0070. According to the Company's Form 10-Q for the quarter ended June 30, 1997, however, total preneed contract assets totaled $2.3 billion;(4) o SCI's failure to actively manage its preneed mortuary trust assets resulted in SCI earning approximately 5.5% annually on these assets. In stark contrast, funeral home costs escalated approximately 8.5% annually during this same period - thereby guaranteeing SCI a loss of at least 3% per annum on these assets. See Exhibit C-1, SCI0005. The 5.5% rate of return on SCI's preneed mortuary trust assets was 1.5% below SCI's own "target" rate of return, and a full 3.0% below the rate of return SCI knew it needed to earn on these preneed mortuary trust assets in order to perform this funeral backlog at break-even. Exhibit C-4, SCI0064; o SCI's preneed mortuary trust assets were not invested in accordance with SCI's own asset allocation policy. SCI had invested 33% of its preneed trust assets in "Cash," when its asset allocation policy required that no more than 10% of such assets be invested in "Cash;" and only 21% of the assets had been invested in "Domestic Equities" when SCI's program had required that 40% of such assets be invested in "Domestic Equities." See Exhibit C-1, SCI0009; Exhibit C-4, SCI0063. These practices, as defendants knew, virtually guaranteed that these preneed mortuary trust assets would not grow sufficiently to allow SCI to perform the associated funerals profitably. As the defendants' own documents state: "Studies have shown that the asset class allocation decision ultimately determines over 90% of the fund's total return." Exhibit C-5, SCI0070; and o 26% ($211 million of $811 million total prearranged funeral funds as of June 30, 1997 - an undeniably material portion) of the preneed trust assets acquired by SCI remained in the possession of "pre-acquisition trustees," inactively managed, and invested in low yielding certificates of deposit. Exhibit C-5, SCI0067. C. DEFENDANTS' SCHEME. By 1998, SCI's failure to actively manage its mortuary trust assets was having an increasingly negative impact on SCI's profit margin. P. 36. Gross margins decreased from 28% to 15% during - ----------------- (4)Quarterly Report on Form 10-Q for the quarter ended June 30, 1997, at 4. - 7 - 15 fiscal year 1998. P. 36. Although defendants were keenly aware of the risk posed by SCI's failure to actively manage the preneed assets, they were severely hampered in correcting the condition because of SCI's need to secret its identity from the public. P.'s 38, 40, 42, Ans. P. 18. Rather than disclosing that SCI had amassed an enormous backlog of unmanaged, underperforming preneed funds and that a material number of SCI's funeral services had been, and would continue to be, performed at significant losses, defendants falsely represented that SCI was actively managing its backlog of acquired preneed trust assets. P. P. 45, 47. At the beginning of the Class Period in July 1998, the defendants publicly announced the creation of SCI Financial Services, Inc., a subsidiary which would purportedly actively manage SCI's preneed trust assets. P. 47. To establish this new organization SCI purchased two companies, each of which had experience in preneed asset management. P. 48. The first acquisition was of American Memorial Life Insurance Company ("AML" or "American Memorial"), and the second was ECI. P. 49. The purchase of ECI is of particular significance because ECI, unlike SCI, already had established, and fully disclosed the existence of, a financial management system which ensured that its customers' preneed investments, or the funeral insurance coverage obtained, would be sufficient to cover adequately the future costs of prearranged funeral services. P. 50. While ECI disclosed that its insurance policies included "built-in escalation clauses" and that earnings on its trust funds "have allowed [it] to adequately cover the inflationary increase in costs of funeral services," SCI remained silent on these points. P. 53. The reason for SCI's omissions is clear: SCI's trust funds had not been managed to grow at a rate equal to or greater than the increase in the costs of funeral services. P. 53. Defendants deceived the Class as to the primary -- and continuing -- reason for SCI's funeral service gross margin contraction during the first three quarters of 1998 by pointing to declining death - 8 - 16 rates in North America, higher costs and lower volumes of funerals throughout the industry. P. 55. In addition, defendants carefully "managed" SCI's reported 1998 second and third quarter earnings by, inter alia, their aggressive acquisition program which provided SCI fresh sources of revenue, including, for example, the purchase of American Memorial in the third quarter of 1998. P. 55. However, defendants knew that SCI's deteriorating funeral service profit margins had already, and were continuing to, impact reported earnings, the all important indicia of SCI's financial condition for the investing public, and that SCI's fiscal year end would soon bring about a day of reckoning. P. 55. By November 1998, the Individual Defendants knew that SCI's fourth quarter 1998 earnings would fall at least between $.08 to $.10 below analysts' estimates. P. 56. The Individual Defendants were also aware, by virtue of their receipt of daily, weekly and monthly profit/loss reports via SCI's "Falcon" system from each of SCI's domestic funeral homes, that this shortfall resulted from the performance of unprofitable preneed funerals, as well as undisclosed increases in costs for those services. P. 56.(5) Senior SCI executives, also aware of this impending shortfall and the reasons for it, openly discussed how to hide the shortfall from investors and how they and the Individual Defendants planned to "bury" this shortfall in a one-time charge that SCI planned to take in connection with its acquisition of ECI. P. 56. Defendants knew the success of their plan hinged on their ability to close the ECI acquisition during the fourth quarter of 1998 so that SCI could take a one-time charge in the fourth quarter and close the ECI transaction without having to disclose the true reasons for the Company's earnings shortfall. P. 56. Pointedly, defendants make no attempt in their motion to challenge the sufficiency of the Complaint's allegations about their scheme to bury expected earnings shortfall in a one-time - ------------------ (5)The defendants have admitted that the Falcon system "allows SCI to determine the level of funeral and cemetery sales." Ans. P. 121. - 9 - 17 charge that SCI planned to take in the fourth quarter in connection with the ECI merger. P. 56. This omission, coupled with defendants' admission that SCI was unable to divest itself of certain properties in time to obtain FTC approval to close the ECI merger in the fourth quarter of 1998, further supports plaintiffs' claims. Ans. P. 59. Defendants' scheme was foiled, however, when SCI was unable to divest itself of certain properties in time to obtain FTC approval to close the ECI transaction in the fourth quarter of 1998. P. 57; Ans. P. 59. Defendants were unable to "bury" the earnings shortfall, which by the end of the fourth quarter had nearly doubled to $.19 to $.20 per share, in an acquisition charge as defendants had planned because the Merger did not close until after the end of the fourth quarter. P. 59. Defendants nonetheless proceeded to close the ECI transaction without ever disclosing to ECI or the Class that SCI would report a drastic shortfall in its 1998 fourth quarter earnings. P. 60. Defendants did so despite the fact that the Merger Agreement between SCI and ECI, dated August 6, 1998 required SCI to disclose to ECI its poor performance during the fourth quarter of 1998 at any time at which it could reasonably be anticipated that such poor performance could have an adverse financial impact on SCI. P. 61. Defendants, aware that disclosure of the adverse financial conditions at SCI would lead to the termination of the Merger by ECI or to a renegotiation of the transaction, refused to take that risk. P. 67. D. DEFENDANTS' MOTIVES. Defendants had strong motives to conceal the true reasons behind SCI's funeral margin contraction and the negative impact that SCI's unprofitable multi-million dollar preneed funeral backlog had already had, and was continuing to have, on SCI's profit margins and earnings. P. 110. By doing so, defendants were able to cause the market price of SCI's stock to become and remain - 10 - 18 materially artificially inflated throughout the Class Period. P. 110. Because the consideration paid by SCI to ECI stockholders was SCI common stock, SCI was able to effectively purchase ECI with "watered stock," thereby saving SCI millions. P. 110. The ECI acquisition was undeniably critical to SCI's ability to turn around its unprofitable preneed business. P. 111. ECI had the right to terminate the Merger Agreement, however, "if the representations and warranties of [SCI] shall fail to be true and correct in all material respects . . . ." P. 112. Thus, prior to negotiating the deal with ECI, SCI had ample motive to maintain SCI's stock price in an effort to acquire ECI in a stock-for-stock transaction for less than ECI's true value. P. 112. After the Merger Agreement was executed, but before the deal closed, SCI had motive to continue to hide conceal adverse developments from ECI to prevent ECI from terminating the Merger Agreement. P. 112. Had SCI disclosed the existence of its problems, ECI would have been able to terminate the Merger Agreement under Section 9.1. P. 112. Defendants also admit that the shelf- registration statements filed with the SEC during the Class Period permitted SCI to "avail itself of much needed funds to finance the Company's acquisitions and operations." Ans. P. 114 (emphasis added). E. THE TRUTH IS REVEALED. On January 26, 1999, just five business days after SCI and ECI jointly announced the completion of the Merger, SCI shocked the investment community by issuing a press release which stated: [SCI], the world's largest funeral and cemetery company, announced today that it expects diluted earnings per share for the fourth quarter of 1998 to be lower than current analyst expectations. - 11 - 19 P. 123. SCI's fourth quarter 1998 gross profits declined by 19% from SCI's third quarter 1998 and 24% from SCI's fourth quarter 1997 gross profits. SCI's earnings per share for fourth quarter 1998 were 28% below the third quarter 1998, 36% below the fourth quarter 1997, and 45% below the average forecast or "consensus estimate" for the fourth quarter by analysts who followed SCI. P. 123. These "consensus estimates" were based on misleading information given directly by SCI to professional market analysts. P. 123. Defendants deceptively failed to disclose to analysts and the market, and to ECI and its shareholders in the course of negotiating and closing the Merger, the truth about SCI's increasingly unprofitable preneed funeral business. P. 123. The market's reaction to the January 26, 1999 disclosure was swift and severe. P. 124. The price of SCI common stock plunged from $34 7/16 per share on January 25 to $19 1/8 per share on trading of over 36 million shares, a one-day decline of $15.3125 per share or 44%. P. 124. This price decline also virtually cut the consideration paid for each share of ECI common stock in the Merger in half.P. 124. On February 9, 1999, the Company issued a press release purporting to explain the earnings shortfall. The primary reasons cited by SCI for the shortfall were decreased revenues and increased costs. However, the true reason for this "surprised" shortfall was revealed later by statements defendant Heiligbrodt made to the press. As alleged, this earnings shortfall resulted from losses on SCI's preneed business, losses which were known to defendants throughout the Class Period. P. 126 (excerpting story in industry publication in which defendant Heiligbrodt stated "the at need value of many of the preneed plans sold in the 1980's is about 20 percent less than the company presently charges for its services"); Ans. P. 127 (admitting, without qualification, story in industry publication - 12 - 20 reporting that "SCI has said in the past that it loses money on some of its preneed services because