4 Amended Class Action Complaint For Violations Of Federal Securities Laws 03/23/2012

101 Pages·2012·4.6 MB·English

by  Reid Friedman

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UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF TEXAS
REID FRIEDMAN, on behalf of himself and Case No.: 11-cv-02098-O
all others similarly situated,
COMPLAINT -- CLASS ACTION
Lead Plaintiff,
AMENDED CLASS ACTION
vs. COMPLAINT FOR VIOLATIONS OF
FEDERAL SECURITIES LAWS
PENSON WORLDWIDE, INC., PHILIP A.
PENDERGRAFT, KEVIN W. MCALEER,
ROGER J. ENGEMOEN, DANIEL P. SON, JURY TRIAL DEMANDED
THOMAS R. JOHNSON, BDO SEIDMAN,
LLP and BDO USA, LLP,
Defendants.
KAPLAN FOX & KILSHEIMER LLP SCHNEIDER WALLACE COTTRELL

BRAYTON KONECKY LLP
Frederic S. Fox Peter Schneider
Jeffrey P. Campisi (admitted pro hac vice) Texas Bar No. 00791615
14th
850 Third Avenue, Floor Ryan R. C. Hicks
New York, New York 10022 Texas Bar No. 240008896
Telephone: [phone] Buffalo Speedway #1100
Facsimile: [phone] Houston, Texas 77098
Telephone: [phone]
Laurence D. King (admitted pro hac vice) Facsimile: [phone]
350 Sansome Street, Suite 400
San Francisco, California 94104
Telephone: [phone]
Facsimile: [phone]
Co-Lead Counsel for Lead Plaintiff Reid Friedman and for the Proposed Class
GRUBER HURST JOHANSEN HAIL SHANK LLP
Michael K. Hurst, Texas Bar No. 10316310
Dena DeNooyer Stroh, Texas Bar. No. 24012522
Texas bar No. 24012522
1445 Ross Ave., Suite 2500
Dallas, TX 75202
Telephone: [phone]
Facsimile: [phone]
Local Counsel
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TABLE OF CONTENTS
I. BACKGROUND ON PENSON’S BUSINESS AND OVERVIEW
OF THE DEFENDANTS’ WRONGFUL CONDUCT...........................................................2
II. PARTIES ................................................................................................................................21
III. PENSON’S FALSE FINANCIAL RESULTS AND BASIS
FOR DEFENDANT BDO’S LIABILITY.............................................................................27
IV. MATERIALLY FALSE AND MISLEADING STATEMENTS .........................................46
V. LOSS CAUSATION/ECONOMIC LOSS.............................................................................80
VI. FRAUD-ON-THE-MARKET DOCTRINE ..........................................................................82
VII. NO SAFE HARBOR..............................................................................................................83
VIII. CLASS ACTION ALLEGATIONS.......................................................................................83
IX. COUNTS.................................................................................................................................85
ii
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Lead Plaintiff Reid Friedman (“Lead Plaintiff”), by his attorneys, on behalf of himself
and all others similarly situated, alleges the following based upon the investigation of Lead
Plaintiff’s counsel, except as to allegations specifically pertaining to Lead Plaintiff, which are
based on personal knowledge. The investigation of counsel included, among other things, a
review of Penson Worldwide, Inc. (“Penson” or the “Company”) public filings with the United
States Securities and Exchange Commission (“SEC”), press releases issued by the Company,
media, news and research analyst reports about the Company, and other publicly available data
concerning Penson, including, but not limited to, publicly available trading data relating to the
price and trading volume of Penson common stock.
1. This action alleges fraud claims under Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder by the SEC
by Lead Plaintiff on behalf of a class of all persons and entities who purchased the common
stock of Penson between March 30, 2007 and August 4, 2011, inclusive (the “Class Period”) to
recover damages caused to the Class by defendants’ violations of the securities laws and further,
alleges non-fraud claims under Section 14(a) of the Exchange Act and Rule 14a-9 promulgated
thereunder, on behalf of shareholders that held Penson common stock as of April 9, 2009, April
12, 2010 and March 7, 2011 and were entitled to vote on the election on Penson’s directors (the
“Action”).
