Richard E. Simpson RS5859
Paul R. Berger
Gregory G. Faragasso
Dean M. Conway
Attorneys for Plaintiff
SECURITIES AND EXCHANGE COMMISSION
450 Fifth Street, N.W.
Washington, D.C. 20549-0911
(202) 942-4791 (Simpson)
(202) 942-9581 (Fax)

UNITED STATES DISTRICT COURT
DISTRICT OF NEW JERSEY

COMPLAINT FOR INJUNCTIVE RELIEF,
DISGORGEMENT AND PENALTIES, FOR VIOLATIONS
OF THE FEDERAL SECURITIES LAWS

Plaintiff Securities and Exchange Commission (the "Commission") alleges as follows against the above-named defendants:

ADDRESSES OF THE PARTIES

1. The address of plaintiff Securities and Exchange Commission is 450 Fifth Street, N.W., Washington, D.C. The address of defendant Ed Johnson is 290 Rileyville Road, Hopewell, New Jersey 08525. The address of defendant MERL Holdings, Inc.com is 290 Rileyville Road, Hopewell, New Jersey 08525.

SUMMARY OF ALLEGATIONS

2. This is a financial fraud case. Ed Johnson, the President, Chairman and Chief Executive Officer of MERL Holdings, Inc.com, engaged in a scheme to inflate MERL's assets and financial results in the company's registration statements on Form SB-2 and Form 10-SB, which were filed with the Commission and disseminated to the public. Johnson's purpose in falsifying MERL's registration statements was to induce investors to buy the company's stock in a public offering. He omitted material information from the registration statements and included MERL's false and misleading financial statements from 1997 and 1998, thereby misrepresenting MERL's financial position and future prospects.
    
3. The falsification of MERL's registration statements was multi-faceted. First, in its 1997 and 1998 financial statements, which it incorporated into its registration statements, MERL improperly consolidated Essex Industries, Inc. MERL acquired Essex in 1996, but shortly thereafter significant legal disputes arose with the seller. These culminated in a Virginia state court's enjoining Johnson and MERL from interfering with Essex's business operations. Notwithstanding this injunction, Johnson consolidated Essex in MERL's financial statements and did not inform the company's auditors of pertinent facts about the injunction. The consolidation of Essex's results in MERL's financial and registration statements violated Generally Accepted Accounting Principles ("GAAP").
    
4. Second, in the 1998 financial statement, MERL materially inflated the value of assets it acquired from Hanold School Stores, Inc. in exchange for shares of MERL's preferred stock. Even though the fair market value of the exchanged stock was not verified, MERL used the $6,962,000 aggregate par value assigned to it to value the Hanold assets. The company's treatment of the Hanold assets violated GAAP.
    
5. Third, Johnson painted a falsely optimistic picture of MERL in the Management's Discussion And Analysis ("MD&A") section of the registration statements. Instead of disclosing a looming liquidity crisis, a rapidly shrinking customer base and severe legal problems, Johnson crafted the MD&A to mask these negative developments and leave the reader with the false impression that MERL was thriving.
    
6. By engaging in the acts alleged herein, the defendants, directly and indirectly, have engaged in, and unless restrained and enjoined by the Court will continue to engage in, transactions, acts, practices and courses of business that violate Section 17(a) of the Securities Act of 1933 [15 U.S.C. § 77q(a)], Section 10(b) of the Securities Exchange Act of 1934 [15 U.S.C. § 78j(b)] and SEC Rule 10b-5 [17 C.F.R. § 240.10b-5].
    