the contract was sold at too low a price"). ARGUMENT I. THE APPLICABLE LEGAL STANDARDS Rule 12(b)(6): Rule 12(b)6) allows for dismissal of a complaint if the plaintiff fails to "state a claim upon which relief may be granted." Robertson v. Strassner, 32 F. Supp. 2d 443, 445 (S.D. Tex. 1998) (citations omitted). A motion to dismiss is "viewed with disfavor and is rarely granted." Lowrey v. Texas A&M University System, 117 F.3d 242, 247 (5th Cir. 1997). Dismissal is appropriate only when "it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Holmes v. Texas A&M Univ., 145 F.3d 681, 683 (5th Cir. 1998). In deciding whether dismissal is warranted, the Court must accept as true the non-conclusory allegations in the plaintiff's complaint. Khurana v. Innovative Health Care Systems, Inc., 130 F.3d 143, 147 (5th Cir. 1997); Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618, 621 (N.D. Tex. 1998). Rule 9(b): Rule 9(b) properly serves to deter vague and conclusory allegations of fraud. But, Rule 9(b) does not allow "defendants by sophisticated claims of ignorance, to plow meritorious claims into stumps...Enforcement of Rule 9(b) should not become .... a tool to require plaintiffs repeatedly to redraft pleadings despite defendants' pre-existing full knowledge of the matters which plaintiffs' pleadings address." Picture Lake Campground v. Holiday Inns, Inc., 497 F. Supp. 858, 866-67 (E.D. Va. 1980). The defendants urge the Court to interpret Rule 9 (and the PSLRA) as requiring plaintiffs to, in effect, prove their claims with evidentiary detail at the pleading stage, Def. Mem. at 14-16, but there is no requirement that plaintiffs plead their evidence in a publicly filed complaint. See, e.g., In - 13 - 21 re Health Management Sec. Litig., 970 F. Supp. 192, 208 (E.D.N.Y. 1997) (Rule 9(b) does not require that the pleading contain "'detailed evidentiary matter'") (quoting Ross v. A.H. Robins Co., 607 F.2d 545, 557 n.20 (2d Cir. 1979)); In re Bausch & Lomb, Inc. Sec. Litig., 941 F. Supp. 1352, 1361 (W.D.N.Y. 1996) (same); In re Cephalon Sec. Litig., [1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) P. 99,562, at 97,799 (E.D. Pa. Aug. 29, 1997) (PSLRA "does not require pleading all of the evidence and proof thereunder supporting a plaintiff's claim"); In re Digi Int'l Sec. Litig., 6 F. Supp. 2d 1089, 1096-97 (D. Minn. 1998) (plaintiffs allegations need not be supported by "underlying documentary evidence"). Facts supporting plaintiffs' allegations of fraud are plead in detail, based on publicly available information and plaintiffs' counsels' extensive investigation into SCI's operations. See, e.g., P. 128. Those facts -- together with the reasonable inferences drawn therefrom -- more than adequately state a claim against defendants.(6) II. THE COMPLAINT STATES CLAIMS AGAINST DEFENDANTS FOR VIOLATIONS OF SECTIONS 11 AND 12(a)(2). The Section 11 and Section 12(a)(2) claims arise from the fact that the owners of the common stock and stock options of ECI, 19 days after the close of the fourth quarter of SCI's financial year, exchanged their ECI stock and options for SCI stock and options based upon SCI's false and - --------------- (6)Defendants resort to a well-worn, conclusory argument, stating that "[t]his securities fraud class action is exactly the type of case that prompted Congress to reform the federal securities laws: that this case is "reminiscent of pre-Reform Act pleadings", and requires dismissal under the PSLRA. Def. Mem. at 2. However, the PSLRA was not enacted to erect impregnable barriers to legitimate private fraud actions, but to deter frivolous litigation. See PSLRA Statement of Managers, 141 Cong. Rec. at H13699 (daily ed. 11/28/95) (recognizing legitimate private fraud actions are an "indispensable tool with which defrauded investors can recover their losses," "promote...confidence in our capital markets," and "help to deter wrongdoing"). This action is the very kind of carefully prepared case, attacking real fraud by insiders, based on a significant investigation of plaintiffs' counsel, that Congress, by weeding out frivolous suits, wanted victims to be able to prosecute more effectively. - 14 - 22 misleading Registration Statement/Prospectus. At the time of the exchange on January 19, 1999, SCI's fourth quarter was already closed, the results were far below expectations, and yet these results were not disclosed to ECI holders. Seven days later, on January 26, 1999, when SCI finally disclosed its poor fourth quarter results, its stock price was cut almost in half and the value of the SCI shares that the ECI holders had received just days earlier were now worth just over half as much -- losing $278 million dollars in value. SCI's Registration Statement/Prospectus warranted -- as defendants admit -- that "as of the closing date," "there has not been any event, occurrence, development or state of circumstances or facts which has had, or could reasonably be anticipated to have, individually or in the aggregate, a Materially Adverse Effect." P.'s 106-107; Ans. at P.'s 106-107 (emphasis added). Because the fourth quarter had already closed at the time of the completion of the stock exchange, and because its results demonstrated a severe earnings shortfall, it is clear that an event had indeed occurred that had a materially adverse effect on SCI's operations. Thus, the Registration Statement/Prospectus' warranty to the contrary was necessarily false and misleading in violation of Sections 11 and 12(a)(2). These claims must be sustained. A. ELEMENTS OF CLAIMS UNDER SECTIONS 11 AND 12(a)(2). Under Section 11 of the 1933 Act, purchasers of registered securities may recover damages if the registration statement contains a material misstatement or omission; plaintiffs do not need to plead or prove fraud, reliance, motive, intent, knowledge or recklessness: [Section 11] impos[es] a stringent standard of liability on the parties who play a direct role in a registered offering. If a plaintiff purchased a security issued pursuant to a registration statement, he need only show a material misstatement or omission to establish his prima facie case. Liability against the issuer of the security is virtually absolute, even for innocent misstatements. - 15 - 23 Herman and MacLean v. Huddleston, 459 U.S. 375, 381 (1983)(emphasis added). See also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 200 (1976)(policy underlying Section 11 was to create liability regardless of fault); In re F & M Distributors, Inc. Sec. Litig., 937 F. Supp. 647, 656 n. 5 (E.D.Mich. 1996)(scienter is not an element of Section 11 or 12(a)(2) claims). To state a claim under Section 11, the Complaint need only allege that: (1) the plaintiff purchased securities traceable to an effective registration statement (see P. 133); (2) the defendant falls within the statutorily enumerated categories (see P. 134); and (3) the registration statement contained a material misstatement or omission.(7) Section 12(a)(2) of the 1933 Act, like Section 11, imposes strict liability for false and misleading statements in a prospectus, and it has no reference to the effective date of the registration statement. See, e.g. Degulis v. LXR Biotechnology, Inc., 928 F. Supp. 1301, 1310 (S.D.N.Y. 1996)("only a material misstatement or omission need be shown to establish a prima facie case [under Section 11 or 12], and scienter need not be alleged"). Rather, Section 12(a)(2) imposes liability whenever a prospectus (such as the one at issue here) is false or misleading and securities are eventually sold or acquired thereby. In Hill York Corporation v. American International Franchises, Inc., 448 F.2d 680 (5th Cir. 1971), the Fifth Circuit set forth the elements of a section 12(a)(2) violation: the plaintiffs were required to prove that the defendants sold or offered to sell these securities by the use of the mails or instruments of transportation or communication in interstate commerce, and that the defendants misrepresented or omitted material facts. In addition the plaintiffs had to show that they had no knowledge of any untruth or omission. The plaintiffs need not prove scienter on the part of the defendants. Finally, the plaintiffs need not prove that they relied in any way on the alleged misrepresentations or omissions. - ------------------ (7)Although absent in their motion, defendants will no doubt argue in their reply that the accuracy of the registration statement is tested on its effective date, November 20, 1998. However, the registration statement itself expressly provides that it will be accurate up until the date of closing. (P. 107). - 16 - 24 Id. at 695 (internal citations omitted). As shown below, defendants violated Sections 11 and 12(a)(2) by consummating an exchange of SCI stock and options for their ECI counterparts on January 19, 1999 based upon false and misleading statements in the Registration Statement/Prospectus regarding SCI's financial health. B. THE AMENDED COMPLAINT ADEQUATELY ALLEGES THE ELEMENTS OF CLAIMS UNDER SECTIONS 11 AND 12(a)(2) FOR MATERIAL OMISSIONS AND MISSTATEMENTS IN THE REGISTRATION STATEMENT/PROSPECTUS. Sections 11 and 12(a)(2) placed defendants under a duty to disclose, both to the investing public and as a condition of the ECI merger, the adverse financial conditions at SCI both during the fourth quarter and after the quarter closed. As of November 1998, the individual defendants knew that ECI had a material shortfall in its fourth quarter earnings but nonetheless falsely represented in the Registration Statement that no material, adverse changes in SCI's business had -- or could -- occur. P. 56. Defendants' knowledge is clear from two admissions in its Answer. First, defendants admit that the Falcon system "allows SCI to determine the level of funeral and cemetery sales" (Ans. P. 121) -- information plaintiffs allege was available on a daily basis. P. 121. Accordingly, by the date the Registration Statement became effective on November 20, 1999, nearly two-thirds of the way through SCI's fourth quarter, SCI had available, via Falcon, data regarding SCI's earnings shortfall. Second, SCI knew that this shortfall could not possibly be made up in the remainder of the quarter because, as defendants' admit, SCI's high fixed cost structure could not be reduced to accommodate slower periods of revenue growth, and supply could not be increased to make up the shortfall because "a death care provider cannot promise to fill an order in 'a week or two.'" P. 119; Ans. 119. Thus, SCI's Falcon system informed it of its earnings shortfall and the nature of the defendants' business made it impossible to recover from that shortfall; in other words, the writing was on the wall. - 17 - 25 Accordingly, even as early as the preliminary effective date of the Registration Statement in November, SCI's claim that there were no materially adverse effects on its business was necessarily false and misleading. See Shaw v. Digital Equip. Corp. 82 F.3d 1194, 1210 (1st Cir. 1996)("Present, known information that strongly implies an important future outcome is not immune from mandatory disclosure merely because it does not foreordain any particular outcome"). For the same reasons, the Registration Statement/Prospectus were defectively misleading when, only twelve business days prior to the end of SCI's quarter, SCI and ECI amended the Merger Agreement in SCI's favor. P.'s 70-71.