cohen, milstein, hausfeld & toll, p.l.l.c steven j. toll...

COHEN, MILSTEIN, HAUSFELD & TOLL, P.L.L.C Steven J. Toll (Admitted Pro Hac Vice) Daniel S. Sommers (DS-2084) Elizabeth A. Berney (Admitted Pro Hac Vice) 1100 New York Avenue, N.W. West Tower, Suite 500 Washington, D.C. 20005 Telephone: (202) 408-4600 Facsimile: (202) 408-4699 Lead Counsel for Lead Plaintiffs

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY

In Re DATATEC SYSTEMS, INC., SECURITIES LITIGATION This Document Relates to: All cases

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Master File No. 2:04-CV-525 WGB-MCA (Document Electronically Filed) CONSOLIDATED SECOND AMENDED CLASS ACTION COMPLAINT FOR VIOLATIONS OF FEDERAL SECURITIES LAWS JURY TRIAL DEMANDED

Lead Plaintiffs Yola Sherman, M. Ronald Sherman, Jean T. Beaubien,

William E. Garrett, Eugene E. Epstein and Joan Shalant (“Lead Plaintiffs” or

“Plaintiffs”), through their attorneys, bring this action on behalf of themselves and

all other persons similarly situated, on personal knowledge as to themselves and

Case 2:04-cv-00525-GEB-MCA Document 54-1 Filed 10/31/2005 of 131

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their own activities, and as to all other matters, based upon the investigation of

Plaintiffs’ counsel, which included, among other things: (i) interviews of former

employees of Datatec Systems, Inc. (ADatatec” or the “Company”) and other

persons with knowledge and information concerning the matters alleged herein,

including the confidential sources described below; (ii) review and analysis of the

public filings of Datatec, including its filings with the Securities and Exchange

Commission (“SEC”); and (iii) review and analysis of news articles, press releases,

announcements, and analysts' reports by or relating to Datatec. Plaintiffs believe

that further evidentiary support for the allegations set forth below will exist after a

reasonable opportunity for discovery.

CONFIDENTIAL SOURCES

Confidential sources (also referred to as “CS-__”) who provided information

in connection with Plaintiffs= counsel's investigation include the following:

CS-1: Confidential Source 1 is a former Datatec project administrator, who

worked at Datatec from approximately six years prior to the Class

Period (defined below) through approximately four months after the

Class Period.

CS-2: Confidential Source 2 is a former high level technology executive at

Datatec, who worked at the Company commencing approximately


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seven years prior to the Class Period through almost one year after the

end of the Class Period. CS-2 had frequent regular direct dealings

with the Chief Executive Officer, Chief Financial Officers, Chief

Operating Officer and other top executives of the Company.

CS-3: Confidential Source 3 is a former Datatec national project manager,

who worked at Datatec commencing approximately four years prior to

the Class Period through approximately one week after the Class

Period began. Throughout the remainder of the Class Period and

afterwards, CS-3 kept informed of events at Datatec by remaining in

close personal contact and frequently conversing with employees

(mostly other project managers) who remained at Datatec.

CS-4: Confidential Source 4 is a former high level sales executive at

Datatec, from approximately 14 years prior to the Class Period

through over one year after the Class Period.

CS-5: Confidential Source 5 is a former Datatec collections manager, who

worked at the Company for approximately 15 years, until

approximately one year prior to the Class Period. Thereafter,

including throughout the Class Period, CS-5 kept in contact with, and

had frequent conversations with former and then current Datatec


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employees. CS-5 worked closely with Datatec=s financial officers

during CS-5's long tenure at Datatec.

CS-6: Confidential Source 6 is a former Datatec regional operations

manager, who worked at the Company commencing approximately

five years prior to the Class Period through approximately 3 months

after the Class Period.

CS-7: Confidential Source 7 is a former Datatec product manager involved

with Datatec=s eDeploy product, who worked at the Company from

approximately seven years prior to the Class Period through the end of

the Class Period.

CS-8: Confidential Source 8 is a former Datatec high-ranking financial

officer, who held this position at Datatec from approximately 3

months prior to the Class Period through after the end of the Class

Period, and who worked for defendant Deloitte & Touche LLP

(“Deloitte”) prior to the Class Period, from the mid-1980s to the mid-

1990s. CS-8 was recommended by Deloitte for his position at

Datatec.

NATURE OF THE ACTION


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1. This is a federal class action on behalf of purchasers of Datatec

securities between June 26, 2003 and December 16, 2003, inclusive, (the “Class

Period”), seeking remedies under the Securities Exchange Act of 1934 (the

“Exchange Act”).

2. Datatec was essentially, at its core, a company which stringed the

cable needed by new stores and other facilities which required computer access.

The business was neither a profitable one nor an advanced technology company

which would attract investors. Competition from local cable stringing companies,

which did not have Datatec’s enormous overhead, was fierce. According to CS-2,

the business should have failed years ago, and was only kept alive through

Defendants’ fraudulent practices for obtaining financing from investors and from

its credit facilities. CS-8, who served as the a high-ranking financial officer at

Datatec throughout the Class Period, similarly explained that Datatec never made

money, had no working capital, had entered into major contracts with unprofitable,

money-losing terms, and was only kept alive through financing from investors and

from Datatec’s over-extended credit line with IBM Credit LLC (“IBM Credit”).

3. Significantly, both before and during the Class Period, Datatec

entered into and was performing work on large, extremely costly, money-losing

“fixed price” contracts to perform cable stringing and related work, while


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portraying to the public that these contracts were profitable. A huge $30 million,

multi-year fixed-price subcontract for Datatec to provide wiring services in

approximately 1,000 The Home Depot, Inc. (“Home Depot”) stores, on which

International Business Machines Corporation/IBM Global Services Division

(“IBM Global” or “IBM Global Services”) served as the general contractor, was

among the costliest of such contracts being performed during the Class Period.

Datatec’s Chief Operating Officer, defendant Raymond Koch (“Koch”), provided

the fraudulent, unrealistic “percentage of completion” and “gross margin” figures,

which were the basis for the revenue recognition pertaining to Datatec’s contracts

employed in Datatec’s public filings. The Company’s money-losing contracts and

business were thus portrayed as profitable. For instance, Koch claimed that the

Home Depot contract had a 25% gross profit margin in March 2003 – even though

such a margin was wholly unrealistic in light of Datatec’s extensive obligations

and the need for numerous expensive return site visits on this fixed price contract.

In reality, the “profit margin” amounted to a 6 to 10% loss. Instead of

acknowledging that massive cost overruns incurred at least from January 2003

onwards would result in a loss on the IBM/Home Depot contract, Defendants only

lowered the gross margin slowly, e.g., to approximately 20% in July 2003, so that

Datatec would continue to report fraudulent inflated net income and revenues.


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Defendant Koch also advised that massive cost overruns on Datatec’s contracts

were collectible, but then knowingly failed to even bill Datatec’s customers for

such cost overruns. Koch also failed to attempt to renegotiate the ruinous “fixed

price” terms of the Home Depot contract; instead, Defendants continued to falsely

portray to the public that the contract was profitable.

4. According to CS-8 and a confidential report (the “Eisner Report”)

prepared by Datatec’s subsequent, post-Class Period auditors, Eisner, LLP

(“Eisner”) (which report was described by CS-8), defendant Deloitte improperly

relied on defendant Koch’s “percentage of completion” and “gross profit margin”

estimates, despite the “red flag” of Koch’s history of continually providing vastly

overstated profit and percentage of completion figures which placed Deloitte on

notice that such estimates could not be relied upon. In accordance with the same

sources, Deloitte approved and “signed off” on the fraudulent presentation of

Datatec’s contracts, net income and revenues without proper investigation.