2. Jurisdiction is conferred by Section 27 of the Exchange Act. Venue is proper
pursuant to Section 27 of Exchange Act as Penson is headquartered in this District.
3. The Defendants are Penson; Philip A. Pendergraft (“Pendergraft”); the
Company’s Chief Executive Officer; Kevin W. McAleer (“McAleer”), the Company’s former
CFO; Roger J. Engemoen (“Engemoen”), the Chairman of the Company’s board of directors;
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Daniel P. Son (“Son”), the Company’s former President and a director; Thomas R. Johnson
(“Johnson”), a former Penson director (the “Penson Defendants”); and BDO Siedman, LLP and
BDO USA, LLP (collectively, “BDO” or the “BDO Defendants”), which audited Penson’s
financial statements and internal control over financial reporting.
4. Pendergraft, McAleer, Son, Engemoen and Johnson are referred to as the
“Individual Defendants.”
I. BACKGROUND ON PENSON’S BUSINESS AND OVERVIEW OF THE
DEFENDANTS’ WRONGFUL CONDUCT
5. Prior to and during the Class Period, Penson, a provider of services to the
financial industry, derived a material part of its income from margin loans to customers. In
connection with margin lending to customers, Penson’s customers pledge collateral, such as
securities, in return for margin loans. According to Penson’s annual report for the year ended
December 31, 2010 filed with the SEC on Form 10-K on March 4, 2011 (“2010 10-K”):
[a]s an integral part of our securities clearing relationships, we maintain a
significant margin lending business with our correspondents and their customers.
Under these margin lending arrangements, we extend credit to our correspondents
and their customers so that they may purchase securities on margin. As is typical
in margin lending arrangements, we extend credit for a portion of the purchase
price of the securities, which is collateralized by existing securities and cash in the
accounts of our correspondents and their customers . . . Over the past year, our net
interest revenues increased from $65.9 million in 2009 to $68.5 million in 2010,
representing approximately 23% and 24% of our aggregate net revenues,
respectively.
6. Accordingly, it was materially important to Penson’s business and to investors
that Penson monitored risk and the value of collateral pledged for margin loans in order to
protect the Company from unreasonable exposure to credit and market risk. Indeed, the Penson
Defendants represented that Penson maintained and applied risk management policies and
procedures that monitored collateral value on a daily and intra-day basis.
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7. Further, the Penson Defendants represented that Penson’s financial results were
prepared in accordance with generally accepted accounting principles (“GAAP”) and that Penson
maintained adequate internal controls over financial reporting. BDO issued unqualified audit
reports concerning Penson’s financial results for 2006 through 2010 and the Company’s internal
control over financial reporting.
8. GAAP required Penson to disclose all significant concentrations of credit risk
arising from all financial instruments, including but not limited to, receivables, such as
receivables from customers, especially nonaccrual receivables and margin loan agreements and
related accounts. Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) 825-10-50 Financial Instruments .
9. Further, as explained below, GAAP and SEC regulations required Penson to
disclose material related party transactions. Under GAAP, related parties include affiliates of
Penson; the principal owners of the Company; other parties with which Penson “may deal if one
party controls or can significantly influence the management or operating policies of the other to
an extent that one of the transacting parties might be prevented from fully pursuing its own
separate interests”; or “other parties that can significantly influence the management or operating
policies of the transacting parties or that have an ownership interest in one of the transacting
parties and can significantly influence the other to an extent that one or more of the transacting
parties might be prevented from fully pursuing its own separate interests.” FASB ASC 850-10-
50 Related Party Transactions . Under GAAP, an “affiliate” is a party that, directly or indirectly
through one or more intermediaries, controls, is controlled by, or is under common control with
an entity.
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10. Pursuant to SEC regulations (17 C.F.R. § 229.404), the Penson Defendants
represented that they caused Penson to disclose transactions in which “the Company was or is a
party, in which the amount involved exceeded $120,000 and in which a director, director
nominee, executive officer, holder of more than 5% of our Common Stock or any member of the
immediate family of any of the foregoing persons had or will have a direct or indirect material
interest.”