7. The Commission seeks a judgment from the Court: (a) enjoining Johnson and MERL from engaging in future violations of the above sections of the federal securities laws; (b) requiring Johnson to account for and disgorge, with prejudgment interest, the illegal profits he obtained and the losses he illegally avoided as a result of selling MERL securities while in possession of material nonpublic information about MERL's true financial condition and the accounting irregularities described below; (c) requiring Johnson to pay an insider trading penalty of three times his illegal profits or losses avoided pursuant to Section 21A(a) of the Securities Exchange Act of 1934 [15 U.S.C. § 78u-1(a)]; (d) requiring Johnson to pay a civil money penalty pursuant to Section 20(d) of the Securities Act of 1933 and Section 21(d)(3) of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77t(d), 78u(d)(3)]; (e) barring Johnson from serving as an officer or director of any public company pursuant to Section 20(e) of the Securities Act of 1933 and Section 21(d)(2) of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77t(e), 78u(d)(2)]; and (f) barring Johnson from participating in the offering of any penny stock pursuant to Section 20(g) of the Securities Act of 1933, Section 21(d)(6) of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77t(g), 78u(d)(6)], and the Court's equitable powers.

JURISDICTION AND VENUE

8. The Court has jurisdiction of this civil enforcement action pursuant to Section 22(a) of the Securities Act of 1933 and Section 21(d) and (e) and Section 27 of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77v(a), 78u(d) & (e), 78aa].
    
9. The defendants made use of the means and instrumentalities of interstate commerce or of the mails in connection with the acts, practices, and courses of business alleged herein, certain of which occurred in the District of New Jersey.
    
10. Venue is proper in this District pursuant to Section 22(a) of the Securities Act of 1933 and Section 27 of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77v(a), 78aa].

THE PARTIES

11. The plaintiff is the Securities and Exchange Commission, which brings this action pursuant to the authority conferred on it by Section 20(b) of the Securities Act of 1933 and Section 21(d) and (e) of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77t(b), 78u(d) & (e)].
     
12. Defendant Ed Johnson, age 53 [dob 7/31/49], is a resident of Hopewell, New Jersey. He is the President, Chairman and Chief Executive Officer of MERL Holdings, Inc.com.
     
13. Defendant MERL Holdings, Inc.com is a corporation with its principal place of business in Hopewell, New Jersey. In its two filings with the Commission, MERL reported that it operated in six business segments: financial services, insurance, retailing of uniforms and books for private schools, manufacturing of uniforms for private schools, lumber production, and information technology consultation. On February 10, 2000, the company was delisted from the Over-The-Counter bulletin board market supervised by the NASD. MERL's common stock is not registered with the Commission.

FACTS

14. The financial condition of MERL Holdings, Inc.com was bleak because of onerous debt and a complete lack of revenue. Ed Johnson needed working capital so that he could rescue his near-bankrupt company and preserve his substantial personal equity stake. Johnson decided to raise money in the public capital markets and began the process by hiring the auditing firm of Mitchell & Titus, LLP to audit MERL's 1997 and 1998 financial statements, which were to be included in a registration statement to be filed with the Commission.
     
15. On January 4, 2000, MERL filed a registration statement on Form SB-2. Small business issuers use the Form SB-2 to register securities to be sold for cash. A short time after MERL's filing, the Commission's Division of Corporation Finance notified MERL that the Form SB-2 contained serious deficiencies. On May 31, 2000, the company filed a registration statement on Form 10-SB, which is the general form of registration for securities pursuant to Section 12(b) or (g) of the Securities Exchange Act of 1934 for small business issuers. On their filing dates, the registration statements became available to public investors on the Commission's EDGAR system. Johnson signed the registration statements, and both of them contained the 1997 and 1998 financial statements, including the misrepresentations described below. On July 18, 2000, MERL withdrew the Form SB-2 and 10-SB registration statements.

I. THE DEFENDANTS IMPROPERLY CONSOLIDATED ESSEX INDUSTRIES.

16. Essex Industries, Inc. was MERL's only bona fide operating entity, producing all of the revenue reflected in the 1997 and 1998 consolidated income statements. As described below, MERL should not have consolidated Essex because it did not have the requisite control over that company. In the MD&A section of the registration statements, Johnson did not explain to potential investors the problems with Essex and he falsely led them to believe it was a MERL entity.
     