5. Defendants also engaged in fraudulent accounting manipulations with

respect to material purchased to use in Datatec’s contracts to perform services for

Lowe’s Companies, Inc. (“Lowe’s”) and CVS Corporation. Datatec “brokered”

the materials to Lowe’s, for cost plus a 10% administrative fee. For the sole

purpose of giving the appearance of profits, revenues and higher gross margins,


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Datatec stockpiled between two and three years of materials for the Lowe’s jobs –

even though the materials suppliers’ delivery time frame was a few days (and

therefore there was no reason to stockpile more than a few days’ worth of

materials), and even though Datatec’s one-year verbal approvals to continue

working with Lowe’s were only renewed or confirmed in writing with actual job

commitments for one quarter (3 months) at a time. According to CS-8 and the

Eisner Report, Deloitte improperly permitted Datatec to recognize profits on

materials purchased for Lowe’s, even though Datatec’s massive materials

inventories in connection with the Lowe’s job had no business purpose and were

extremely unrealistic in relation to the Lowe’s jobs’ scope.

6. According to CS-8, if Datatec’s auditor during the Class Period,

defendant Deloitte, had followed normal audit procedures, Deloitte would have

rendered a “going concern” opinion, advising the public of the doubtfulness of

Datatec’s viability going forward as a “going concern.”

7. In addition to the improper recognition of net income and revenues on

contracts and Lowe’s materials purchases, CS-8 explained the following: The

Company’s IBM Credit credit line was over-extended at $28.5 million, and, from

at least March 2003 onwards, IBM Credit continually privately advised the

Company that it would not lend the Company further sums. On virtually a daily


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basis, at the request of defendant Isaac J. Gaon (“Gaon”), Company controller

Simon Jethwani or an accounting manager such as Chris Benyak called IBM Credit

to wire additional funds to Datatec’s bank account. IBM Credit frequently stated

that it would not wire the requested funds or further funds to Datatec. IBM Credit

only temporarily relented, and wired the Company funds for the current day bills

after Gaon advised IBM Credit that, without the funds, Datatec would have to

close its doors and would not be able to perform on the large Home Depot

subcontract, on which IBM Global Services served as the contractor. CS-8 called

Deloitte on several occasions commencing in March 2003, and related to Deloitte

audit partner Mark Davis the foregoing conversations and Datatec’s lack of funds.

8. The Company’s lack of funds and situation with IBM Credit were

red flags that put Deloitte on notice of Datatec’s lack of viability. In light of these

and/or other red flags, Deloitte should have asked for a reconciliation of the

application of debt proceeds and examined where the Company’s borrowings were

being spent, and what was occurring with the Company’s contract jobs. When

heavy debts are being incurred, it is normal auditing procedure for the auditor to

examine why the debts are being incurred; what the company’s financial

requirements are; where the money is being deployed; and, if there are increased

costs associated with the company’s contracts, whether it is reasonably likely that


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these costs will be recouped. Moreover, the fact that the Company’s cash and cash

equivalents during the Class Period, of approximately $155,000, were enough for

only three or four days’ expenses, particularly when viewed against the Company’s

almost $30 million of borrowings on its over-extended credit line, was another “red

flag” that put Deloitte on notice of Datatec’s lack of viability.

9. In fact, both before and during the Class Period, Datatec could not

meet its payroll or other bills without resorting to the manipulations described

herein, which included enormous borrowings, a repeatedly employed phantom

invoicing scheme, and a phantom products scheme designed to portray the

Company as a high technology company rather than as a cable stringing company.

10. Thus, throughout the Class Period, Defendants gave the investing

public a false picture of the Company=s contract profitability, financial condition,

balance sheet, and products, and failed to disclose that the Company had become

reliant on fraudulently-obtained financing, and that the Company’s ability to

continue as a going concern was severely in doubt.

11. Indeed, on June 26, 2003, Defendant Gaon, the Company=s CEO, told

investors that the Company was on track to post earnings for fiscal year 2004

(ending April 30, 2004) of $0.14 to $0.16 per share. On September 15, 2003,


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Individual Defendants reiterated favorable fiscal 2004 full year earnings guidance,

of $0.12 per share.

12. On December 5, 2003, Datatec surprised investors with the news that

Gaon had stepped down as Chairman and CEO of the Company, and been replaced

by a new CEO, Raul Pupo. The Company also announced that board member

Mark Berenblut had resigned.

13. Also on December 5, 2003, Datatec announced that it was retracting

its previously announced earnings estimates for Fiscal 2004. Far from earning

$0.14 to $0.16 per share, or $0.12 per share, the Company would suffer a net loss

for the fiscal quarter ended October 31, 2003, as well as an overall net loss for

Fiscal 2004. Although the Company=s stock price dropped substantially on the

news (nearly 34%), the full impact of the adverse news did not come out for almost

another two weeks.

14. On December 17, 2003, the close of the Class Period, Datatec

announced that it would suffer a $10 million loss for the fiscal quarter ended

October 31, 2003. In addition, the Company told investors it was delaying the

filing with the SEC of its quarterly report for the quarter ending October 31, 2003,

and that the Company=s Audit Committee had decided to hire outside counsel to

conduct an independent review of the Company=s valuation of its long-term


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contracts. In addition, the Company advised investors that on December 12, 2003,

IBM Credit had informed the Company that it would not provide Datatec with a

written default waiver for the fiscal quarter ended October 31, 2003. The

Company=s stock fell another 15% on extremely high volume of 2.3 million shares.

15. After the Class Period, the special situation advisory firm of Traxi

LLC issued an internal restatement of Datatec’s profits, based on the Eisner

Report, which indicated that Datatec’s profits had been overstated by $15 million.

JURISDICTION AND VENUE

16. This Court has jurisdiction over the subject matter of this action

pursuant to 28 U.S.C. ''1331 and 1337 and Section 27 of the Exchange Act (15

U.S.C. ' 78aa).

17. The claims asserted herein arise under Sections 10(b) and 20(a) of the

Exchange Act (15 U.S.C. '' 78j(b) and 78t(a)) and Rule 10b-5 promulgated

thereunder (17 C.F.R. ' 240.10b-5).

18. Venue is proper in this District pursuant to Section 27 of the

Exchange Act (15 U.S.C. ' 78aa) and 28 U.S.C. ' 1391(b). Substantial acts in

furtherance of the alleged fraud, including the preparation and dissemination of

materially false and misleading information, and/or its effects have occurred within


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this District. In addition, Datatec was headquartered in Fairfield, New Jersey,

within this District, at all times relevant to this litigation.

19. In connection with the acts and omissions alleged in this complaint,

Defendants, directly or indirectly, used the means and instrumentalities of

interstate commerce, including, but not limited to, the United States mails,

interstate telephone communications, and the facilities of the national securities

markets.

PARTIES

Plaintiffs:

20. On December 23, 2004, the Court appointed Yola Sherman, M.

Ronald Sherman, Jean T. Beaubien, William E. Garrett, Eugene E. Epstein and

Joan Shalant to serve as Lead Plaintiffs pursuant to 15 U.S.C. ' 78(u)-4. Lead

Plaintiffs purchased Datatec common stock at artificially inflated prices during the

Class Period and were damaged thereby. Certifications for the Lead Plaintiffs were

previously submitted to the Court.