(8) At this point in time, Falcon had provided defendants with nearly conclusive fourth quarter results and there was even less time to make up the shortfall that was now all but a fait accompli. Still, defendants failed to disclose the deteriorating results or the material impact on SCI's business operations, leaving uncorrected the unavoidably false and misleading statement of "no materially adverse effect" in the Registration Statement/Prospectus. P. 71, 56-57. Then, on December 31, 1998, the ECI shareholders voted to approve the merger and stock exchange, still without any disclosure of the fourth quarter debacle. Finally, 19 days after the fourth quarter had closed, sealing SCI's poor performance, SCI unbelievably continued to keep private its knowledge of the dramatic decline in SCI's earnings, waiting until one week after the acquisition transaction was safely closed to share its knowledge with the world and the ECI shareholders that SCI's fourth quarter results were nearly 50% below expectations. "[I]n the context of a public offering, there is a strong affirmative duty of disclosure." Shaw v. Digital Equip. Corp. 82 F.3d at 1202 (emphasis added). In the Shaw case, the First Circuit sustained Section 11 claims based upon a failure to disclose poor quarterly results in a registration - ------------------ (8)Plaintiffs believe that this amendment to the Merger Agreement (which was incorporated in the Registration Statement/Prospectus), created a new effective date in late December 1998. - 18 - 26 statement that became effective 11 days prior to the end of the quarter. Id. at 1211. The Court analogized the defendant corporation to an inside trader, arguing that just as an individual insider with material nonpublic information about a pending merger. . . could not purchase his company's securities without making disclosure, the company itself may not engage in such a purchase of its own stock, if it is in possession of such undisclosed information. By extension, a comparable rule should apply to issuers engaged in a stock offering. Otherwise, a corporate issuer selling its own securities would be left free to exploit its information trading advantage, at the expense of investors, by delaying disclosure of material nonpublic negative news until after completion of the offering. Id. at 1204 (internal citations omitted and emphasis added). Any other rule "would allow companies to exploit what amounts to a naked informational trading advantage." Id. at 1209. Thus, at "any point in a quarter," if "there is a sufficient probability that unexpected disastrous quarter-to-date performance will carry forward to the end of the quarter," to avoid liability, such results must be disclosed if "a reasonable investor would likely consider the interim performance important to the overall mix of information available.". Id. at 1210 (emphasis added). The facts of the instant case are even more egregious than Shaw because, here, the defendants thrice traded on inside information, utilizing their "naked informational trading advantage" by failing to disclose negative information material to the acquisition of ECI, in November of the fourth quarter, 12 business days before the quarter's end, and even after the quarter had closed -- in spite of their express promise in the Registration Statement/Prospectus to report such information up until the date the transaction closed.(9) Accordingly, plaintiffs have amply met their pleading burden to allege - ------------------ (9)Plaintiffs allege that the cause of the material fourth quarter earnings shortfall was principally the result of the undisclosed mounting backlog of unprofitable preneed contracts, and that the failure to disclose the shortfall prior to the closure of the ECI transaction was the culmination of defendants' six-month fraudulent campaign to cover up a long-standing financial crisis. Defendants claim that the shortfall was caused by business reasons outside of its control. See Def. Mem. at 9, n. 10 (citing company press release). While the reasons for SCI's fourth quarter earnings shortfall are a factual dispute to be resolved at trial, these reasons are irrelevant to plaintiffs' Section 11 and 12(a)(2) claims. - 19 - 27 material misstatements and omissions. Nothing more is required under Sections 11 and 12(a)(2) of the 1933 Act. Herman & MacLean v. Huddleston, 459 U.S. at 381-82.(10) C. PLAINTIFFS' SECTION 11 AND 12(a)(2) CLAIMS ARE NOT SUBJECT TO FED. R. CIV. P. 9(b) OR TO THE PARTICULARITY REQUIREMENTS OF THE PSLRA Defendants also argue -- albeit in a conclusory manner in a cursory footnote -- that the plaintiffs' 1933 Act claims are subject to the particularity requirements of the PSLRA and Rule 9(b) because the gravamen of all the claims is fraud. See Def. Mem. at 13. This argument has no merit. The PSLRA, which included amendments to both the 1933 Act and the 1934 Securities Exchange Act of 1934 (the "1934 Act"), only added "particularity" pleading requirements to the 1934 Act, clearly preserving the strict liability of the 1933 Act claims. Compare 15 U.S.C. Section 77z-1 with 15 U.S.C. Section 78u-4. Plaintiffs' prima facie case for violations of Section 11 and 12(a)(2) is pled by alleging the presence of false and misleading statements or omissions in the Registration Statement. Degulis v. LXR Biotechnology, Inc., 928 F. Supp. 1301, 1310 (S.D.N.Y. 1996). See also In re Nationsmart Sec. Litig., 130 F.3d 309, 315 (8th Cir. 1997) (declining to apply Rule 9(b) to Section 11 claim because Section 11 does not include fraud or mistake as an element). Kensington Capital - -------------- (10)As the Shaw court noted, the duty of an inside trader -- whether an individual or a corporation -- is to "disclose or abstain from trading." Shaw, 82 F3d at 1203. Plaintiffs' Section 11 and Section 12(a)(2) claims on behalf of the ECI holders are predicated on SCI's failure to disclose, making its Registration Statement/Prospectus false and misleading. In addition, plaintiffs also assert Section 10(b) claims on behalf of the ECI holders, based upon SCI's knowing or deliberately reckless failure to abstain from trading when it was in possession of superior information than that available to the market. As demonstrated below, plaintiffs have plead their 10(b) claims with sufficient particularity and with sufficiently strong allegations of scienter to survive dismissal. See Point III, infra. Accordingly, the ECI holders' 10(b) claims must be sustained as well. - 20 - 28 Management v. Oakley, Inc., [1999 Transfer Binder] Fed. Sec. L. Rep. (CCH) P. 90,411, at 91,855 (C.D.Cal. Jan. 14, 1999) (same). III. THE COMPLAINT STATES CLAIMS FOR VIOLATIONS OF SECTION 10(b) AND RULE 10b-5. Not only are the statements in the Registration Statement per se actionable under Sections 11 and 12(a)(2), but those statements, as well as the other statements detailed in the Complaint, give rise to a cause of action under Section 10(b).(11) A. THE CIRCUMSTANCES OF DEFENDANTS' FRAUD ARE STATED WITH SUFFICIENT PARTICULARITY UNDER RULE 9(B) AND THE PSLRA. Pursuant to Rule 9(b) of the Federal Rules of Civil Procedure a plaintiff must specify the "statements contended to be fraudulent, identify the speaker, state when and where the statements were made, and explain why the statements were fraudulent." Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618, 622 (N.D. Tex. 1998). Plaintiffs have identified the precise omissions and misstatements alleged to have been made, the Registration Statement, press release, or SEC filing in which they were made, the context and the manner in which the statements were misleading and what defendants gained by the alleged fraud. If an allegation regarding a statement or omission is made on information and belief, the PSLRA requires the complaint to state with particularity "all facts on which that belief is formed." 15 U.S.C. Section 78u-4(b)(1). Because the Complaint's detailed allegations of falsity are based on the - ---------------- (11)See, e.g., Shaw, 82 F.3d at 1221 (the same misstatements and omissions in a Registration Statement which give rise to Section 11 and 12(a)(2) claims may give rise to a cause of action under Section 10(b) provided that plaintiffs establish the additional elements of Rule 10(b); Williams v. WMX Technologies, Inc., 112 F.3d 175, 177 (5th Cir. 1997) ("to state a claim based on Section 10(b) of the Securities Exchange Act of 1934 the plaintiff must allege 1) a misstatement or omission; 2) of material fact; 3) made with the intent to defraud; 4) on which the plaintiff relied; and 5) which proximately caused the plaintiff's injury."). - 21 - 29 investigation of plaintiffs' counsel (P. 128) rather than on information and belief, the PSLRA's information and belief pleading requirements do not apply.(12) Moreover, even if the Complaint were deemed to have been alleged on information and belief for purposes of the PSLRA, its allegations of fact more than sufficiently meet the requirements of the PSLRA. 1. DEFENDANTS' FRAUDULENT STATEMENTS IN CONNECTION WITH THE ECI ACQUISITION AND THE FOURTH QUARTER OF 1998. The Complaint alleges specific facts showing defendants carefully considered a plan to deceive the investing public about SCI's financially debilitating preneed contracts and underperforming acquired mortuary trust assets -- a plan which reached an unprecedented level in the fourth quarter of 1998, by which time it had become clear to defendants that the increasingly adverse impact on SCI's reported results could continue to be concealed only by burying deteriorating earnings in a "charge" attributed to the ECI acquisition. In Section 10.10 of the Merger Agreement, which was attached as an Exhibit to the Registration Statement, defendants represented that no "events" had occurred which had, or could reasonably be anticipated to have, individually or in the aggregate, a "Material Adverse Effect." P.'s 63-66. - --------------- (12)See, e.g., Schlagel v. Learning Tree, [1999 Transfer Binder] Fed. Sec. L. Rep. (CCH) P. 90,403, at 91,816 n.4 (C.D. Cal. Dec. 23, 1998) (plaintiffs' allegations, based upon the investigation of their counsel, did not constitute pleading on information and belief); Cherednichenko v. Quarterdeck Corp., [1998 Supp. Transfer Binder] Fed. Sec. L. Rep. (CCH) P. 90,108, at 90,142 n.3 (C.D. Cal. Nov. 26, 1997) ("Plaintiffs' allegations are based on the investigation of their counsel, not on information and belief. The heightened standard does not apply here."); Zeid v. Kimberley, 973 F. Supp. 910, 915; Lister v. Oakley, Inc., No. SA CV 97-809-GLT (EEX) 1999 U.S. Dist. LEXIS 389, at *7 (C.D. Cal. Jan. 14, 1999); Warman v. Overland Data, Inc., [1998 Supp. Transfer Binder] Fed. Sec. L. Rep. (CCH) P. 90,167, at 90,529 (S.D. Cal. Feb. 23, 1998). See also In re Employee Solutions Sec. Litig., CIV 97-545-PHX-RGS-OMP, 1998 U.S. Dist. LEXIS 16444, at *13 (D. Ariz. Sept. 29, 1998) (plaintiffs are not required to reveal the individual sources of their allegations under the PSLRA). - 22 - 30 The Complaint specifies in detail why that statement was misleading. Defendants knew when the statement was made that SCI's unprofitable acquired preneed contracts had already had, and were continuing to have, "a material adverse effect" which was required to be disclosed pursuant to the Merger Agreement. P. 56. By November 1998, defendants knew that SCI's fourth quarter 1998 earnings would fall at least between .$08 to $.10 below analysts' estimates, and talked openly among themselves about their scheme to hide the deteriorating earnings with a special "charge" attributed to the ECI acquisition. P. 56. Disclosure of the drastic impact of servicing the preneed contracts either would require renegotiation or termination of the ECI deal -- a risk defendants were unwilling to take. P. 67. Similarly, on December 14, 1998, when the Merger Agreement was amended, the Complaint alleges that defendants again failed to disclose materially deteriorating fourth quarter earnings caused by, inter alia, the impact of the Company's acquired mortuary trust assets. P. 71. This was less than two weeks prior to the end of SCI's fourth quarter, by which time defendants were aware of the extent of the earnings shortfall. P. 71. By that time, defendants knew they would not be able to continue to conceal SCI's deteriorating financial condition from the public when it came time to file year end reports with the SEC.P. 56. Moreover, the true condition of SCI -- not only in the fourth quarter, but throughout the Class Period, was well known to the Individual Defendants, who closely monitored results from SCI's many funeral homes through next-day reports generated by SCI's computer system, "Falcon." P. 56. The Complaint alleges with the particularity required by Rule 9(b) and the PSLRA, why the statements made in connection with the ECI merger were false and misleading.