17. On May 31, 1996, MERL acquired 100 percent of Essex's common stock from its owner, Charles E. Weeden, Sr., in exchange for 125,000 shares of MERL common stock. A short time later, significant disputes arose between the parties, and Weeden filed suit in Virginia state court to rescind the transaction. On December 17, 1996, the court enjoined MERL and Johnson from exerting any control over Essex. The injunction prohibited MERL and Johnson from entering into or terminating any agreements on behalf of Essex, transferring any funds out of Essex, altering the existing officers or directors, making personnel changes at Essex, transacting any business in the name of Essex, or pledging or in any way encumbering any of Essex's stock or assets.
     
18. In an effort to effect a settlement, the Virginia court dissolved the injunction in June 1998. On July 24, 1998, Weeden, MERL and Johnson entered into a settlement agreement, pursuant to which MERL gave Weeden a $750,000 promissory note in exchange for the transfer of his 125,000 shares of MERL stock to MERL Financial Group, Inc., a separate company owned by Johnson and his wife. MERL placed the Essex stock it had originally received into escrow in order to secure payment on the promissory note and pursuant to a security agreement between the parties.
     
19. MERL did not make the very first payment on the promissory note, and Weeden refused to transfer his MERL stock to MERL Financial. In January 2000, the escrow agent found MERL and Johnson in default of the settlement agreement and released the escrowed Essex stock to Weeden's attorney. MERL was in default at the time Mitchell & Titus issued its audit opinion on the consolidated financial statements, and Weeden had regained unequivocal control of Essex by the time MERL filed its registration statement on Form 10-SB on May 31, 2000.
     
20. During the period in which the injunction was in effect (December 1996 through June 1998), the parties were returned to the pre-sale status quo, and MERL did not have the control of Essex required to consolidate the company in its financial statements. MERL was under court order not to interfere with Essex's financial, business or operating decisions. Because of the injunction, it was improper for MERL to present consolidated financial statements.
     
21. After execution of the settlement agreement (July 1998 through January 2000), control of Essex by Johnson and MERL was still very much in doubt. The settlement agreement, promissory note and security agreement contained numerous restrictive covenants which limited MERL's ability to make operational decisions for Essex. These covenants served as "substantive participating rights" for Weeden, as defined in the relevant accounting principles. They nullified MERL's control and precluded the consolidation of Essex.
     
22. In sum, it was improper to consolidate Essex and include its operating results and net assets for the 1997 and 1998 fiscal years. The consolidation caused MERL's revenues in 1997 and 1998 to be overstated by 100 percent. MERL's financial statements, which were included in the registration statements it filed with the Commission, were materially false and misleading.
     
23. Johnson knew about the problems with Essex. Nevertheless, he consolidated Essex's results in MERL's financial statements. His incentive for doing so was that Essex comprised the only revenue and majority of the net assets of the consolidated "business." Although MERL's first registration statement, the Form SB-2, vaguely alluded to a "question of ownership" concerning "the Essex Stock," the MD&A and litigation disclosures failed to mention that a blanket injunction had been in effect against Johnson and MERL during all of 1997 and the first six months of 1998.

II. THE DEFENDANTS OVERVALUED THE HANOLD ASSETS.

24. On December 30, 1998, MERL acquired the school uniform and bookstore businesses of Hanold Stores, Inc. MERL paid the purchase price using 696,200 shares of its $10.00 par value preferred stock. MERL purported to record this transaction on its books using the "purchase accounting" method, which is governed by Accounting Principles Board ("APB") Opinion No. 16. To comply with APB 16, the company was required to determine whether the preferred stock or the acquired assets had a reasonably determinable value. MERL then should have recorded the transaction at the more clearly evident value of the two.
     
25. MERL did neither. Instead, the company initially recorded the value of the Hanold businesses at $6,962,000, which was simply the aggregate par value of MERL's preferred stock. In contrast, Hanold had recorded the assets at only $1,634,516. MERL's accounting treatment was inconsistent with APB 16 because the company did not arrive at an objective determination of the fair value of the acquired assets. While Mitchell & Titus subsequently recommended a downward adjustment to $2,071,425, the decision to value the transaction at this amount was still arbitrary, and the Hanold assets were reported in MERL's financial statements at a materially inflated value.
     