Defendants:

21. Defendant Gaon served as Datatec=s Chairman of the Board from

December 1997 until his resignation from all his positions at Datatec on or about

December 5, 2003. Gaon also served as a Director from 1992 until his December


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2003 resignation; and as Datatec’s Chief Executive Officer from October 1994

until his December 5, 2003 resignation. In addition, Gaon served as Datatec’s

CFO from April 1992 until October 1994. Gaon is also a chartered accountant.

Gaon was Datatec’s primary contact with IBM Credit, and was intimately involved

with directing the fraudulent invoicing scheme and other fraudulent activities at

Datatec.

22. Defendant Koch served as Datatec=s Chief Operating Officer from

approximately July 2001 through the entire Class Period. From 1989 to 2000,

Koch also held several senior executive positions with the Company and its

subsidiary Datatec Industries, Inc. as follows: Chief Operating Officer and

Executive Vice President of the Company from 1996 to 2000; President and Chief

Operating Officer of Datatec Industries from 1994 to 1996; President of Datatec

Industries from 1991 to 1994; and Executive Vice President of Datatec Industries

from 1989 to 1991. Defendants Gaon and Koch are also referred to as “Individual

Defendants.”

23. During the Class Period, Koch was in charge of operations, according

to CS-8, who further explained the following: The Company’s field managers and

all of its field operations personnel reported to Koch. Datatec’s field managers

reported to Koch as to the percentage of each job that was complete, and Koch


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provided and signed off on percentage of completion numbers used for the

Company’s revenue recognition in its public filings. Datatec’s production and

warehouse personnel and customer support personnel also reported to Koch.

Essentially, the entire business other than finance, HR, and legal, reported to Koch.

Koch was also responsible for the Company’s eDeploy product – to make sure that

it was used on jobs and integrated with Datatec’s field operations. Furthermore,

Koch was Datatec’s primary contact with IBM Global Services, which was the

general contractor on the multi-million dollar Home Depot contract which Datatec

performed on during the Class Period.

24. Defendant Deloitte is an auditing and accounting firm which Datatec

engaged as its principal independent accountants on April 11, 2002. Deloitte

served as the Datatec’s auditor throughout the Class Period, and resigned

approximately four months afterwards, in April 2004. Deloitte’s Independent

Auditors’ Report accompanied Datatec’s filings to the SEC during the Class

Period, including Datatec’s Form 10-K for the year ended April 30, 2003, filed

July 23, 2003, and included an unqualified opinion. The Deloitte audit team

assigned to Datatec during the Class Period consisted of Deloitte audit partner

Mark Davis, based in Deloitte’s New York office at Two World Financial Center,

225 Liberty Street, New York, New York 10281, as well as accounting manager


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Nick Sankar, two senior accountants and a first year staff member. According to

CS-8, the Deloitte audit team during the year prior to the Class Period was led by a

different audit partner, from a Deloitte New Jersey office. This former audit

partner had brought up issues with which Datatec had disagreed. CS-8 reported

that Deloitte backed off on the issues that Deloitte had raised, and, by mutual

agreement with Datatec, removed the audit partner, and then assigned Mark Davis

to the Datatec account. Deloitte is a subsidiary of Deloitte & Touche USA LLP,

which is a member firm of the global organization, Deloitte Touche Tohmatsu.

25. When Deloitte was first engaged by Datatec (replacing Arthur

Anderson), Deloitte performed a re-audit of Datatec’s previous three years of

financials, and concluded that there were only minor errors in how Arthur

Anderson had accounted for certain items, totaling a few hundred thousand to one

million dollars. Deloitte audit partner Mark Davis signed off on the re-audit. In

the course of the re-audit, extensive information regarding Datatec’s financial

condition was provided to Deloitte.

26. After Deloitte’s resignation in April 2004, non-party Eisner & Co.

was engaged by Datatec’s audit committee as Datatec’s auditor, and was asked to

review the Company’s last three years’ financials. A team of three or four CPAs,

led by Eisner & Co. partner Robert Levine, worked at Datatec for two months, and


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among other things, reviewed the revenue recognition on Datatec’s contracts for

the fiscal years 2002, 2003 and 2004 and for the quarter ending July 31, 2003.

Among other things, Eisner & Co.’s conclusions from this review were highly

critical of Deloitte. These conclusions were embodied in a report (the “Eisner

Report”) in approximately August 2004. In August 2004, the Eisner Report was

read over the telephone to various Datatec executives and other individuals,

including CS-8.

27. Defendants are liable as direct participants with respect to the wrongs

complained of herein. In addition, Individual Defendants were “controlling

persons” within the meaning of Section 20(a) of the Exchange Act. Each exercised

his power and influence to cause the Company to engage in the fraudulent

practices complained of herein. In addition, on July 22, 2003, Defendant Gaon

signed Section 302 certifications pursuant to Sarbanes-Oxley that, among other

things, Defendant had reviewed Datatec’s 2003 Form 10-K, and that the financial

statements, and other financial information included therein fairly presented in all

material respects Datatec’s financial condition, results of operations and cash

flows, and that Defendant was responsible for establishing and maintaining

Datatec’s disclosure controls and procedures.


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28. It is appropriate to treat 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

public statements, are the collective action of the narrowly defined group of

Individual Defendants identified herein. During the Class Period, Individual

Defendants, as senior executive officers and/or directors of Datatec, directly

participated in the management of the Company, were directly involved in the day-

to-day operations of the Company at the highest levels, and were privy to

confidential and proprietary information concerning Datatec, its operations,

finances, financial condition, present and future business prospects. Individual

Defendants also had access to material adverse non-public information concerning

Datatec. Because of their positions with Datatec, Individual Defendants had access

to non-public information about its business, finances, products, markets and

present and future business prospects via access to internal corporate documents,

conversations and connections with other corporate officers and employees,

attendance at management and board of directors meetings and committees thereof

and via reports and other information provided to them in connection therewith.

Because of their direct participation in the activities complained of herein, and

possession of such information, Individual Defendants knew or recklessly


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disregarded the fact that adverse facts specified herein had not been disclosed to,

and were being concealed from, the investing public.

29. In addition, even if Individual Defendants are not treated as a group

for pleading purposes, according to CS-8, the Individual Defendants actually

reviewed the Company’s public filings during the Class Period, and provided input

and comments to the drafts, which were always circulated to Individual Defendants

five or six days prior to the due date. Individual Defendants also signed off on the

final filings. In addition, defendant Koch provided the information for, and signed

off on the percentage of completion numbers which were the basis of the

Company’s fraudulent, inflated revenue and net income (profits) recognition.

30. Individual Defendants, because of their positions with the Company,

controlled and/or possessed the authority to control the contents of its reports, press

releases and presentations to securities analysts and through them, to the investing

public. Individual Defendants were provided with copies of the Company=s reports

and press releases alleged herein to be misleading, prior to or shortly after their

issuance and had the ability and opportunity to prevent their issuance or cause

them to be corrected. Thus, Individual Defendants had the opportunity to commit

the fraudulent acts alleged herein.


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31. As senior executive officers and/or directors and as controlling

persons of a publicly-traded company whose common stock was, and is, registered

with the SEC pursuant to the Exchange Act, and was traded on the NASDAQ

Small Capital Market (ANASDAQ@) and governed by the federal securities laws,

Individual Defendants had a duty to disseminate promptly accurate and truthful

information with respect to Datatec=s financial condition and performance, growth,

operations, financial statements, business, products, markets, management,

earnings and present and future business prospects, to correct any previously

issued statements that had become materially misleading or untrue, so that the

market price of Datatec=s common stock would be based upon truthful and accurate

information. Individual Defendants= misrepresentations and omissions during the

Class Period violated these specific requirements and obligations.