(13) - ---------------- (13) Accordingly, even if plaintiffs were required to state their Sections 11 and 12 claims with particularity -- which they are not -- they have done so. - 23 - 31 2. THE COMPLAINT ALSO ALLEGES WITH PARTICULARITY THE DEFENDANTS' FALSE AND MISLEADING STATEMENTS THROUGHOUT THE CLASS PERIOD. Not only does the Complaint satisfy the PSLRA and Rule 9(b)'s particularity requirements with respect to the defendants' false and misleading statements in connection with the ECI acquisition, but it also satisfies those requirements with respect to the defendants' statements throughout the Class Period. In this case, as in many others, there were material undisclosed facts concerning the same subject -- SCI's unprofitable acquired preneed funeral contracts and the impact they were having on the Company's overall profit margins and performance -- that rendered all of the challenged statements from the beginning of the Class Period materially false and misleading when made. The Complaint specifies how and why these undisclosed adverse facts rendered each of the defendants' affirmative statements identified in the Complaint false and misleading when made. See P.'s 73, 75, 78, 80, 82, 84, 86, 88, 90, 92, 94, 96, 98, 100, 102, 103, 104, 106-108 (false and misleading statements) followed by P.'s 74, 76, 77, 79, 81, 83, 85, 87, 89, 91, 93, 95, 97, 99, 101, 105, 109 (detailed explanations of why the statements were materially false and misleading). In an attempt to transform plaintiffs' Complaint into a case they might rather defend, defendants mischaracterize these detailed allegations of fraud as "conclusory." Def. Mem. at 12-16. Defendants' claim is belied by the Complaint's specific allegations regarding each of the alleged omissions and misstatements, which must be deemed to be true on a motion to dismiss. For example, plaintiffs do not merely "conclude" that the Company's 1998 third quarter 10-Q omitted material information regarding the Company's underperforming preneed contracts and mortuary trust assets. P. 100. They allege, very specifically, that the Company's backlog of prearranged funeral contracts included a material number of contracts that were backed by mortuary trust assets that were inadequately funded or were funded by assets invested only to ensure growth adequate to cover "the - 24 - 32 cost of providing a price guaranteed funeral." P. 101(a). At the time the 1998 third quarter 10-Q was filed, a material number of SCI's funeral services had been, and would continue to be, performed at significant losses, resulting in an increasingly sharp erosion in SCI's profit margins for funeral services. P. 101(b).(14) The Complaint more than adequately satisfies Rule 9(b) and the PSLRA's particularity requirements. Nothing more is required. B. THE PRENEED STUDY, ALONG WITH DEFENDANTS' PUBLIC STATEMENTS AND ADMISSIONS, AMPLY SUPPORT THE ALLEGATIONS IN THE COMPLAINT. Defendants argue that the collection of select unauthenticated documents they assert constitute the preneed study rebuts each of plaintiff's allegations, based on their own, self-serving interpretation of those documents. This argument -- which clearly addresses the merits of the Complaint -- is entirely improper on a motion to dismiss where the Court must accept as true reasonable inferences drawn from plaintiffs' allegations. Khurana v. Innovative Health Care Systems, Inc., 130 F.3d 143, 147 (5th Cir. 1997); Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618, 621 (N.D. Tex. 1998); accord, In re Stratosphere Corp. Sec Litig., 1 F. Supp. 2d 1096, 1109 (D. Nev. 1998)(resolving disputed facts or inferences improper on motion to dismiss). Defendants' "explanation," which at its core admits the existence of SCI's preneed problems, goes to SCI's ultimate defense. It is a merits argument, which should be presented to the jury at trial, after plaintiffs have had their right to complete merits discovery, and where SCI's "defenses" will be subject to cross-examination and the rules of evidence; it has no place in a motion to dismiss. In any - ------------------ (14)The Complaint also sets forth in detail the number of funeral homes SCI acquired (P. 20), the increased costs associated with providing funeral services, (P. 26), SCI's increasing backlog of preneed contracts, (P. 28), the negative impact on SCI's profit margin (P.'s 36-37), the Company's attempts to conceal its plunging profit margins (P.'s 42-71), and the admitted negative impact on earnings resulting from losses on SCI's preneed business. P. 126. - 25 - 33 event, SCI's defense is meritless. Even the select documents defendants rely on, along with defendants' post Class Period public statements and admissions, amply support the allegations in the Complaint. Indeed, the defendants have admitted that fourth quarter earnings shortfall was caused by SCI's unprofitable preneed business. See P. 126 (excerpting story in industry publication in which defendant Heiligbrodt stated "the at need value of many of the preneed plans sold in the 1980's is about 20 percent less than the company presently charges for its services"); Ans. P. 127 (admitting without qualification, story in industry publication reporting that "SCI has said in the past that it looses money on some of its preneed services because the contract was sold at too low a price"). Defendants do not deny the explosive growth in preneed contracts. See Ans. P.'s 28 (conceding "between 1992 and 1998, in just a six-year period, SCI's prearranged funeral contract backlog increased three-fold, from $1.2 billion to $3.7 billion"); P. 31. Defendants also admit that CD's were used to finance the future cost of performing the funeral services for preneed customers. Ans. P. 24. And the defendants' own submissions show that SCI had a material amount of its mortuary trust assets -- 33% -- tied up in cash or other low risk/low return investments (Exhibit C-1, SCI0009), despite knowing this percentage was potentially disastrous. See Exhibit C-1, SCI0009: ExhibitC-4 SCI0063 (SCI's "policy" was to invest only 10% of the preneed investments in cash).(15) - ----------------- (15)Defendants' reliance on statements in their documents about "return over inflation" of 2% (Exhibit C-4, SCI0064) to refute the merits of the Complaint are woefully inapt. "Inflation" refers to a "continuing rise in the general price level." Merriam Webster's Collegiate Dictionary 598-99 (10th ed. 1993) (emphasis added). The Complaint alleges that there were specific cost increases in the funeral industry, stating "the costs associated with providing funeral services increased at an average annual rate of 8.5%. . . ." P. 26. Thus, defendants knew, or were reckless in not knowing, that a mere 2% return over inflation (assumed in defendants' documents to be 3.5%, Exhibit C-1, SCI0005) was totally insufficient in the face of 8.5% cost increases. - 26 - 34 C. PLAINTIFFS ARE NOT REQUIRED BY THE PSLRA OR RULE 9(b) TO IDENTIFY INTERNAL DOCUMENTS OR INFORMANTS. Contrary to defendants' argument (Def. Mem. at 21-23), plaintiffs need not specify which internal documents they relied on or even that they relied on internal documents at all. The Complaint satisfies the PSLRA by alleging compelling facts which raise a strong inference of scienter without reference to any internal documents, and by identifying with particularity the facts that support plaintiffs' claim that the specific statements made by defendants were misleading. See Coates v. Heartland Wireless Communications, Inc., 26 F. Supp. 2d 910, 916 (N.D. Tex. 1998). Once a plaintiff sets forth the specifics of an internal corporate problem and its importance, as plaintiffs have done, the Second Circuit precedents from which the PSLRA standard is derived do not require a plaintiff to have personal knowledge or identify precisely how the problems were communicated to the company's top executives. See, e.g., Cosmas v. Hassett, 886 F.2d at 12-13 (2d Cir. 1989), Cohen v. Koenig, 25 F.3d 1168, 1173 (2d Cir. 1994); Goldman v. Belden, 754 F.2d 1059, 1070 (2d Cir. 1985). The court in In re Bausch & Lomb Sec. Litig., 941 F. Supp. 1352, 1361 (W.D.N.Y. 1996), addressed this very issue, and upheld plaintiffs' complaint even though the "complaint did not point to any specific documents that defendants saw, nor did it state precisely when or how each individual defendant became aware that the Company's statements to the public were false or misleading." Id. Notably, the court concluded, "We will not demand clairvoyance from pleaders." Id. (citation omitted). Defendants also assert that plaintiffs must identify the underlying sources of their factual allegations (i.e., the names of their confidential informants) before plaintiffs' factual allegations may be accepted as true by the Court. Def. Mem. at 21-23. However, such a requirement is refuted by the plain and unambiguous language of the PSLRA. The PSLRA states (for 1934 Act claims only): - 27 - 35 [T]he complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed. 15 U.S.C. Section 78u-4(b)(1) (emphasis added). Thus, even if the Complaint's allegations were made on "information and belief," the PSLRA requires only that plaintiffs plead all facts upon which their belief is based, not the sources of those facts. There is absolutely no reference in the PSLRA to the word "source," let alone a requirement that plaintiffs identify their sources by name in a publicly-filed pleading.(16) IV. THE COMPLAINT ADEQUATELY ALLEGES SCIENTER A. THE LEGAL STANDARDS. Plaintiffs may meet the requirements of Rule 9(b) and the PSLRA as applied to Section 10(b) by "alleging either motive and opportunity to commit fraud, or by pleading facts which identify circumstances indicating defendants' conscious or reckless behavior, so long as the totality of the allegations raises a strong inference of fraudulent intent. Robertson v. Strassner, 32 F. Supp. 2d 443, 446 (S.D. Tex. 1998). Accord, Zuckerman v. Foxmeyer Health Corp., 4 F. Supp. 2d 618, 622 (N.D. Tex. 1998), STI Classic Fund v. Bollinger Industries, Inc., 1996 U.S. Dist. Lexis 21553, *3 - ------------------ (16) An earlier draft of the PSLRA (requiring plaintiffs to plead "all information") was ultimately changed to require only the pleading of "all facts." This change was proposed by Judge Anthony Scirica of the Third Circuit on behalf of the Judicial Conference of the United States in order to conform the requirements of Section 21D(b)(1) of the PSLRA to those set forth in Rule 9(b). See 141 Cong. Rec. S19044-45 (Dec. 21, 1995) (remarks of Senator Domenici reproducing letter from the Hon. Anthony Scirica). See also House-Senate Conference Report, H. R. Rep. No. 104-369, at 41 (Nov. 28, 1995) (noting that the final text was "specifically written to conform the language to Rule 9(b)'s notion of pleading with 'particularity'"); Schaffer v. Evolving Sys., Inc., 29 F. Supp. 2d 1213, 1223 (D. Colo. 1998) (holding that Section 78u-4(b)(1) appears to be "merely a codification" of pre-existing Rule 9(b) jurisprudence). - 28 - 36 (N.D. Tex. 1996)(holding that the "motive and opportunity" test survived the PSLRA). See also, Press v. Chemical Inv. Servs. Corp., 166 F.3d 529, 537-38 (2d Cir. 1999). Defendants incorrectly argue that the Fifth Circuit's decision in Williams v. WMX Techs., Inc., 112 F.3d 175, 178 (5th Cir.) cert. denied, 118 S.Ct. 412 (1997), is inapposite. In Williams, the Fifth Circuit applied the Second Circuit's approach to proper pleading of securities fraud allegations, and expressly stated that, although the case before it was filed prior to the PSLRA's effective date, "the [PSLRA] adopted the same standard we apply today." Id. at 177-178. It is therefore hardly surprising that of the seven published and unpublished district court cases in the Fifth Circuit that have commented on the pleading requirements for the scienter element under the PSLRA, all but one - - - Parcelsus, 1998 WL 1108373 (N.D. Tex. 1998) -- interpret the act to allow a plaintiff to plead scienter by showing motive and opportunity. See, McNamara v. Bre-X Minerals Ltd., 57 F. Supp. 2d 396 (E.D. Tex. 1999)(circumstantial evidence of conscious misbehavior or recklessness satisfies the pleading requirement; facts showing motive and opportunity can also satisfy the requirement, although they may not always do so conclusively); Coates v. Heartland Wireless Communications, Inc., 55 F. Supp. 2d 628, 633 (N.D. Tex. 1999)("This court holds that scienter can be pleaded based on motive and opportunity to commit fraud; Hartsell v. SourceMedia, Inc., 1999 WL 649645 (N.D. Texas 1999) ("allegations of motive and opportunity are sufficient.")17; accord Robertson v. Strassner, - --------------- (17)The transcript of the hearing in Hartsell v. Source Media Inc., No. 3:98-CV-1980-R (N.D. Tex. July 15, 1999) before Judge Buchmeyer is attached hereto as Exhibit A. Judge Buchmeyer rejected the Ninth Circuit's opinion in Silicon Graphics, supra, finding that the better approach allows plaintiffs to prove scienter through motive and opportunity. Exh. A, pg. 33, 15-25. - 29 - 37 32 F. Supp. 2d 443 (S.D. Tex. 1998); Zuckerman v. Foxmeyer Health Corp., 4 Supp. 2d 618 (S.D. Tex. 1998); STI Classic Fund v. Bollinger Industries, Inc., 1996 WL 885802 (N.D. Tex. 1996).