26. Johnson's main objective in the acquisition was to obtain Hanold's customer list. However, he did not perform any due diligence or obtain any professional assistance in determining the value of the list for reporting purposes. Instead, he arbitrarily posited a value of $15.00 for each customer on the list. He recorded the list at a materially inflated value of $2,608,110, purportedly representing 173,874 customers who had made purchases from Hanold in the past.
     
27. Mitchell & Titus subsequently recommended a downward adjustment of the list to $1,575,944. However, this adjusted value was still arbitrary because it depended on baseless and untested assumptions that Johnson provided the auditors. The overvalued customer list caused MERL's 1998 balance sheet to be materially inflated, and the balance sheet was included in the company's registration statements.

III. THE DEFENDANTS MADE FALSE AND MISLEADING
STATEMENTS IN THE MANAGEMENT'S DISCUSSION
AND ANALYSIS SECTION OF THE PUBLIC FILINGS.

28. Johnson drafted the textual portions of MERL's registration statement on Form SB-2 with the partial help of two law firms. He generally reviewed the Form SB-2 and worked on the MD&A. The Commission's Division of Corporation Finance determined that the Form SB-2 was inadequate because, among other things, the auditors' report was not signed, the audit opinion was qualified, and the Hanold acquisition did not appear to be accounted for in accordance with APB 16.
     
29. In addition to these problems, the MD&A in the Form SB-2 mischaracterized MERL's financial position and future prospects. Item 303 of Regulation S-B states that the MD&A "should address the past and future financial condition and results of operation of the small business issuer, with particular emphasis on the prospects for the future." The MD&A's description of MERL's prospects for the future was deficient and misleading. Johnson also omitted material adverse information about the company's present and future operations.
     
30. The most egregious falsehood in the MD&A concerned MERL's liquidity position. The company had neither cash nor the ability to generate it. MERL could not meet its payroll commitments or pay vendors, including its attorneys and accountants, and was delinquent on its taxes in Texas, resulting in that State's seizure of certain of the company's property. After the Hanold acquisition, sales of the Hanold School Stores declined and eventually vanished altogether. Retailers who once sold Hanold's merchandise abandoned MERL because it did not pay their commissions.
     
31. MERL was in dire financial straits and was unable to satisfy its obligations as they became due. Johnson comprehended these problems. Nevertheless, in the MD&A section of the Form SB-2, he painted a prosperous picture of MERL and did not disclose any of its liquidity problems or negative sales trends. For example, the MD&A stated:
     
• "We believe that MERL School Stores will continue its current success." [MERL School Stores filed for bankruptcy protection within a few months.]
   
• "Many of these stores have been in operation for over ten years and have established a customer following, which management believes will continue under our ownership."
   
• "Management anticipates hiring additional employees to accommodate the growth in MERL School Stores' business."
   
• "At the time of acquisition, MERL School Stores marketed to over 200,000 students. The student sales with the FirstAccess Partners Card would increase liquidity . . . ."
   
32. The registration statement on Form 10-SB, which MERL filed on May 31, 2000, was nearly identical to the Form SB-2. Therefore, the MD&A in the Form 10-SB had the same errors and misstatements. However, in the Form 10-SB Johnson also mischaracterized his personal background in that MERL falsely stated that it believed, as a result of having conducted due diligence, that no officers or directors "have been involved in, any legal proceedings material to an evaluation of the ability or integrity of any director or officer." In reality, Johnson had been tried, convicted and imprisoned for a felony involving the misapplication of funds belonging to a savings and loan association in which he had been president. Johnson deceived potential investors by omitting this vital information about his criminal background and personal integrity.