32. Defendants are liable as participants in a fraudulent scheme and

course of conduct that operated as a fraud or deceit on purchasers of Datatec

common stock by disseminating materially false and misleading statements and/or

concealing material adverse facts. The scheme: (i) deceived the investing public

regarding Datatec=s business, operations and management and the intrinsic value of

Datatec common stock; (ii) enabled Datatec to obtain more than $8.4 million in

private placements and other financing transactions; (iii) allowed the Company to


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obtain waivers of default on its existing $25 million credit line with IBM; and (iv)

caused Plaintiffs and members of the Class to purchase Datatec securities at

artificially inflated prices.

Non–Party Datatec:

33. Datatec is a corporation organized under the laws of Delaware with its

principal executive offices located at 1275 Alderman Drive, Alpharetta, Georgia

30005. On December 14, 2004, Datatec filed a bankruptcy petition pursuant to 11

U.S.C. § 1101 et. seq. Accordingly, Datatec is not named as a defendant herein at

this juncture due to its bankruptcy filing and the protections afforded by the

automatic bankruptcy stay.

THE FRAUDULENT SCHEMES

34. Individual Defendants described Datatec’s business as follows:

Datatec Systems, Inc., and its subsidiaries . . . are in the business of providing rapid and accurate technology services and licensing software tools designed to accelerate the delivery and management of complex Information Technology (“IT”) solutions for technology providers, primarily Original Equipment Manufacturers (“OEMs”), systems integrators, independent software vendors, telecommunications carriers and service providers . . . as well as to a select number of “Fortune 2000” customers in the United States and Canada. (Datatec Form 10-K for the fiscal year ending 4/30/03, filed 7/23/03) 35. However, according to CS-2, Datatec was essentially, at its core, a

company which stringed the cable needed by new stores and other facilities which


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require computer access. Datatec’s core business was not profitable, and faced

fierce competition from local cable stringing companies, which did not have

Datatec’s enormous overhead. Datatec could not meet its payroll, vendor and other

bills without fraudulent manipulation.

36. Moreover, according to CS-8, Datatec had entered into large fixed-

price contracts which were causing the Company to lose enormous sums of money.

37. Thus, throughout the Class Period, Individual Defendants tried to

portray Datatec as an advanced technology company, which was creating new

breakthrough software products which would appeal to investors. Defendants gave

the market place a false picture of the Company=s contract profitability, financial

condition, balance sheet, and products, and failed to disclose that Datatec was

recognizing inflated revenues and net income by using grossly over-estimated

gross profit margins for its contracts, and by purchasing unnecessary materials for

Lowe’s; that the Company had become reliant on financing obtained with

“phantom invoices”; and that the Individual Defendants were touting essentially

non-existent products to keep investors pouring money into the Company when

Datatec was neither profitable nor solvent.

The Scheme To Employ Unreasonable And Overstated Gross Profit Margins To Fraudulently Inflate Net Income and Revenues:


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38. According to CS-8, during the Class Period, most of Datatec’s

contracts were fixed revenue contracts. CS-8 explained that each month, an

estimated gross profit margin was applied to each of Datatec’s contracts, on a

percentage of completion basis, to determine the revenues and gross profit to be

recognized. At the end of each quarter, the gross profit margins were reviewed by

Koch and Deloitte. The estimated gross profit margin percentage employed in

revenue and gross profit calculations was critical. Tweaking a gross profit margin

by 1% can produce a profit from a loss; it is a very sensitive factor. On many of

the Company’s contracts, the gross profit margin was initially estimated (for

purposes of revenue recognition calculations) at 35%. However, such estimated

margins were grossly unrealistic. The actual gross profit margins on Datatec’s

contracts ended up in the low teens, single digits, or in the loss column.

39. CS-8 explained that the impact on the Company’s financials of over-

estimating gross profit margins was as follows: The use of excessive estimated

gross profit margins failed to recognize the fact that the Company would be

incurring costs that it was not going to cover in revenues. Hence, the Company’s

reported expenses were understated in its income statements. Consequently,

reported net income and revenues were inflated.


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40. According to the Eisner Report (as described by CS-8), the most

egregious problem with the Company’s financials during the Class Period was

Defendants’ use of grossly overstated gross profit margins. The resulting

understatement of expenses and losses amounted to approximately $10 million for

the three fiscal years ending April 31, 2003, up to and including the quarters

ending October 31, 2003. The largest understatements were for the latter period

when large losses were being incurred on the Home Depot contract, specifically

FY2003 and the quarters ending October 31, 2003. The Eisner Report criticized

Deloitte for relying on defendant Koch’s gross profit margin and percentage-of-

completion ratios, because Koch had persistently and repeatedly in the past

provided estimated percentage of completion / gross margin figures that had to be

significantly reduced upon contract completion.

41. According to CS-8, Deloitte merely spent a few hours per quarter

questioning Koch about gross margin percentages estimates established on jobs

after Deloitte saw the accumulated costs being incurred on the contracts. Deloitte

had a list of contracts, and asked Koch how the contracts were proceeding, and

what percentage of the job was complete. Deloitte asked, “Do you think we should

take the gross profit margin down?” “How do you think we can maintain the gross

margin estimate when it’s currently running much lower?” Normally, the disparity


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was a large number, such as 25%. Koch offered excuses - such as that it was a

heavy up front job, or that Datatec would be able to bill for overcharges – which

Deloitte accepted with little or no investigation, despite the information in

Deloitte’s possession that Koch had a history of providing grossly over-estimated

gross profit margin percentages.

42. According to CS-8, in approximately December 2003 or January 2004

(after the end of the Class Period), Deloitte produced a work paper – using data

that had been in Deloitte’s possession for years – which showed the severe

deterioration in gross profit margin on every one of approximately 20 major

Datatec contracts, from the time the estimated gross profit margin was established

(at the outset of each contract), through completion. This Deloitte work paper was

prepared by Deloitte partner Mark Davis’ staff, and consisted of two pages of

accumulated data points. A vertical column listed about 20 (mostly Fortune 500)

clients. The horizontal columns listed the date when the estimated gross profit

margin was established for each contract, the estimated gross margin percentage

first established, and how that gross profit margin changed (deteriorated) each

fiscal quarter, from the time the percentage was set up through completion of the

contract. The estimated gross profit margin percentages gradually deteriorated

over time during the course of the contracts – and the actual profit margins were


26

far below the estimates. A sentence or two at the top of the work paper set forth

the purpose of the paper’s analysis, or contained the title of the work paper.

43. According to CS-8, there was never a reserve set up at Datatec to

allow for the aggressive estimated gross profit margins and percentages of

completion upon which Datatec based its income and revenue recognition. CS-8

explained that historical experience is telling. If a gross profit margin is too

aggressive, the accountants are obligated to require the establishment of a reserve,

or to check the veracity of the gross profit margin by checking with third parties

involved with the company’s contracts. According to CS-8, Deloitte “never

bothered” to examine the historical trend before or during the Class Period,

although the data to do so was in Deloitte’s possession, and examining the

historical trend was essential to a fair presentation of the Company’s financial

statements. Instead of examining the historical trend, Deloitte improperly relied on

assurances from defendant Koch.