(18) In Re Silicon Graphics II, 183 F.3d at 977-79 (9th Cir. 1999), heavily relied on by defendants, is at odds with this Circuit's interpretation of the PSLRA's pleading requirements, as is evident from WMX Technologies and district court cases such as Zuckerman and Strassner. See also In re Advanta Corp. Sec. Litig., 1999 WL 395997, at *3 (3d Cir. June 17, 1999) (noting that the Fifth Circuit in Williams concluded that the PSLRA codified the Second Circuit standard for pleading scienter). Indeed, none of the other Circuit Courts to address the PSLRA thus far (the First, Second, Third, Sixth and Eleventh) have taken the extreme view endorsed by the Silicon Graphics court, and have held that motive and opportunity are either alone sufficient to prove scienter or can - -- at minimum -- constitute strong evidence of the requisite state of mind. See, Greebel v. FTP Software, Inc., 1999 WL 902898 (1st Cir. 1999); Press v. Chemical Investment Services Corp., 166 F.3d 529, 538 (2d Cir. 1999); In re Advanta, supra. In re Comshare, Inc. Sec. Litig., 183 F.3d 542, 549 (6th Cir. 1999); Bryant v. Avado Brands, Inc., 1999 WL 688050, *12 (11th Cir. 1999). Defendants also indulge in a misguided attempt to minimize the strong allegations of fraudulent intent by dissecting plaintiffs' allegations, and arguing that each factor, standing alone, is insufficient to prove scienter. Def. Mem. at 33-37. This argument is based on a misinterpretation of the PSLRA, which requires that the totality of the allegations raises a strong inference of fraudulent intent. Robertson v. Strassner, 32 F. Supp. 2d at 446. Accord, Zuckerman v. Foxmeyer Health - --------------- (18)Defendants' arguments that the PSLRA imposed a new scienter standard based on legislative history have been considered and discussed at great length by the district courts ruling on the issue, and then rejected. "[T]he Legislative history of the [Reform Act] does not indicate that Congress acted to eliminate recklessness as a basis for scienter. . . ." McNamara, 57 F.Supp. at 634 (citing Marksman Partners, L.P. v. Chantal Pharm. Corp., 927 F.Supp. 1297, 1310 (C.D. Cal. 1996). - 30 - 38 Corp., 4 F. Supp. 2d 618, 622 (N.D. Tex. 1998). This case does more than raise allegations that defendants made false and misleading statements to maintain favorable ratings on debt securities (Def. Mem. at 33) or to consummate a merger (Def. Mem. at 34) alone. Viewed in totality, the Complaint's numerous, detailed allegations set forth amply defendants' motive, opportunity, and reckless or deliberate conduct in compliance with the PSLRA. B. THE DEFENDANTS ACTED WITH ACTUAL KNOWLEDGE OR A RECKLESS DISREGARD FOR THE TRUTH. The Complaint alleges specific facts which create a strong inference that the defendants acted with, at least, a reckless disregard for the truth, and in many instances, acted intentionally and deliberately, including: o According to SCI insiders, by November 1998 the individual defendants knew that SCI's fourth quarter earnings would fall at least between $.08 to $.10 below analysts' estimates. P. 56; o Senior executives and the defendants were not only aware of the impending earnings shortfall, they openly discussed how to hide the shortfall from investors and plotted an intricate plan to "bury" the shortfall in a one-time charge that SCI would take in connection with the ECI merger. P. 56; o The Falcon system provided the individual defendants daily, weekly, and monthly profit/loss reports from each of the Company's more than 3,000 domestic funeral homes. Falcon reported SCI's performance of a material number of unprofitable preneed funerals as well as undisclosed changes in SCI's costs, for each and every funeral home owned by SCI, making it simply not credible that these defendants were unaware of SCI's financial performance. P. 20, 56; o Due to the Falcon system's reporting methods and the extremely high level of recurring, budgeted, fixed costs which do not fluctuate in the death care industry, death care providers such as SCI, can easily predict quarterly results. Defendants knew that fourth quarter results -- absent "burial" of the preneed impact in an ECI-related charge -- would be significantly less than estimated. P. 119; and o Defendant Heiligbrodt admitted, subsequent to the Class Period, that the Company's earnings shortfalls reported for fiscal year 1998 resulted from losses on SCI's preneed business, P.'s 126, 127. - 31 - 39 Moreover, the Individual Defendants controlled and approved the issuance of SCI's financial statements, press releases, and SEC filings during the Class Period. The magnitude of the fraud also supports the strong inference of scienter: On January 26, 1999, SCI announced that its fourth quarter 1998 gross profits declined 19% from its third quarter gross profits and 24% from SCI's fourth quarter 1997 gross profits. SCI's EPS for the fourth quarter of 1998 were a remarkable 36% below SCI's EPS for the fourth quarter of 1997 and 45% below the consensus estimate. P. 123. The magnitude of the completely unexpected shortfall caused SCI's shares to drop over 44% in one day. P. 124. Rehm v. Eagle Finance Corp., 954 F. Supp. 1246, 1254 (N.D. Ill. 1997)("[t]he more serious the error, the less believable are defendants' protests that they were completely unaware of defendants true financial status and the stronger the inference that defendants must have known about the discrepancy."). There is also the close proximity of the January 26, 1999 disclosure of SCI's deteriorated finances and the date on which the completion of the ECI merger was closed, a lapse of only five business days. P. 123. Defendants' failure to reveal the material, negative impact of the debilitating inherited preneed and inadequately invested mortuary trust assets is itself strong circumstantial evidence of scienter. See, e.g., Powers v. Eichen, 977 F. Supp. 1031, 1039 (S.D. Cal. 1997) (Where "bad news" was disclosed approximately four weeks after defendants' optimistic statements were made the court held that "[t]he proximity of the bad news to the dates that the defendants made optimistic statements is circumstantial evidence that the defendants knew that their optimistic statements were false."); Friedberg v. Discreet Logic Inc., 959 F. Supp. 42, 51 (D. Mass. 1997)(court upheld a complaint where the time lapse between the optimistic statements and the - 32 - 40 disclosure of negative news was approximately two months because of "the temporal proximity between an alleged misstatement and the later disclosure of inconsistent information."). C. DEFENDANTS ALSO HAD MOTIVE AND OPPORTUNITY TO ENGAGE IN THE FRAUDULENT SCHEME. Defendants also had both motive and opportunity to create a false picture of SCI's operating condition in order to maintain its artificially inflated stock price. It is undisputed that the Individual Defendants, all high ranking officers of SCI with access to internal documents, "Falcon" generated reports from each separate funeral home, attendance at regular meetings, and inside knowledge of the Company's affairs, had the opportunity to engage in the fraudulent scheme. P.'s 8-15. Defendants also had motive. To plead motive adequately requires a showing of "concrete benefits that could be realized by one or more of the false statements." In re Health Management, 970 F. Supp. 192, 202 (E.D.N.Y. 1997), quoting Shields v. Citytrust Bancorp, 25 F.3d 1124, 1128 (2d Cir. 1994)(internal quotations omitted). Here, defendants were motivated to keep the price of SCI's stock as high as possible prior to the effective date of the ECI merger. The ECI acquisition was critical to SCI's ability to turn around its increasingly unprofitable acquired preneed business. P. 111. As a result of SCI's disclosure on January 26, 1999, the consideration paid for each share of ECI common stock in the Merger was cut virtually in half. P. 124. ECI shareholders who received SCI common stock worth $25.53 per share when the deal closed, now held shares worth only $12.79 per share. P. 124. The total consideration paid for ECI was effectively reduced from $556 million to $278 million. Id. Allegations that defendants were motivated to issue false and misleading statements in order to complete stock-for-stock acquisitions sufficiently pleads motive. See Gross v. Medaphis Corp., 977 F.Supp. 1463, 1471 (N.D. Ga. 1997); Marra v. Tel-Save Holdings, Inc., 1999 WL 317103 (E.D.Pa. - 33 - 41 1999). In Tel-Save, the court found a strong inference of fraudulent intent where plaintiffs identified a specific acquisition that occurred during the class period which was funded by a combination of Tel- Save stock and cash. Id. at *9. See also, Duncan v. Pencer, No. 94 Civ. 0321, U.S. Dist. LEXIS 401, at *48-49 (S.D.N.Y. Jan. 18, 1996) (company's motive to obtain monies to "fund its expansion and otherwise satisfy its financial needs" held sufficient to withstand a motion to dismiss); Harvey M. Jasper Retirement Trust v. Ivax Corp., 920 F.Supp. 1260, 1264-65 (S.D. Fla. 1995) (allegations that defendants inflated stock price to use as currency in stock-for-stock merger transaction showed what defendants gained by their misrepresentations).(19) In addition to consummating the ECI merger -- and consummating it on terms favorable to SCI -- defendants were motivated to misrepresent SCI's true financial condition because: o Defendants needed to maintain favorable ratings on debt securities, in particular, the May 29, 1998 registration of up to $1 billion of debt, common stock and warrants, and an October 15, 1998 registration for $500 million in SCI preferred stock. By failing to disclose the nature of SCI's unprofitable preneed business, SCI was able to save millions of dollars in interest payments that would otherwise have been paid to bondholders. P.'s 113-115; and o It was necessary for SCI to retain its favorable Standard & Poor's credit rating in order to continue to "avail itself of much need funds" to further its acquisition spree, revenues from which SCI used to mask the poor performance of its prearranged funeral contracts. P.'s 116-117; Ans. P. 114 (emphasis added.) Finally, defendants argue that any inference of scienter is negated by the absence of insider trading. Def. Mem. at 36-36. SCI did, however, engage in insider trading by exchanging inflated - ----------------- (19) While it may be that "unsubstantiated allegations that [a company] sought to inflate its market price to consummate unspecified acquisitions do not raise a strong inference of scienter," In re Home Health Corp. of America, Inc. Sec. Litig., 1999 WL 79057, *15 (E.D. Pa. 1999), that is not the case here. The allegations about SCI's stock-for-stock merger with ECI are neither unsubstantiated nor unspecified. Defendants reliance on Leventhal v. Tow, 1999 WL 270089, *10-11 (D. Conn. 1999) and Health Management, supra, is misplaced. In both cases, the court found that allegations that defendants were motivated by a desire to complete unspecified future stock-for-stock transactions was insufficient to allege scienter. - 34 - 42 SCI stock for ECI stock in the Merger, an act defendants admit "constituted a sale of securities." within the meaning of the statue prohibiting "selling a security while inpossession of material, nonpublic information." 