11. Further, the Penson Defendants represented that to the extent that Penson
extended margin credit to related parties, such credit was “extended in the ordinary course of
business, on substantially the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with unaffiliated third parties and had not
involved more than normal risk of collectability or presented other unfavorable features.”
12. However, during the Class Period, unknown to investors, the Penson Defendants’
representations were materially false and misleading because they failed to disclose:
a. a significant concentrations of credit risk arising from margin loans to
related parties Christopher J. Hall (“Hall”) and entities controlled by Hall,
including Call Now, Inc. (“Call Now”) and Hemisphere Trust, that were
inadequately collateralized by risky illiquid and worthless debt (the
“Retama Series B Bonds”) issued by the Retama Development
Corporation (“RDC”), a purported developer of a horse race track and real
estate project in Selma, Texas (“Retama Park”);
b. that the Company had extended margin credit and other loans to related
parties Hall, Call Now and Hemisphere of at least $43 million;
c. that, in stark contrast to the Penson Defendants’ representations, the
Penson Defendants extended margin credit and other loans to related
parties Call Now, Hall and Hemisphere on terms that were not in the
ordinary course of business or on the same terms as those prevailing at the
time for comparable transactions with unaffiliated third parties, and
involved more than normal risk of collectability or presented other
material risks because the Retama Series B Bonds that were pledged as
collateral were worthless;
4
(cid:9)(cid:9)(cid:9)
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d. that at December 31, 2009 Penson had a concentration of credit risk of
approximately $52.4 million in non-performing loans (“Nonaccrual
Receivables”), and at December 31, 2010 Penson had a concentration of
credit risk of approximately $97.4 million in Nonaccrual Receivables, of
which approximately $43 million were collateralized by the Retama Series
B Bonds;
e. that the Penson Defendants caused Penson to materially understate the
Company’s allowance for doubtful accounts and that, as a result, the
Company’s reported net income was materially overstated in violation of
GAAP, and under FASB Codification 250-10-20; 250-45-24, Penson was
required to restate and correct its previously issued financial statements for
December 31, 2009 through March 31, 2011 as follows:
(cid:9) (cid:9)
December 31, December 31, March 31,
(cid:9) (cid:9)
2009 2010 2011
Net income (loss) as
reported $16,011,000 (cid:9) $ (19,847,000) (cid:9) $ (2,861,000)
Restatement required,
net of tax (6,000,000) (cid:9) (14,000,000) (cid:9) (8,000,000)
Net income (loss) as
restated $10,011,000 (cid:9) $ (33,847,000) (cid:9) $ (10,861,000)
Misstatement % 60% (cid:9) 71% (cid:9) 282%

f. (cid:9) Penson’s internal control over financial reporting was materially defective.
13. Penson’s shareholders learned the truth about the Company’s through a series of
partial disclosures. Penson’s common stock declined from a Class Period high of over $33 per
share to close at $2.12 per share at the end of the Class Period, a staggering decline of over
$30.88 per share or approximately 94%.
14. Penson stock has not recovered. On March 21, 2012, Penson stock closed at
$0.88 per share.
A. (cid:9) Background on Related Parties Hall, Johnson, Call Now, and Hemisphere
15. Prior to and during the Class Period, Call Now, a Florida corporation, operated
and managed the Retama Park racetrack in Selma, Texas, through an 80% owned subsidiary,
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Retama Entertainment Group, Inc. (“REG”). Hall was Chairman and a controlling shareholder
of Call Now.
16. In late 1997, Call Now, in conjunction with Retama Partners, the holder of the
racing license for Retama Park, formed REG, a management company created to assume
management responsibilities at Retama Park. Retama Park is owned by the RDC, a local
government corporation organized by and acting on behalf of the City of Selma, Texas.
17. The RDC issued $7 million in Series A bonds and $86.9 million of Retema Series
B Bonds to raise money for development of Retama Park.
18. As of April 1997, Hall and Call Now owned Retama Series A bonds with a face
value of $7 million and Retama Series B bonds with a face value of $86.9 million. The RDC
only had to pay back the Retama Series B Bonds if the RDC generated positive cash flow.