44. CS-8 also related that Gretchen Kittel, an employee in Datatec’s

finance department who maintained percentage of completion work papers,

frequently brought to the attention of Koch and Gaon – both in written memos and

orally – that the percentage of completion estimates used for the Company’s

financial statements were unrealistically overstated. Ms. Kittel brought Koch


27

detailed spreadsheets indicating that accumulated costs incurred to date on the

Company’s contracts were far higher than expected, and asked Koch whether the

costs were in line with the percentage of the contract which was complete. Koch

disregarded Ms. Kittel’s information, and either refused to lower the gross profit

margin / percentage of completion, or lowered it only slightly.

45. Ms. Kittel provided most of the general ledger detail to the Deloitte

junior and senior auditors, and also presented her analysis of the detail to Deloitte.

Ms. Kittel presented to Deloitte a break down of costs from specific jobs and how

much profit was to be realized on each job. This consisted of 8-1/2 by 14 legal

sheets analyzing jobs by quarters in progress, with separate percentage of

completion calculations for each job. Ms. Kittel kept a database of this

information. Ms. Kittel also sent her analysis to Koch with comments such as “I

don’t understand how we can go forward with x, y and z job at x%.”

46. Ms. Kittel often voiced her concerns, in memos to Koch. Ms. Kittel

also provided supporting detail for the financial statements to Deloitte. Deloitte

asked Koch about the detail provided by Ms. Kittel, but then Deloitte accepted

Koch’s assurances.

47. The disastrous fixed-price Home Depot contract is a prime example of

the fraudulent nature of Defendants’ use of excessive overstated gross profits


28

margin estimates to calculate the income and revenues recognized in the

Company’s financials.

48. According to CS-8, the background on the Home Depot contract is as

follows: Home Depot had awarded a $100-million multi-year contract to IBM

Global to act as its general contractor to rewire and do related work on

approximately 1000 Home Depot stores. Datatec and another company won the

RFP to subcontract the Home Depot job. IBM Global split the work between the

two companies. Datatec was to provide services to approximately 500 stores. The

Home Depot contract work consisted of Datatec employees (IBEW Local 3

electrical workers) wiring Home Depot stores after hours, from 11 p.m. to 5 a.m.,

using hi-lo’s (cherry-pickers, or lifts) from Hertz’s equipment division.

49. IBM Global then learned that the other company’s subcontractors

were performing miserably. Consequently, in August or September of 2002, IBM

Global approached Datatec to wire all approximately 1000 Home Depot stores.

Datatec’s initial $15 million contract thus became a $30 million contract.

Datatec’s approximately 300 employees had to grow to approximately 800

employees to service the enlarged Home Depot contract. Yet, Datatec did not

increase its pricing to account for the huge recruiting and training costs which

Datatec needed to incur to grow from 300 to 800 employees. Datatec had to recruit


29

and train approximately 500 employees into the field, all members of IBEW Local

3. Administrative costs also increased. For instance, Datatec’s general counsel

had to field complaints from the union as to numerous matters, including the

assignment of two employees per hotel room, and overtime calculations.

50. According to CS-8, Datatec started receiving notices in January and

February 2003 to return to Home Depot’s sites to fix various problems with

Datatec’s rewiring jobs for Home Depot. Datatec continued to receive such notices

during May 2003 through the summer of 2003. A massive redeployment effort

was involved. Individual Defendants Koch and Gaon, and other personnel

throughout the Company had to re-schedule employees and send teams of

expensive employees and equipment back to Home Depot’s sites.

51. Most of the problems in the notices requiring revisits by Datatec

personnel were due to work changes initiated by Home Depot or faulty information

originally provided by Home Depot or IBM Global in the sample specifications in

the contract. For instance, many store configurations were different from the

specifications, and as a result, the cable which Datatec initially brought to the site

was insufficient. However, Individual Defendants did not approach IBM Global or

Home Depot about obtaining more compensation on the fixed price contract.

Meanwhile, from approximately January 2003 through approximately September


30

2003, Datatec’s unbilled costs were skyrocketing. To handle Home Depot revisits,

four hundred Datatec employees were working overtime, at $40/hour, renting vans,

renting equipment, incurring matching union costs, and being paid every two

weeks.

52. Despite the apparent massive cost overruns on the Home Depot

contract, Datatec and Defendants only gradually decreased the gross profit margin

on this contract by small amounts, and continued to employ wholly unrealistic,

extremely aggressive gross profit margins, as a result of which the Home Depot

contract expenses were vastly understated, and Datatec’s income and revenues

were overstated. The estimated gross profit margin employed to calculate income

recognition on the Home Depot contract was originally set at 25% to 30%. In

March 2003 – long after revisit notices started pouring into the Company – the

estimated gross profit margin employed was still 25%. From March to December

2003, the estimated gross margin was gradually reduced from 25% to 22% (in

approximately July 2003) to 19% to 15% to 6% (in October 2003) -- and

ultimately was actually determined to be negative 6% or 10% (in December 2003).

53. Although Deloitte noticed the cost overruns in approximately July

2003, Deloitte merely asked Koch if he thought he could collect unbilled costs on

the Home Depot contract. Deloitte accepted Koch’s affirmative response at face


31

value, without confirming with the customer that unbilled costs could be recouped

despite the fixed-price contract. Deloitte also failed to analyze remaining costs on

the Home Depot contract and other Datatec contracts. Deloitte could have

analyzed the remaining costs by confirming with project managers the remaining

work to be done, and computing the costs that would be incurred thereon.

Deloitte’s reliance on bald assurances from Koch and failure to properly adjust

Koch’s estimates downwards was particularly unreasonable in light of Koch’s long

history of providing vastly overstated gross margin percentages on Datatec’s

contracts – and in light of the Company’s poor cash position and extraordinary

borrowings – which required the auditor to scrutinize estimates carefully and

engage in extra audit procedures. As noted above, the Eisner Report criticized

Deloitte for its failures in the foregoing regard.

The Scheme To Fraudulently Recognize Inflated Revenues, Gross Profit and Net Income On Lowe’s Materials Purchases

54. The Eisner Report also was critical of a fraudulent scheme by which

ever-increasing inventories of materials, purportedly purchased for jobs for

Lowe’s, were used to improperly recognize revenues, gross profits and net income.

As related by CS-8, the scheme consisted of the following:

55. Datatec bought the materials from suppliers such as Anixter and

Graybar and other vendors, which were purportedly to be used on jobs for Lowe’s


32

for which Lowe’s would be charged a 10% administrative fee. The materials were

either drop-shipped to Lowe’s or, more frequently as Datatec’s materials orders

vastly increased, sent to Datatec’s warehouse in Atlanta.

56. Deloitte permitted Datatec to recognize revenues as soon as Datatec

bought the materials because, supposedly, Datatec had an agreement with Lowe’s

to reimburse Datatec for materials plus pay an administrative fee. Thus, the

“margin” (i.e., $10,000 on a $100,000 materials order) was recognized at the time

the materials vendor accepted Datatec’s order for materials. However, the

immediate recognition of revenue was improper, unreasonable and fraudulent for a

number of reasons. First, Lowe’s awarded jobs quarterly; and there was no written

contract for a year or the several years’ worth of materials purchases which Datatec

made. Second, there was no business reason to purchase and hold years’ worth of

supplies. Suppliers such as Graybar usually delivered supplies within a few days

to 30 days’ notice; thus there was no reason to stockpile materials. Moreover,

Datatec did not purchase sufficient materials to obtain a bulk discount that could

justify a large purchase plus warehousing costs.