IV. THE DEFENDANTS ISSUED FALSE PRESS RELEASES.

33. MERL had a practice of amplifying its accounting irregularities by issuing false press releases. MERL issued false press releases dated June 25 and July 13, 1998, by including the financial results of Essex as part of MERL's consolidated operations. On October 15, 1998, the company issued a release trumpeting a nonexistent relationship with BankOne. Shortly after the Hanold acquisition, MERL issued a release dated January 5, 1999 falsely claiming that MERL had "Increase[d] Net Worth by 482%." The company issued a series of releases dated August 19, September 2 and November 22, 1999, which falsely announced triple digit sales increases (attributable primarily to the operating results of the acquired Hanold assets and Essex).

V. JOHNSON ENGAGED IN INSIDER TRADING.

 
34. From October 16, 1998 through December 7, 1999, Johnson sold MERL stock while in possession of material nonpublic information about the company's true financial condition and the accounting irregularities described above. On October 16, 1998, Johnson sold 4,000 shares of MERL stock at $2.00 per share for proceeds of $7,634.73; on November 27 and 30, 1998, he sold 4,000 shares at $1.875 per share for proceeds of $7,124.74; on December 17, 23 and 31, 1998, he sold 8,000 shares at various prices for proceeds of $8,198.43; on January 5, 6 and 8, 1999, he sold 8,000 shares at various prices for proceeds of $5,877.90; on October 6 and 27, 1999, he sold 2,500 shares at various prices for proceeds of $2,949.88; on November 22, 23 and 24, 1999, he sold 6,000 shares at various prices for proceeds of $7,362.21; and on December 6 and 7, 1999, he sold 4,000 shares at various prices for proceeds of $5,343.55. In the aggregate, he sold 36,500 shares of MERL stock for proceeds of $44,491.44. The losses that Johnson illegally avoided by virtue of his sales were 100 percent of his proceeds because MERL stock was worthless.

FIRST CLAIM
 
The Defendants' Violations Of
Securities Act Section 17(a)

35. The Commission realleges and reincorporates paragraphs 1 through 34 above.
     
36. From 1997 through 2000, Ed Johnson and MERL Holdings, Inc.com, by use of the means or instruments of interstate commerce or of the mails, in connection with the offer or sale of securities: (a) employed devices, schemes, or artifices to defraud; (b) made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and/or (c) engaged in acts, practices or courses of business which operated or would operate as a fraud or deceit upon the offerees of MERL securities.
     
37. The defendants' scheme included, among others, the following fraudulent devices, fraudulent acts, untrue statements of material fact, and material omissions:
     
1. In MERL's registration statements on Form SB-2 and Form 10-SB, the defendants improperly consolidated Essex Industries, Inc., when they knew or were reckless in not knowing that MERL did not have control of Essex.
    
2. In MERL's registration statements on Form SB-2 and Form 10-SB, the defendants falsely represented that the net assets acquired from Hanold Stores, Inc. were worth $2,071,425, when they knew or were reckless in not knowing that such assets were worth significantly less than $2,071,425.
    
3. In MERL's registration statements on Form SB-2 and Form 10-SB, the defendants falsely represented that the customer list from Hanold was worth $1,575,944, when they knew or were reckless in not knowing that the list was worth significantly less than $1,575,944.
    
4. In the MD&A section of MERL's registration statements on Form SB-2 and Form 10-SB, the defendants falsely represented that the company's prospects for the future were good, when they knew or were reckless in not knowing that the company was experiencing significant liquidity problems and negative sales trends.
    
5. In the MD&A section of MERL's registration statement on Form 10-SB, the defendants falsely represented that MERL believed no existing officers or directors had been involved in any legal proceedings material to an evaluation of their ability or integrity, when they knew or were reckless in not knowing that Johnson had been tried, convicted and imprisoned for a felony involving the misapplication of funds belonging to a savings and loan association.
    
38. By reason of their actions alleged herein, Johnson and MERL each violated Section 17(a) of the Securities Act of 1933 [15 U.S.C. § 77q(a)].