15U.S.C. Section 78t-1. Ans. P. 171. Moreover, in the face of detailed, substantial allegations of motive, opportunity, and a reckless disregard for the truth, even the absence of insider trading by any defendant is no defense to a well-pled complaint. See e.g., STI Classic Fund v. Bollinger Indus. Inc., 1996 U.S. Dist. LEXIS 21553, at *5-6 (N.D. Tex. Oct. 25, 1996) (motive established in post-PSLRA case despite absence of any insider trading); In re Wells Fargo, 12 F.3d 922, 931 (9th Cir. 1993) (allegations of unusual insider trading not required to establish scienter); In re Compaq Sec. Litig., 848 F. Supp. 1307, 1311 (S.D. Tex. 1993). Accord Hanon v. Dataproducts Corp., 976 F.2d 497, 507 (9th Cir. 1992); Cosmas v. Hassett, 886 F.2d 8, 13 (2d. Cir. 1989). Indeed, post-PSLRA decisions have found scienter in the absence of any insider trading. See, e.g., Gross, 977 F.Supp. at 1472 (scienter established through allegations that defendants made false statements in order to inflate the value of its stock thereby facilitating the acquisition of other companies); Epstein v. Itron, Inc., 993 F.Supp. 1314, 1326-27 (E.D. Wash. 1998).(20) Considering the totality of the circumstances in this case, including the fact that insider trading is not required to establish scienter, and the particularized facts demonstrating defendants knew of the - --------------- (20)The Individual Defendants also had motives to maintain and enhance the price of SCI common stock to protect and enhance their executive positions and the substantial compensation and prestige obtained thereby. See, e.g., Zuckerman v. Foxmeyer Health Corp. 4 F. Supp. 2d 618, 627 (N.D. Tx. 1998) (personal pecuniary benefits can create a strong motive to engage in fraud); In re Compaq Sec. Litig., 848 F. Supp. at 1311; Weiner v. Quaker Oats Co., 129 F. 3d 310, 318 n.8 (3d Cir. 1997); Blake v. Dierdorff, 856 F.2d 1365, 1369-70 (9th Cir. 1988). See also Wells Fargo 12 F.3d at 931 (allegations that defendants "stood to receive more compensation because of the alleged non-disclosure of material information" sufficient to raise an inference of scienter); In re Digi Int'l Inc. Sec. Litig., 6 F. Supp. 2d 1089, 1098 (D. Minn. 1998) (holding that allegations that individual defendants could receive substantially more performance-based compensation as a result of misrepresentations constituted evidence of scienter). - 35 - 43 adverse impacts of SCI's multi-billion dollar preneed funeral backlog on SCI's profit margins and earnings, there can be no doubt that defendants had both the motive and opportunity to commit fraud. See, Robertson v. Strassner, 32 F. Supp. 2d at 449 (defendants "misperceive Plaintiffs' allegations as to motive and place[d] undue reliance on Defendants' sales of OEDC stock"); see also Zuckerman, 4 F. Supp. 2d at 627 ("[a]fter consideration of the entire complaint, the Court is of the opinion that Plaintiffs have succeeded in alleging scienter). V. THE FALSE AND MISLEADING STATEMENTS CHALLENGED IN THE COMPLAINT ARE NEITHER "PUFFERY" NOR "FORWARD LOOKING." A. DEFENDANTS' STATEMENTS REGARDING SCI'S GROWTH AND PROFITABILITY ARE MORE THAN MERE CORPORATE PUFFERY. Defendants argue that numerous statements alleged to be false and misleading in the Complaint are merely statements of "corporate optimism." Def. Mem. at 24. Unable to refute the actual statements alleged to be false and misleading, defendants cite -- piecemeal -- to one or two sentences taken out of context from plaintiffs' allegations. In fact, when these very allegations are viewed in their entirety, it is evident that these statements are not only false and misleading, but actionable. See, e.g., P.'s 75, 84, 78, 96. For example, P. 75 challenges a series of statements by defendant Heiligbrodt about SCI's acquisition of American Life, statements defendants claim are merely "vaguely optimistic statements." Def. Mem. at 24. Not true. Heiligbrodt's statements were intended to and did convey the impression to the investing public that SCI was in the midst of a "profitable expansion into the preneed insurance business" and that SCI's acquisition of American Memorial was undertaken to build on and increase the profitability of its existing preneed "profit base". See P.'s 74(a-f), 75-76. In fact, when Heiligbrodt's statements were made, SCI's profitability was being severely undercut by its existing backlog of preneed funeral - 36 - 44 contracts. The acquisition of American Memorial and planned expansion into preneed insurance was an attempt to fraudulently mask the growing reductions in SCI's overall profit margins caused by having to provide unprofitable prearranged funeral services and to ensure that SCI would not be saddled with even more dormant and underperforming mortuary trust assets. P. 76. Similarly, in P. 84, which defendants also challenge as "mere puffery", defendant Champagne characterized "the most compelling way" for SCI to "increase its market share" was to "increase the level of the prearranged funeral business". P. 84. With respect to the American Memorial acquisition, Champagne added: "You're effectively building your backlog of funding for pre-arranged funerals which has the effect of expanding or maintaining SCI's prearranged funeral business...[t]hat is a very important aspect to a company like SCI. There is a lot of competition for prearranged funeral business." P. 84. Defendants' statements touting SCI's acquisition and boasting of the growing and enormous volume of preneed funeral business -- a critical cause of SCI's devastating January 26 earnings shortfall -- was an act designed to mislead the investing public. To imply, as the defendants do in their brief, that investors would dismiss as mere "puffery" statements about the strength of SCI's preneed business -- which by defendants' own representations constituted a "very important aspect" of SCI's business -- is just disingenuous. See also, P. 78 (defendants' discussion of the increasing backlog of prearranged funeral contracts without any mention of the resulting adverse impact on profit margins caused by unprofitable acquired contracts); P. 80 (discussion of SCI's "leading market positions" without disclosure of how SCI became a "market leader" through the acquisition of funeral homes with underperforming preneed mortuary trust assets); P. 82 (comparing ECI's operational - 37 - 45 systems to SCI's, notably excluding disclosure that ECI, unlike SCI, had an established program to ensure its ability to cover the cost of prearranged funerals).(21) Contrary to defendants' assertions, federal courts repeatedly have upheld challenges to statements far more general than those they label "too vague" in this case. As long as a reasonable investor could arguably rely on the statement, "general expressions of optimism may be actionable under the federal securities laws." Hanon v. Dataproducts Corp., 976 F.2d 497, 501 (9th Cir. 1992); Virginia Bankshares v. Sandberg, 501 U.S. 1083, 1091-93 (1991)(even "indefinite and unverifiable" expressions of insiders "are reasonably understood to rest on a factual basis that justifies them as accurate."). See also, Cooper v. Pickett, 137 F.3d 616, 629 (9th Cir. 1997)(general statements of optimism actionable "if not genuinely or reasonably believed, or if the speaker is aware of undisclosed facts that tend seriously to undermine the statement's accuracy"). B. DEFENDANTS' STATEMENTS AND OMISSIONS ARE NOT PROTECTED BY THE SAFE HARBOR PROVISIONS OF THE PSLRA. Defendants' contention that the misrepresentations alleged are "forward- looking," and therefore protected by the statutory safe harbor provision (Def. Mem. at 21-26), is wrong. Defendants, of course, concede that their omissions are not protected by any safe harbor provision. The Complaint's allegations challenge statements of then existing known facts, not - ------------------- (21)Defendants' reliance on In re Verifone Sec. Litig., 784 F. Supp. 1471, 1482 (N.D. Ca. 1992), is misplaced. There the court held that a corporation need not disclose "its own internal forecasts or otherwise provide the market with the corporation's prediction of its own future. The decision was based on the belief that disclosure of predictions is "duplicative information already known to most analysts," that such predictions were likely to be a "hinderance, not a benefit, to investors," and that the securities laws do not oblige a corporation to bury shareholders with trivial information. Id. at 1482-83. The Complaint here alleges, however, that the defendants violated the securities laws by failing to disclose "hard" factual information about SCI's unprofitable acquired preneed business and mortuary trust assets. See, e.g., P.'s 29-37. Disclosure of internal forecasts or "soft" information is simply not at issue. - 38 - 46 "forward-looking" information, and therefore do not fall within the statutory safe harbor. See Harris v. Ivax, 182 F.3d 799, 806 (11th Cir. 1999) ("Of course, if any of the individual sentences describing known facts (such as the customer's bankruptcy) were allegedly false, we could easily conclude that the smaller, non-forward-looking statement falls outside the safe harbor."). The nature of the fraud in this case is the defendants' concealment of the ongoing effect of SCI's existing acquired preneed business -- the negative impact of which was fully known to defendants throughout the Class Period, and which continued to adversely impact the Company's profitability. See, e.g., Gross v. Medaphis, 977 F. Supp. at 1473 ("the statutory safe harbor, like the 'bespeaks caution' doctrine, does not insulate defendants from private securities liability based on statements that misrepresent historical/hard or current facts"). Even if any of the statements detailing SCI's ongoing and past business operations could somehow be considered "forward-looking" -- which they simply cannot -- none of the statements were accompanied by "meaningful cautionary statements." See Harris v. Ivax, 182 F.3d at 804, 806 ("A defendant can fully benefit from the safe harbor's shelter only when it has disclosed risk factors in a warning accompanying the forward looking statement."). Defendants' reliance on SCI's warnings about such generalized "risks" as the state of the economy and SCI's level of acquisition activity is misplaced. Def. Mem. at 27. Nothing specific, unique or meaningful in respect to the actual, and then existing, material problems that SCI had already and was continuing to experience with its unprofitable acquired preneed business, the failure to properly invest mortuary trust assets or the resulting impact on SCI's profitability as a result of having to service contracts at a loss was ever disclosed during the Class Period. - 39 - 47 Investors had to wait until after the Class Period and after the closing of the Merger -- when defendant Heiligbrodt admitted that the earnings shortfall was due to the underperforming preneed contracts -- to discover the truth about the Company's financial situation. Defendants cannot seek shelter within the PSLRA's safe harbor to escape liability for deceiving and defrauding the investing public.(22) CONCLUSION For all of the foregoing reasons, the Court should deny defendants' motion in all respects. DATED: November 5, 1999 Respectfully submitted, By: -------------------------------- ROGER B. GREENBERG Attorney-in-Charge State Bar No. 08390000 12 Greenway Plaza, 10th Fl. Houston, TX 77046 (713) 627-2720 (713) 627-7057 Fax LEAD COUNSEL FOR PLAINTIFFS OF COUNSEL: GREENBERG, PEDEN, SIEGMYER & OSHMAN, P.C. David E. Sharp Tenth Floor, 12 Greenway Plaza Houston, TX 77046 (713) 627-2720 (713) 627-7057 Fax - --------------- (22)Plaintiffs have also stated claims against the Individual Defendants as "control persons" of SCI pursuant to Sections 20(a) and 15. See,. e.g., P.'s 166-173. Defendants do not contest the Individual Defendants' "control" status, relying instead entirely on their mistaken assertion that the Complaint does not state claims for primary liability. Def. Mem. at 4, n.4. - 40 - 48 WOLF POPPER LLP BERGER & MONTAGUE, PC Robert M. Kornreich Todd S. Collins Paul O. Paradis Michael L. Block Peter Safirstein 1622 Locust Street Catherine E. Anderson Philadelphia, PA 19103 845 Third Avenue New York, NY 10022 BOIES & SCHILLER, LLP Richard Drubel BERMAN, DEVALERIO & PEASE LLP 26 South Main Street Glen DeValerio Hanover, New Hampshire 03755 Michael T. Matraia One Liberty Square BRUCE G. MURPHY Boston, MA 02109 265 Llywyd's Lane Veto Beach, Florida 32963 BERNSTEIN LITOWITZ BERGER & GROSSMANN, LLP CHANDLER LAW OFFICES Douglas M. McKeige George Chandler 1285 Avenue of the Americas P.O. Box 3400 33rd Floor Lufkin, TX 75901 New York, NY 10019 CLAXTON & HILL, PLLC LAW OFFICES OF STEVEN E. CAULEY, PA Roger F. Claxton Steven E. Cauley Robert J. Hill Suite 218, Cypress Plaza 3131 McKinney Avenue - LB 103 Little Rock, AK 72212 700 McKinney Place Dallas, Texas 75204-2471 COHEN, MILSTEIN, HAUSFELD & TOLL, PLLC Steven J. Toll CONSTANT & VELA 999 Third Avenue, Suite 3600 Anthony Constant Seatlle, WA 98104 802 North Caranachua Suite 1570 MILBERG WEISS BERSHAD Corpus Christi, TX 78401 HYNES & LERACH LLP Abraham Rappaport CRUSE, SCOTT, HENDERSON & ALLEN, LLP Maya Saxena Sam W. Cruse 5355 Town Center Road 600 Travis Street, Suite 3900 Suite 900 Houston, TX 77002-2910 Boca Raton, FL 33486 FARUQI & FARUQI ABBEY, GARDY & SQUITIERI LLP Nadeem Farqui Mark S. Gardy 415 Madison Avenue 212 East 39th Street New York, NY 10017 New York, NY 10016 BARRACK, RODOS & BACINE 2001 Market Street, 33rd Floor Philadephia, PA 19103