57. At the end of each quarter during and prior to the Class Period, Gaon

asked Koch if Koch could buy more materials for Lowe’s, and how that would

impact Datatec’s bottom line. Gaon then told Koch to buy more materials, and


33

Koch and his staff bought more materials, with funds loaned to Datatec by Lowe’s.

In at least one of the applicable quarters during the Class Period, more materials

were purchased to “make revenues” and to increase Datatec’s gross profit margin.

Both prior to and during the Class Period, Datatec purchased materials for Lowe’s

in the amount of approximately $1 million per month ($12 million per year), the

overwhelming majority of which was unnecessary for existing projects and

purchased solely to inflate net income and revenues. These purchases generated

fraudulent, inflated net income and revenues of approximately $1 million per year.

As of the end of the Class Period, the cumulative inflated net income and revenue

from this mechanism was in excess of $3 million.

58. Datatec borrowed money from Lowe’s to buy the above-described

materials. Lowe’s was getting services at such a low rate from Datatec that Lowe’s

didn’t mind lending Datatec the money for the supplies. The Lowe’s arrangement

provided cash flow and “enhanced” Datatec’s financial statements. Although

Datatec borrowed the money from Lowe’s to purchase the material, Datatec never

paid the vendors right away.

59. In addition, if and when Datatec eventually used the pre-ordered

materials for a job for Lowe’s, Defendants improperly caused Datatec to record the

remainder of the gross sale price as revenue, and record the balance as COGS.


34

(For instance, on a $100,000 materials order, $10,000 would be recognized

immediately upon the materials vendor’s acceptance of the purchase order; and if

and when the materials were used, $90,000 in revenue and $90,000 in COGS was

recorded, thereby causing the inflation of both.) According to CS-8, Datatec also

engaged in essentially the same materials purchasing scheme with CVS

Corporation during the Class Period, which was known to Deloitte.

The Phantom Invoicing Scheme:

60. Throughout the Class Period, Defendants failed to disclose that the

Company was obtaining financing on its credit lines with “phantom invoices,” and

had become completely reliant on the financing obtained through this fraudulent

mechanism to stay afloat. Several confidential sources, including CS-1, CS-2, CS-

3 and CS-5, described the following phantom invoicing scheme, which Individual

Defendants personally directed:

61. Both prior to the Class Period and during the Class Period with

increasing frequency and magnitude, Individual Defendants regularly placed

phantom invoices on Datatec’s books, to overstate the Company’s accounts

receivable, and to enable Datatec to obtain critical accounts receivable financing

through its $25 million credit facility with IBM Credit LLC (AIBM Credit@).

Datatec=s true but undisclosed financial condition was so precarious that Datatec


35

needed the fraudulently-obtained accounts receivable financing for Datatec to meet

its semi-monthly payroll, and to avoid having Datatec=s vendors cut off essential

supplies.

62. Specifically, according to CS-1, CS-2, and CS-5, Individual

Defendants, including Gaon, directed Datatec=s employees to post to Datatec=s

accounts receivable phony invoices for work that was not yet done and/or not yet

billable. According to CS-2, this same “phantom invoicing” device was used to

“cure” a variety of Datatec’s business problems. First, prior to each semi-monthly

payroll, the head of Datatec’s HR department would tell Individual Defendants,

including Gaon, that there was not enough money to meet the payroll – and

Individual Defendants would “cure” the problem by ordering phantom invoices to

be issued and posted to the Company’s accounts receivable, thereby obtaining

approximately 85% financing on those receivables. Second, Datatec also

frequently received threats from its supply vendors to cut off the Company’s

essential supplies if overdue payments were not forthcoming. Again, the solution

was to issue phantom invoices and thereby fraudulently obtain accounts receivable

financing.

63. CS-8 also confirmed that the phantom invoices were used to obtain

further funds from IBM Credit. CS-8 explained that the actual impact of the


36

phantom invoicing on the Company’s public financial presentations was that the

Company’s borrowings significantly exceeded the publicly disclosed 85% of the

Company’s accounts receivable. The purported 85% formula was disclosed, inter

alia, in Datatec’s 2003 Form 10-K for the period ended April 30, 2003, filed July

23, 2003, Item 7, MD&A, Senior Credit Facility. Therefore, Individual

Defendants’ disclosures describing the mechanics underlying the IBM Credit credit

facility were materially misstated. (CS-8 explained that the Company’s fraudulent

revenue recognition was achieved through Defendants’ schemes of using grossly

overstated percentages of completion, and manipulation of the Lowe’s accounts,

described herein.)

64. Individual Defendants constantly faced the prospect of not being able

to meet Datatec’s payroll throughout the Class Period. Datatec was also constantly

in jeopardy of being cut off by its vendors, such as Graybar (which sells just about

everything that Datatec would use at a job site – such as oil, screws, brackets, and

clamps), Hertz (which rented Datatec the vans and lifts used at all of Datatec’s job

sites), materials companies, and cable companies. According to CS-2, Gaon

attended the “vendor meetings” held at Datatec which concerned getting money to

the vendors who were threatening to discontinue sending needed supplies to

Datatec.


37

65. On each of the above-described occasions, Individual Defendants,

usually Gaon himself, telephoned certain Company managers, and ordered them to

direct the Company’s project administrators to post phantom invoices to the

Company’s accounts receivable. These invoices listed work which the Company

“expected” to do in the coming weeks as already complete. CS-2 often personally

overheard Defendant Gaon issuing such instructions to Datatec’s managers during

the Class Period. The managers then called in the project administrators who

reported to them, and gave them the same instructions. CS-1’s manager called in

CS-1 for a meeting shortly before every payroll, and instructed CS-1 to post the

phantom invoices, while commenting: “Corporate says we need to do it again.”

66. Datatec’s project administrators complained about these instructions.

CS-3, a national project manager, reported that “at least half” of the 8 project

administrators with whom he had contact complained about being asked to post

phantom invoices. Some project administrators objected strenuously. According

to CS-1, one project administrator, who worked in the Company’s Dallas office,

and who had an accounting degree, complained to supervisory personnel that what

Individual Defendants were asking them to do was illegal, and that the Company

could not post phantom invoices. Individual Defendants responded by moving this

project administrator into an area with different responsibilities (collections).


38

67. Upon receipt of the instructions handed down from their managers,

the project administrators thereupon obtained information from project managers

as to future estimated work to be done by the Company, and “pre-invoiced” the

work on the Company’s accounts receivable, as if the work had already been done.

Once the “pre-invoice” was placed on the Company’s accounts receivable, the

Company would receive financing from IBM Credit of approximately 85% of the

amount of the invoice.

68. In the ensuing weeks, if and when the “pre-invoiced” work was

performed, the Company reversed the “pre-invoice” and issued a real invoice to the

customer. These manipulations played havoc with the Company’s billing

processes, and wasted enormous amounts of Datatec employees’ time. CS-1

described the havoc created by the pre-invoicing as “a nightmare,” and said that it

resulted in triple the amount of work. As a result of the extensive pre-invoicing,

the Company’s accounts receivable bore no relation to reality, and billing had to be

done by hand to try to avoid sending the phantom “pre-invoices” to customers who

were not supposed to receive bills for work that was not yet performed. According

to CS-3, who was a national project manager, Datatec’s project managers were

constantly concerned that pre-invoices would accidentally be sent to their

customers for work that was not yet performed. CS-3 heard of a number of


39

occasions prior to and during the Class Period when pre-invoices were in fact sent

to customers erroneously. For instance, according to CS-3, in approximately mid-

2003, AT&T / Banc One received one of these “funny invoices” for “an obnoxious

number” – approximately $75,000 or $125,000. Datatec sales representatives or

project managers then had to “back track” and give excuses to their irate customers

for such bills, such as “It was just a clerical error.”