SECOND CLAIM
 
The Defendants' Violations Of
Exchange Act Section 10(b)
And Rule 10b-5

39. The Commission realleges and reincorporates paragraphs 1 through 34 above.
     
40. From 1997 through 2000, Ed Johnson and MERL Holdings, Inc.com, by use of the means or instruments of interstate commerce or of the mails, in connection with the purchase or sale of securities: (a) employed devices, schemes, or artifices to defraud; (b) made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and/or (c) engaged in acts, practices or courses of business which operated or would operate as a fraud or deceit upon the purchasers of MERL securities.
     
41. The defendants' scheme included, among others, the following fraudulent devices, fraudulent acts, untrue statements of material fact, and material omissions: a. In MERL's registration statements on Form SB-2 and Form 10-SB, the defendants improperly consolidated Essex Industries, Inc., when they knew or were reckless in not knowing that MERL did not have control of Essex. b. In MERL's registration statements on Form SB-2 and Form 10-SB, the defendants falsely represented that the net assets acquired from Hanold Stores, Inc. were worth $2,071,425, when they knew or were reckless in not knowing that such assets were worth significantly less than $2,071,425. c. In MERL's registration statements on Form SB-2 and Form 10-SB, the defendants falsely represented that the customer list from Hanold was worth $1,575,944, when they knew or were reckless in not knowing that the list was worth significantly less than $1,575,944. d. In the MD&A section of MERL's registration statements on Form SB-2 and Form 10-SB, the defendants falsely represented that the company's prospects for the future were good, when they knew or were reckless in not knowing that the company was experiencing significant liquidity problems and negative sales trends. e. In the MD&A section of MERL's registration statement on Form 10-SB, the defendants falsely represented that MERL believed no existing officers or directors had been involved in any legal proceedings material to an evaluation of their ability or integrity, when they knew or were reckless in not knowing that Johnson had been tried, convicted and imprisoned for a felony involving the misapplication of funds belonging to a savings and loan association.
     
42. By reason of their actions alleged herein, Johnson and MERL each violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder [15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5].

PRAYER FOR RELIEF

WHEREFORE, the Commission respectfully requests that the Court:

I.

Enter judgment in favor of the Commission finding that defendants Ed Johnson and MERL Holdings, Inc.com each violated the securities laws and Rule promulgated thereunder as alleged herein;

II.

Permanently enjoin Ed Johnson from violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder [15 U.S.C. §§ 77q(a), 78j(b); 17 C.F.R. § 240.10b-5];

III.

Permanently enjoin MERL Holdings, Inc.com from violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder [15 U.S.C. §§ 77q(a), 78j(b); 17 C.F.R. § 240.10b-5];

IV.

Order Ed Johnson to account for and disgorge the $44,491.44 in illegal profits he obtained and losses he illegally avoided as a result of his sales of the stock of MERL Holdings, Inc.com while in possession of material nonpublic information about MERL's true financial condition and the accounting irregularities described above, and to pay prejudgment interest thereon;

V.

Order Ed Johnson to pay an insider trading penalty equal to three times his illegal profits or losses avoided pursuant to Section 21A(a) of the Securities Exchange Act of 1934 [15 U.S.C. § 78u-1(a)];

VI.

Order Ed Johnson to pay a civil monetary penalty pursuant to Section 20(d) of the Securities Act and Section 21(d)(3) of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77t(d), 78u(d)(3)];

VII.

Bar Ed Johnson from serving as an officer or director of any public company pursuant to Section 20(e) of the Securities Act of 1933 and Section 21(d)(2) of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77t(e), 78u(d)(2)];

VIII.

Bar Ed Johnson from participating in the offering of any penny stock pursuant to Section 20(g) of the Securities Act of 1933, Section 21(d)(6) of the Securities Exchange Act of 1934 [15 U.S.C. §§ 77t(g), 78u(d)(1)], and the Court's equitable powers; and

IX.

Grant such other relief as this Court may deem just and proper.