- 41 - 49 FINKELSTEIN & KRINSK LAW OFFICES OF DENNIS J. JOHNSON Howard D. Finkelstein Dennis J. Johnson Jeffrey R. Krinsk 1690 Williston Road 501 West Broadway, Suite 1250 South Burlington, VT 05403 San Diego, CA 92101-3579 LOCKRIDGE, GRINDAL, NAUEN & HOSTEIN, FRANK & ROSEN PLLP Alan L. Frank Richard A. Lockridge David T. Shulick Karen M. Hanson 1835 Market Street, Suite 320 100 Washington Avenue South, Suite 2200 Philadelphia, PA 19103 Minneapolis, MN 55401 HOEFFNER, BILEK & EIDMAN LOWEY DANNENBERG BEMPORAD Thomas E. Bilek & SELINGER PC 720 Lyric Office Center Richard Bemporad 440 Louisiana, Suite 720 David C. Harrison Houston, TX 77002 The Gateway - 11th Floor One North Lexington Avenue JAROSLAWICZ & JAROS White Plains, NY 10601-1714 David Jaroslawicz 150 William Street LYNN STODGHILL MELCHIMER New York, NY 10038 AND TILLOTSON, LLP Thomas M. McIsheimer KAPLAN, KILSHEIMER & FOX LLP M. Brett Johnson Robert N. Kaplan 750 N. Pearl Street, Suite 1400 Peter A. Lennon Dallas, TX 75201 Janine R. Azriliant 685 Third Avenue, 26th Floor RABIN & PECKEL LLP New York, NY 10017 Marvin L. Frank Joseph V. McBride KENNETH A. ELAN 275 Madison Avenue, 34th Floor 217 Broadway, Suite 404 New York, NY 10016 New York, NY 10007 SCHIFFRIN & BARROWAY, LLP KIRBY MCINERNEY & SQUIRE Andrew L. Barroway Jeffrey H. Squire David Kessler Ira M. Press Three Bala Plaza East, Suite 400 830 Third Avenue, 10th Floor Bala Cynwyd, Penn. 19004 New York, NY 10022 SCOTT & SCOTT LAW OFFICES OF CLAYTON E. DARK, JR. Neil Rothstein Clayton E. Dark, Jr. 108 Norwich Avenue P.O. Box 2207 P.O. Box 192 Lufkin, TX 75902-2207 Cochester, CT 06415
- 42 - 50 SCOTT, DOUGLASS & MCCONNICO, LLP Stephen E. McConnico 600 Congress Avenue, 15th Floor Austin, TX 78701-2334 SPECTOR & ROSEMAN, PC Eugene A. Spector Jeffrey L. Kodroff 1818 Market Street, Suite 2500 Philadelphia, PA 19103 STULL STULL & BRODY Jules Brody Aaron Brody 6 East 45th Street New York, NY 10017 SUSMAN GODFREY LLP Kenneth S. Marks 5100 First Interstate Bank Plaza 1000 Louisiana Houston, TX 77002-5096 THE OLSEN LAW FIRM Kurt Olsen 2121 K. Street, N.W. Suite 800 Washington, D.C. 20037 WEISS & YOURMAN Joseph H. Weiss 551 Fifth Avenue, Suite 1600 New York, NY 10176 WHITTINGTON, VONSTERNBERG, EMERSON & WILSHER, LLP John G. Emerson, Jr. 2600 South Gessner, Suite 600 Houston, TX 77063 WOLF, HALDENSTEIN, ADLER, FREEMAN & HERZ, LLP Fred T. Isquith Robert Abrams 270 Madison Avenue New York, NY 10016 - 43 - 51 CERTIFICATE OF SERVICE I do hereby certify that on this the 5th day of November 1999, a true and correct copy of the Opposition has been duly and properly serviced upon counsel of record in accordance with the Federal Rules of Civil Procedure. ----------------------------------------- David E. Sharp - 44 - EX-99.5 9 PLAINTIFF'S ORIGINAL PETITION FILED 1 EXHIBIT 99.5 NO. _______________ JAMES P. HUNTER, III and ) IN THE DISTRICT COURT JAMES P. HUNTER, III FAMILY TRUST, ) ) Plaintiffs, ) ) vs. ) ) ) SERVICE CORPORATION INTERNATIONAL, ) ANGELINA COUNTY, TEXAS ROBERT L. WALTRIP, ) L. WILLIAM HEILIGBRODT, ) GEORGE R. CHAMPAGNE, ) W. BLAIR WALTRIP, ) JAMES M. SHELGER, ) WESLEY T. MCRAE and ) PRICEWATERHOUSECOOPERS, L.L.P. ) ) ________ JUDICIAL DISTRICT Defendants. ) PLAINTIFF'S ORIGINAL PETITION TO THE HONORABLE JUDGE OF SAID COURT: Plaintiffs James P. Hunter, III and James P. Hunter, III Family Trust complain of defendants Service Corporation International, Robert L. Waltrip, L. William Heiligbrodt, George R. Champagne, W. Blair Waltrip, James M. Shelger, Wesley T. McRae and PricewaterhouseCoopers, L.L.P. and for cause would show the following: I. NATURE OF ACTION 1. Plaintiffs (collectively Hunter), sues for fraud and misrepresentation under state statutory and common law. Hunter gave up shares and stock options in Equity Corporation International (Equity) and acquired the shares of Service Corporation International (SCI) in the stock-for-stock merger of Equity into SCI (the Merger) on January 19, 1999. Jim Hunter also surrendered his positions as Chairman, CEO, and President of Equity and accepted instead a position 2 as an employee and officer of SCI. As the top executive officer of Equity and its chairman, as well as one of Equity's largest shareholders, Jim Hunter's consent to the Merger was essential to its consummation. To persuade Jim Hunter to consent to the Merger and to accept employment by SCI, SCI and the other defendants hid knowledge they had and were under a duty to disclose concerning SCI's poor financial performance in the quarter ending December 31, 1998. In so doing, defendants misrepresented and concealed material information that, had it been disclosed, would have resulted in termination of the transaction. II. JURISDICTION AND VENUE 2. The claims asserted herein arise under the Texas Securities Act, Tex. Rev. Civ. Stat art. 581-33, Tex. Bus. & Comm. Code Section 27.01, common law fraud, negligent misrepresentation, and conspiracy. 3. This Court has jurisdiction pursuant to Tex. Gov. Code Sections 24.007 and 24.008. 4. Venue is proper in this Court pursuant to Tex. Civ. Prac. & Rem. Code Section 15.002. III. PARTIES 5. Plaintiff Jim Hunter is a resident of Lufkin, Texas. Jim Hunter was the Chairman of the Board, President, and Chief Executive Officer of Equity from the time of its spin-off in 1990 from SCI until the Merger. Jim Hunter built Equity into the fourth largest publicly-traded provider of deathcare services and products in the United States, and increased annual revenues from $18 million in 1990 to an estimated $206 million in 1998. 6. Defendant SCI is a corporation organized under the laws of the State of Texas with its principal executive offices located at 1929 Allen Parkway, Houston, Texas. J. Clifford Gunter, -2- 3 III, of the law firm of Bracewell & Patterson, L.L.P., 711 Louisiana Street, Suite 2900, Houston, Texas 77002 has been authorized by defendant SCI to accept service of this Plaintiffs' Original Petition. A copy of Plaintiffs' Original Petition has been delivered to him. 7. Defendant Robert L. Waltrip (Waltrip) is the Chief Executive Officer and Chairman of the Board of SCI. Waltrip resides in Houston, Texas. J. Clifford Gunter, III, of the law firm of Bracewell & Patterson, L.L.P., 711 Louisiana Street, Suite 2900, Houston, Texas 77002 has been authorized by defendant Waltrip to accept service of this Plaintiffs' Original Petition. A copy of Plaintiffs' Original Petition has been delivered to him. 8. L. William Heiligbrodt (Heiligbrodt) was the President and Chief Operating Officer of SCI from before the time he contacted Hunter on July 22, 1998, to ask Hunter to consider the Merger, until February 11, 1999. J. Clifford Gunter, III, of the law firm of Bracewell & Patterson, L.L.P., 711 Louisiana Street, Suite 2900, Houston, Texas 77002 has been authorized by defendant Heiligbrodt to accept service of this Plaintiffs' Original Petition. A copy of Plaintiffs' Original Petition has been delivered to him. 9. George R. Champagne (Champagne) has been the Executive Vice President and Chief Financial Officer of SCI since before July 22, 1998. J. Clifford Gunter, III, of the law firm of Bracewell & Patterson, L.L.P., 711 Louisiana Street, Suite 2900, Houston, Texas 77002 has been authorized by defendant Champagne to accept service of this Plaintiffs' Original Petition. A copy of Plaintiffs' Original Petition has been delivered to him. 10. W. Blair Waltrip (Blair Waltrip) is the son of R. L. Waltrip and has been an Executive Vice President of SCI since before July 22, 1998. J. Clifford Gunter, III, of the law firm of Bracewell & Patterson, L.L.P., 711 Louisiana Street, Suite 2900, Houston, Texas 77002 has been authorized by defendant Blair Waltrip to accept service of this Plaintiffs' Original Petition. A copy -3- 4 of Plaintiffs' Original Petition has been delivered to him. 11. James M. Shelger (Shelger) is the Senior Vice President, Secretary and General Counsel of SCI and has held such position since before July 22, 1998. J. Clifford Gunter, III, of the law firm of Bracewell & Patterson, L.L.P., 711 Louisiana Street, Suite 2900, Houston, Texas 77002 has been authorized by defendant Shelger to accept service of this Plaintiffs' Original Petition. A copy of Plaintiffs' Original Petition has been delivered to him. 12. Defendant Wesley T. McRae (McRae) was the Controller of SCI during 1998. J. Clifford Gunter, III, of the law firm of Bracewell & Patterson, L.L.P., 711 Louisiana Street, Suite 2900, Houston, Texas 77002 has been authorized by defendant McRae to accept service of this Plaintiffs' Original Petition. A copy of Plaintiffs' Original Petition has been delivered to him. 13. Defendants Waltrip, Heiligbrodt, Champagne, Blair Waltrip, Shelger, and McRae (the Individual Defendants), as senior officers or directors of SCI, were controlling persons of the Company. Each exercised his power and influence to cause SCI to engage in the fraudulent acts and practices complained of herein. 14. Defendant Pricewaterhouse Coopers, L.L.P. (Pricewaterhouse) is a national accounting firm with offices throughout the United States, including two in Houston, Texas, one at 1201 Louisiana, Suite 2900, Houston, Texas 77002-5678 and another at 1100 Louisiana, Suite 4100, Houston, Texas 77002-9980. Pricewaterhouse may be served with process at either of the above locations. IV. FACTS NEGOTIATION AND CLOSING OF THE MERGER AGREEMENT 15. On July 22, 1998, defendants Heiligbrodt and Waltrip contacted Jim Hunter to ask -4- 5 him whether Equity would be interested in being acquired by SCI. 16. Jim Hunter thought that SCI was an attractive merger prospect for Equity in the summer of 1998. On April 23, 1998, SCI had announced record revenues and earnings, increased margins, and "increased investment returns associated with the larger asset base from cemetery merchandise and endowment care trust funds." On July 23, 1998, SCI had reported record revenues and earnings for the second quarter of 1998. The Company had fueled its growth primarily through acquisitions such as Equity and had apparently been quite successful in integrating and managing its acquisitions. Accordingly, when defendants Heiligbrodt and Waltrip contacted Jim Hunter on July 22, 1998, Jim Hunter decided to consider a merger with SCI. 17. On July 27, 1998, Heiligbrodt met with Jim Hunter. Heiligbrodt told Jim Hunter that SCI was a strong company with a bright future and that SCI expected no significant problems despite unfavorable business trends in the industry. Heiligbrodt also told Jim Hunter the Merger was in the best interests of the Equity shareholders because they would gain the liquidity, stability, and growth associated with ownership of SCI's stock. At the meeting, Heiligbrodt delivered a letter signed by defendant Waltrip reiterating Heiligbrodt's statements about the benefits of merging with SCI and urging Jim Hunter to enter into formal merger negotiations. 18. Following the July 27, 1998 meeting, Equity formally retained ABN AMRO as its financial advisor. SCI hired J.P. Morgan & Co. (Morgan). Negotiations for the Merger began in earnest. 19. SCI and Equity executed a merger agreement (the Merger Agreement) on August 6, 1998. 20. In connection with the Merger, Jim Hunter agreed to an employment agreement with SCI and its subsidiary to serve as SCI's Executive Vice President for at least three years. The -5- 6 employment agreement provided for a salary, discretionary bonuses, and other compensation to Jim Hunter. 