69. The phantom invoicing began well before the Class Period on a

limited basis, and continued to snowball, until it became a regular occurrence

throughout the Class Period. For instance, in 1999, the project manager on a

project for LibbyOwensFord complained to CS-3 about having to invoice ahead of

time, but the invoicing was only a little ahead of time, about a week. CS-1, CS-2,

CS-3 and CS-5 noted that the pre-invoicing increased throughout the years, and

during the Class Period, was the “regular” way of doing business.

70. The impact on accounts receivable from the pre-invoicing was

dramatic, and became more so over time. CS-5 reported that in 2002, only $1

million out of $11 million on the accounts receivable aging was real. Nonetheless,

despite the fact that Defendant Gaon had instructed Datatec’s employees to engage

in pre-invoicing, according to CS-5, Gaon sometimes “played dumb” as to the

impact on the accounts receivable aging. CS-5 reported attending meetings in


40

approximately 2002, with Gaon, as well as the then-CFO, and another manager,

during which the following conversation repeatedly took place:

Gaon: “I don’t understand why you can’t collect more money on the accounts receivable.” CS-5: “Because the invoices aren’t real and haven’t been sent to the customers yet.” Gaon: “Who told people to invoice when the invoices aren’t real?” CS-5: “You did.”

71. Although CS-5 witnessed the conversation recounted in the preceding

paragraph prior to the Class Period, the situation kept escalating and was even

worse during the Class Period. CS-2 reported that during the Class Period, pre-

invoicing was a frequent occurrence, the “regular” way of doing business. CS-2

reported that the amounts directed to be pre-billed were substantial and

meaningful, usually over $100,000, and frequently involved Datatec’s largest

accounts, including Home Depot. CS-2 often heard Defendant Gaon say during

the Class Period, “We need to pre-bill $100,000 of the project today.” CS-2

opposed the pre-billing strategy in conversations with Gaon. However, CS-2

reported that at no time during his seven years at Datatec (which included the Class

Period) did Gaon abandon the pre-billing practices.


41

72. Similarly, CS-3 reported that the pre-invoicing continued to escalate:

There were progressive stages: When Datatec was doing better, there was just a

little pushing ahead on invoices, with the excuse from management that it was just

so that the Company could “close out the month.” Later, the invoicing was

required to be more and more ahead of time. For instance, CS-3 reported that the

invoicing for a large project involving AT&T and Banc One was “well ahead of

time.” Project managers started receiving emails every two weeks, just before

payroll, to “get everything in” that could conceivably lead to billings. By 2003,

and during the Class Period, if there was any remote possibility of invoicing an

item, Individual Defendants pre-invoiced it.

73. Not surprisingly given what the finance personnel were asked to do,

there was enormous turnover in Datatec’s finance department throughout the years.

CS-5 reported that there were eight different bosses (usually the controller) in the

finance department over the course of 5 years. According to CS-1, there was “a

whole shuffle” in the finance department beginning in 2003, in which a “whole

new crew” was brought in by Defendant Gaon. The previous payroll person was

the only individual who stayed with the Company. About 8 out of 10 people in the

finance department were swapped in 2003.


42

74. According to CS-5, Individual Defendants also furthered their pre-

invoicing scheme by manipulating audits of Datatec’s accounts receivable. When

auditors sent letters to customers requesting confirmation of the phantom accounts

receivable listed on Datatec’s books, Individual Defendants arranged to have

Datatec’s sales representatives and project managers prevail upon Datatec’s

customers to either discard the auditor letters or falsely confirm the phantom

invoices, “as a favor.” Smaller customers generally went along with confirming to

the auditors that invoices were true when they were not. Datatec’s major

customers (such as Dayton Hudson, Walgreens and Walmart) would not confirm to

the auditors that the invoices were true, but instead often discarded the auditor

letters without responding to them.

75. CS-5 reported that Datatec had other finance companies prior to IBM

Credit, and that whenever Datatec “got in trouble” with its financing company (i.e.,

the finance company finally did an extensive audit and learned what was really

occurring, or became completely dissatisfied because the poor collections did not

reflect the amounts shown on the accounts receivable), Datatec switched financing

companies. Prior to IBM Credit, there was a finance company called Finova which

Datatec had these types of problems with.


43

76. According to CS-1 and CS-5, towards the end of the Class Period,

auditors for IBM Credit went “on a rampage” and undertook a very extensive audit

of Datatec=s accounts receivable because the accounts receivable – and the amounts

actually paid to Datatec by customers against the accounts receivable -- were so

askew that they did not make any sense. IBM Credit demanded extensive back-up

materials from Individual Defendants, and apparently learned the truth about the

phony invoicing.

77. However, according to CS-8, some of the IBM Credit personnel

actually knew about the phantom invoicing scheme all along, but had their own

agenda: First, the IBM Credit personnel did not want to acknowledge that they

should long ago have written-off much of Datatec’s IBM Credit credit line

borrowings. Instead, IBM Credit determined not to make more funds available to

Datatec. Second, the IBM Credit personnel did not want to “pull” Datatec’s credit

line while Datatec was doing subcontracting work for IBM Global Services on the

Home Depot contract at a bargain-basement price. The Home Depot contract was

over a $100 million contract for IBM Global Services, and IBM Global Services

did not want to jeopardize this contract by taking drastic measures against one of

its subcontractors before its work was finished.


44

78. According to CS-8, Deloitte was also aware of the phantom invoicing

which Datatec used to draw down the IBM Credit credit line, but did not alter its

audit report to reflect the Company’s use of this fraudulent scheme or the

precariousness of the Company’s financial situation revealed by the invoicing

scheme. Deloitte knew this through several means, including through its work

with Chris Benyak, the Datatec accountant in charge of the IBM Credit credit line,

and through reading the quarterly reports of IBM’s internal auditors, which showed

what was invoiced and what was collected. These quarterly IBM Credit reports

stated that invoices used for draw downs of the credit line had not been invoiced

out to Datatec’s customers. Deloitte received these IBM Credit audit reports every

quarter from Datatec’s accounting staff.

79. A few days before the end of the Class Period – and after Datatec’s

work on the Home Depot contract was complete -- IBM Credit essentially

cancelled Datatec’s credit facility. Previously, commencing with the fiscal quarter

ended January 31, 2001, through and including the fiscal quarter ended July 31,

2003, IBM Credit had always provided the Company with written default waivers

for the Company’s non-compliance with certain financial covenants in the IBM

Credit facility. However on December 12, 2003, IBM Credit informed the


45

Company that it would not provide the Company with a written waiver for the

fiscal quarter ended October 31, 2003.

80. The investing public and others were kept in the dark about Individual

Defendants’ fraudulent invoices, the full extent of Datatec’s non-compliance with

IBM Credit=s financing requirements, and the true state of Datatec’s financial

condition indicated by Individual Defendants’ phantom invoicing scheme.

The Phantom Products Scheme:

81. In addition, during the Class Period, Individual Defendants touted

certain new software products, including an “Asset Guardian” service, as well

along in development, in order to entice investors to invest in the Company. The

following information regarding Datatec’s phantom products was related by CS-2,

a high-level former technology executive at Datatec:

82. Asset Guardian was, “by definition a product which couldn’t exist” --

particularly as Individual Defendants conceived and touted it, according to CS-2.