19. BDO Seidman, LLP audited Call Now’s financial statements for the year ended
December 31, 1997 and as of December 31, 1997, both the Retama Series A Bonds and Retama
Series B Bonds had a combined value of $9 million. Therefore, at best, the Retama Series B
Bonds were valued at 10% of their face value of $86.9 million, and, at worst, were valued at 2%
of their face value, if the Series A Bonds were valued at face value of $7 million.
20. In May 1999, Call Now “sold” one-half of its holdings of Retama Series B Bonds
with a face amount of $43,462,500 in exchange for $2.0 million of Retama Series A bonds to
two trusts controlled by Hall – Hemisphere Trust and Global Trust, a transaction that indicated
the Retama Series B Bonds were trading at pennies on the dollar and worth substantially less
than their face value.
21. Hall, Call Now, Hemisphere Trust and Global Trust were related parties as that
term is defined in FASB ASC 850-10-50.
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B. (cid:9) Penson’s Margin Lending Exposes the Company to a Concentration of Risk
in Retama Series B Bonds; Hall, Hemisphere and Call Now Become Related
Parties
22. In November 2001, Hall appointed Johnson as Call Now’s President and CEO.
Johnson worked for Hall’s bond trading firm Howe Solomon & Hall (“HSH”) from 1989 to
1999, thus Johnson had a long standing relationship with Hall.
23. Starting in 2001, through a series of margin loan transactions, the Penson
Defendants, Hall, Hemisphere, Call Now became related parties as that term is defined in FASB
ASC 850-10-50.
24. In 2001, Hall, Call Now, Hemisphere Trust and Global Trust, pledged the Retama
Series B Bonds with a face value of approximately $86.9 million to Penson for margin loans)
(the “Related Party Margin Loans”). At least four “Margin Accounts” were maintained by
Penson and/or it subsidiaries, Penson Financial Services, Inc. (“PFSI”) and SAI Holdings, Inc.
(“SAI”), on behalf of Hall and Hemisphere (account numbers 80002066, 80002041, 16091027
for Hall and Hemisphere accounts, and at least one Call Now account).
25. By February 2002, Hall controlled 89% of Call Now’s common stock.
26. On June 26, 2003, Hall, through Call Now, loaned Penson $6 million through a
note convertible into Penson common stock (the “June 2003 Note”)
27. In August 2003, Hall placed Johnson on Penson’s board of directors. Hall caused
the Penson Defendants to appoint Johnson to Penson’s board of directors pursuant to a provision
in the June 2003 Note between the Company and Call Now that required that Penson use its best
efforts to appoint a nominee of Call Now to the board of directors.
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28. On December 23, 2003 an additional $600,000 was loaned by Hall, through Call
Now, to Penson and the additional loan was added to the principal amount of the June 2003
Note.
29. Also on December 23, 2003, Johnson, entered into a convertible promissory note
with Penson in the principal amount of $50,000 (“Johnson Note”)
30. Hall and Penson entered into a Convertible Note dated December 30, 2003 in
favor of Hall (“Hall Note”).
31. On June 30, 2005, the June 2003 Note, the Johnson Note and the Hall Note were
converted into 3,283,582 Penson common shares at a conversion price of $2.01 per share.
32. Prior to and during the Class Period, the Retama Series B Bonds, the collateral
pledged to support the Related Party Margin Loans, were illiquid and worthless. The RDC had
received a qualified going concern audit opinion every year since its inception in 1996 and had
never reported a profit. The Retama Series B Bonds had never paid a penny in interest or
principal since they were issued. As a result, the Retama Series B Bonds were written down to a
fair value of $0 in 2006 by Call Now.
33. Further, the RDC was only able to continue operations of Retama Park by
borrowing money from Call Now. In turn, Call Now funded its loans to RDC from draws
against Call Now’s margin accounts with Penson – accounts that were collateralized, in material
part, by the Retama Series B Bonds.
34. Therefore, Call Now, Hall and Defendant Johnson, and therefore Penson, were
acutely aware of the poor financial condition and results of the RDC and that in the event Penson
stopped lending to Call Now and the RDC, both entities would fail.
8