21. In the Merger Agreement, SCI represented that at the closing date of the Merger, there had been no development that could reasonably be anticipated to be adverse to SCI's business or financial condition (sections 4.7 and 10.10(g)), and promised that SCI would promptly notify Equity if it learned of any such development (section 7.9). Equity had the right to terminate the Merger Agreement in the event of any such development (sections 8.2(a) and 9.1(a)(i)). Hunter relied on SCI's representations and promises, and understood that SCI had a duty to disclose any such adverse development to Equity, and therefore to Jim Hunter, Equity's CEO. 22. The Merger Agreement was incorporated by reference in and attached to a November 20, 1998 Prospectus and Proxy Statement (the Prospectus) that was transmitted to Hunter. The Prospectus explicitly stated that shareholders should rely on the information contained in and incorporated by reference in the Prospectus. 23. In December 1998, the Merger Agreement was amended to lower the exchange ratio for the Merger, reflecting the rising price of SCI stock. On December 12, 1998, SCI amended the Prospectus to disclose the lower exchange ratio. In accordance with the renegotiated exchange ratio, Hunter received when the Merger closed 0.71053 shares of SCI stock for each of his shares of Equity stock, and exchanged his Equity stock options for SCI stock options on the same exchange ratio. 24. The merger closed on January 19, 1999. Through January 19, 1999, SCI did not disclose to Equity or Hunter any development that could reasonably be anticipated to be adverse to SCI's business or financial condition. Hunter reasonably believed that there had been no such adverse development up to and including January 19, 1999, because he knew that SCI was required to disclose any such development to Equity, and SCI had not done so. -6- 7 SCI DISCLOSES ITS POOR RESULTS 25. Within seven days of the Merger, however, SCI publicly announced on January 26, 1999 that it had substantially missed both its fourth quarter and its annual earnings estimates. 26. SCI's failure to meet its earnings estimates was material information to Hunter. If Hunter had known that SCI anticipated missing or had missed its earnings estimates before the Merger closed on January 19, 1999, Jim Hunter would have caused Equity to terminate the Merger Agreement. SCI's failure to meet its earnings estimates was a development that could reasonably be anticipated to be adverse to SCI's business or financial condition and SCI did in fact anticipate that it would be adverse to SCI's business and financial condition. SCI knew that the earnings information would come as a tremendous shock to the investment community and would cause an immediate and drastic drop in the price of SCI's shares. HUNTER DISCOVERS THE FRAUD AND IS TOLD TO RESIGN 27. After SCI publicly announced its failure to meet its earnings estimates on January 26, 1999, SCI's CFO, defendant George Champagne, acknowledged to Jim Hunter that SCI had known before the Merger closed that SCI would substantially miss its earnings estimates. 28. In addition, after the January 26, 1999 announcement, an employee of Pricewaterhouse told Jim Hunter that Pricewaterhouse knew before the Merger closed that SCI would substantially miss its earnings estimates, and that this information was memorialized in a memorandum that had been sent to SCI. 29. In late February or early March, 1999, Jim Hunter was asked to attend a meeting in which counsel for SCI asked for Jim Hunter's reaction to the statement that "our investigation has shown that senior management of SCI had no knowledge of the impending earnings shortfall." Jim Hunter responded that the statement was ludicrous. -7- 8 30. Two days later, defendant Waltrip advised Jim Hunter that there was no longer any place for him in the SCI organization. Accordingly, Jim Hunter resigned as an officer of SCI and entered into an amendment of his employment agreement with SCI. Pursuant to the amendment, the term of the employment agreement was limited, Jim Hunter's duties were restricted, and Jim Hunter's eligibility to earn bonus payments was constrained. CAUSES OF ACTION COUNT I TEXAS SECURITIES ACT, ART. 581-33 31. Plaintiffs repeat and reallege each allegation contained above. 32. Plaintiffs bring this Count under the Texas Securities Act, Art. 581-33A, B, and C, against all defendants. 33. SCI offered to buy from Hunter their Equity shares, and to sell to Hunter SCI shares, by means of an untrue statement of a material fact, and by an omission to state a state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading. 34. SCI was the issuer for the SCI shares sold to Hunter via the Merger. SCI disseminated a prospectus for the Merger exchange shares registered under 15 U.S.C. Section 77f. The prospectus contained an untrue statement of material fact, and omissions of material fact necessary in order to make the statements made, in light of the circumstances under which they are made, not misleading. 35. Plaintiffs had no knowledge of the misrepresentations or omissions at the time of the Merger when they sold their Equity shares and purchased SCI shares. 36. Each of the defendants had knowledge of the misrepresentations and omissions or in -8- 9 the exercise of reasonable care would have known of the untruths or omissions. 37. Each of the Individual Defendants was a control person of SCI for purposes of art. 581-33 F and so is liable jointly and severally with SCI for SCI's violations of art. 581-33 A, B and C. 38. Pricewaterhouse materially aided SCI, for purposes of art. 581-33 F, in violating art. 581-33 A, B and C. Pricewaterhouse acted directly or indirectly with the intent to deceive Hunter or acted with reckless disregard for the truth or for the law. Accordingly, Pricewaterhouse is liable jointly and severally with SCI for SCI's violations of art. 581-33 A, B and C. 39. Pursuant to art. 581-33 D, Hunter hereby tenders their SCI shares and options and seeks recovery of the value of the Equity shares and options they surrendered upon the Merger, which were worth several millions of dollars, with any offsets as provided under the statute. 40. Hunter also seeks costs and reasonable attorney's fees. COUNT II TEXAS BUSINESS & COMMERCE CODE SECTION 27.01 41. Plaintiffs repeat and reallege each allegation contained above. 42. Plaintiffs bring this Count for fraud in a transaction involving stock in a corporation under Tex. Bus. & Comm. Code Section 27.01 against all defendants. 43. SCI and the Individual Defendants misrepresented that there had been no development that could reasonably be anticipated to be adverse to SCI's business or financial condition through the date the Merger was consummated. 44. SCI and the Individual Defendants made the material misrepresentations with the intent to induce Jim Hunter to refrain from terminating the Merger Agreement and to cause Equity to consummate the Merger after shareholder approval. -9- 10 45. Hunter relied on the material misrepresentations. 46. Hunter had no knowledge of the falsity of SCI's material misrepresentations. 47. As persons who made material false representations to Hunter in violation of Section 27.01(a), SCI and the Individual Defendants are liable to Hunter for actual damages under Section 27.01(b). Hunter's actual damages are in the millions of dollars, and include their loss on the value of their Equity stock and options as well as Jim Hunter's diminished compensation as an employee of SCI. 48. Because SCI and the Individual Defendants had actual awareness of the falsity of their material misrepresentations, they are liable to Hunter for exemplary damages under Section 27.01(c). 49. Pricewaterhouse had actual awareness of the falsity of SCI's and the Individual Defendants' material misrepresentations, but failed to disclose same to Equity and Hunter. Pricewaterhouse benefitted from the fraud in that it retained SCI's audit business. Accordingly, Pricewaterhouse is liable to Hunter for actual and exemplary damages under Section 27.01(d). 50. All the defendants are liable to Hunter under Section 27.01(e) for reasonable and necessary attorney's fees, expert witness fees, costs for copies of depositions, and costs of court. COUNT III COMMON LAW FRAUD 51. Plaintiffs repeat and reallege each allegation contained above. 52. Plaintiffs allege this Count against SCI and the Individual Defendants. 53. SCI and the Individual Defendants made the material misrepresentations described above. In addition, SCI and the Individual Defendants had a duty to disclose the information concerning SCI's poor results, but failed to do so. As soon as SCI learned of the possibility that it would miss its earnings target, SCI had a duty to inform Equity, and therefore Hunter, and the failure -10- 11 to do so constituted a material omission and a continuing misrepresentation that it had not suffered any adverse development. 54. SCI and the Individual Defendants knew that the misrepresentations were false when made or made such material misrepresentations recklessly and without any knowledge of their truth, and knew that the omissions failed to correct prior representations that were false. 55. SCI and the Individual Defendants intended that Hunter rely on the material misrepresentations. 56. Hunter did rely on SCI's and the Individual Defendants' material misrepresentations. 57. As result of the defendants' fraud, Hunter suffered injury. Hunter's actual damages are in the millions of dollars, and include their loss on the value of their Equity stock and options as well as Jim Hunter's diminished compensation as an employee of SCI. The defendants are liable to Hunter for actual damages. 58. Defendants wilfully and intentionally defrauded Hunter and so are liable to them for exemplary damages. COUNT IV NEGLIGENT MISREPRESENTATION 59. Plaintiffs repeat and reallege each allegation contained above. 60. Plaintiffs bring this Count against SCI and the Individual Defendants. 61. SCI and the Individual Defendants provided false information to Hunter in the course of their business or in a transaction in which they had a pecuniary interest. 62. SCI and the Individual Defendants provided the false information for the guidance of Hunter in Hunter's business. 63. SCI and the Individual Defendants did not exercise reasonable care or competence -11- 12 in obtaining or communicating the information to Hunter. 64. As a result of SCI's and the Individual Defendant's negligent misrepresentations, Hunter suffered damages. Hunter's actual damages are in the millions of dollars, and include their loss on the value of their Equity stock and options as well as Jim Hunter's diminished compensation as an employee of SCI. COUNT V CONSPIRACY 65. Plaintiffs repeat and reallege each allegation contained above. 66. SCI and Pricewaterhouse conspired to hide SCI's true value for the purpose of inducing Jim Hunter to effect the Merger. In furtherance of such purpose, SCI and Pricewaterhouse agreed to commit and did commit the violations of common law and statutory law described above. Hunter suffered damages in the millions of dollars as a result of SCI's and Pricewaterhouse's unlawful acts. WHEREFORE, plaintiffs pray for relief and judgment, as follows: o Compensatory damages against all defendants, jointly and severally; o Exemplary damages against all defendants; o Interest on damages in accordance with law; o Plaintiff's reasonable attorney's fees; o Costs of court; o Expert witness fees; o Costs of copies of depositions; and o Such other and further relief as the Court may deem just and proper. -12- 13 JURY TRIAL DEMANDED Plaintiffs hereby demand a trial by jury. DATED: 11-10-99 Respectfully submitted, ------------------ SUSMAN GODFREY L.L.P. By: /s/ MARK L.D. WAWRO --------------------------------- Mark L.D. Wawro State Bar No. 20988275 1000 Louisiana Street, Suite 5100 Houston, Texas 77002 Telephone: (713) 651-9366 Fax: (713) 654-6666 Martha A. Evans State Bar No. 06723870 SUSMAN GODFREY L.L.P. 2323 Bryan Street, Suite 1400 Dallas, Texas 75201 Telephone: (214) 754-1900 Fax: (214) 754-1933 Attorneys for Plaintiffs -----END PRIVACY-ENHANCED MESSAGE-----