The product was supposed to manage the entire life cycle of a technology asset

(such as a computer, phone device, or any other technology device) from its

earliest conception to the final phases of disposal. The product was supposed to

manage technology assets’ life cycles all the way from procurement (sourcing,

purchasing), through deployment, configuration, installation, help desks,


46

maintenance, depreciation, technology refresh, planned obsolescence, retirement

and disposal, and everywhere in-between. The project was impossibly over-

ambitious. A lot of large companies – far larger than Datatec – “aspire just to bite

off just a small piece of the life cycle management products, and make a living

from that,” according to CS-2.

83. In reality, Individual Defendants knew or recklessly disregarded that

Asset Guardian was utter “pie in the sky,” and was impossible to produce with the

limited financial and manpower resources Individual Defendants allotted to it.

However, Defendant Gaon knew that investors would like the concept. According

to CS-2, Individual Defendants thus merely went through the motions of trying to

develop the Asset Guardian product, and tried to put together a “skeletal product,

like a slide show,” to show to investors.

84. Some of the specific facts which Individual Defendants knew or

disregarded as to the impossibility of Datatec developing Asset Guardian, given

Datatec’s limited resources, included the following:

(a) According to CS-2 (who made his views known to Individual Defendants), development of the extraordinarily ambitious Asset Guardian project would have required millions upon millions of dollars (perhaps $30 million, but it is difficult to know, since “it’s never been done” and “nothing like that exists”) and a coordinated effort of hundreds of top programmers at a powerhouse software development company


47

such as IBM or Microsoft. A company of Datatec’s size “couldn’t pull it off if it had 100 years,” according to CS-2.

(b) Individual Defendants’ development efforts were paltry “for

show” efforts amounted to only the tiniest fraction of what the project required. Individual Defendants merely allocated to the project approximately $250,000 (for software and database applications and hardware), and approximately twelve programmers all together, consisting of some offshore developers, and the Datatec team which had previously failed to produce other viable software products whom CS-2 referred to as the “failed eDeploy team.” CS-7, a former project manager for eDeploy, explained that, after a series of layoffs, Datatec’s “software development division” consisted of only 10 people by May 2001, and continued to be cut until the few remaining people were all laid off at the end of 2003.

(c) Datatec’s competency was never in software development; it

was not a software development company. The same small team of programmers went from one failed project to another, while Individual Defendants touted the failed projects.

85. Asset Guardian was merely the last of Datatec’s “phantom

products.” These products only existed as “power point presentations.” Individual

Defendants would put on “dog and pony shows” for investors, and act as if

significant development of the product was only days away. Investors would

throw money at the Company, which Individual Defendants would promptly

squander.

86. Another failed Datatec product was “eDeploy.” Datatec previously

received $10 million of financing from IBM for eDeploy. Datatec and Individual


48

Defendants went through the $10 million in approximately a year and a half. At

the same time, Datatec had lavish offices in Denver, with budgets for ski vacations

for employees, a frozen margarita machine and foosball in the office: “It was a

dot.com party,” according to CS-2.

87. eDeploy was supposed to manage a technology deployment project

when devices were located in many different locations. However, it wound up

being a web-based spreadsheet instead of a product with any intrinsic value.

eDeploy was a “skeleton, extremely bare bones” compared to what it was supposed

to be. It was more work to use eDeploy than not to, and it created more work

(administration and paperwork) than it saved, because it was so poorly designed

and executed. Individual Defendants made rules attempting to force Datatec’s

managers to use eDeploy in their work, but the managers refused to use eDeploy

because it created so much extra work. Some Datatec managers were fired for

refusing to use eDeploy. Outside companies who licensed eDeploy from Datatec

discovered that it was unusable in its natural state. These companies either

discontinued using eDeploy, or revised it themselves. CS-2 summed up eDeploy

as follows: “It was just another failed software product.”

88. Another such failed Datatec product, which the same programmers

worked on, was IWPS. IWPS was supposed to be a software configuration tool,


49

which configured computer devices “wholesale” – loading software onto hundreds

of computers in an unattended and automatic fashion, to the customers’ specs,

without the need for anyone to spend “one on one” time with the individual

computers. It never worked.

89. The same developers who failed at putting together IWPS and

eDeploy went on to fail with Asset Guardian. Asset Guardian never saw the light

of day, and was never licensed or used.

90. Behind each of Datatec’s phantom products, there was someone –

usually a crony of Defendant Gaon’s – who had the vision for the product.

91. According to CS-2, Michael Lazar was the individual responsible for

the vision for Asset Guardian. Lazar and Gaon went “way back” and had

previously worked with one another at Glassgal. Raul Pupo, Datatec’s new CEO

after Gaon resigned, immediately recognized that Asset Guardian was valueless.

During Pupo’s first two weeks as CEO, he dismissed Lazar and everyone else who

had anything to do with Asset Guardian.

MATERIALLY FALSE AND MISLEADING

STATEMENTS ISSUED DURING THE CLASS PERIOD

92. The Class Period began on June 26, 2003. On that date, the Individual

Defendants issued a press release announcing the financial results of its fourth

quarter of fiscal 2003 (ending April 30, 2003) and revenue and earnings guidance


50

for fiscal 2004.1 Individual Defendants reported that for fiscal 2003, the Company

would report $125.1 million in revenues and $1.4 million in income, or $0.04 per

share.

93. Also on June 26, 2003, with respect to fiscal 2004 (ending April 30,

2004), Individual Defendants stated the following:

For fiscal 2004, Datatec expects that sales, excluding potential sales from new government opportunities, will be in the range of $120 to $125 million and earnings per share will be between $0.14 and $0.16. The Company expects to be profitable in all four quarters. Any Government sales in the year would be incremental to both the top and bottom line forecasts.

94. Chairman and CEO Gaon stated that the Company would be working

to improve its gross profit margins, profitability and cash flow, in an attempt to

reduce the Company=s future working capital needs: “The Company expects to

achieve improvements to gross margins, profitability and cash flows by taking a

more selective approach to project opportunities, adjusting its sales mix and

continuing to focus on expense control.” Gaon told the public that the Company=s

recent acquisition of Millenium Care, combined with Datatec=s Asset Guardian

software-enabled services, was expected to contribute to the gross margin

improvement.

1 The Company=s fiscal year begins on May 1, and thus its quarters break down as follows: Q1 (May 1 to July 31); Q2 (August 1 to October 31); Q3 (November 1 to January 31); Q4 (February 1 to April 30).


51

95. The statements in the preceding three paragraphs were materially false

and misleading when made for the following reasons:

(a) The statements setting forth Datatec’s financial results for its fourth quarter of fiscal 2003 (ending April 30, 2004) were materially false and misleading because they (i) failed to disclose that the results were based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills.

(b) The statements setting forth Datatec’s positive revenue and

earnings guidance for fiscal 2004 lacked any reasonable basis and were materially false and misleading because they (i) failed to disclose that the guidance was based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated


52

by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting and could only continue to meet its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills, and knew, or recklessly disregarded that the revenue and earnings guidance had no basis in reality.

(c) The statement that “Datatec’s Asset Guardian software-enabled

services is expected to contribute to . . . gross margin improvement” had no reasonable basis and was materially false and misleading because the Asset Guardian software was essentially “pie in the sky” and could not “contribute to . . . gross margin improvement.” Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

96. On July 3, 2003, Datatec announced that it had received “aggregate

gross proceeds of $4.9 million from six funds managed by The Palladin Group

L.P., one of the Company’s current lenders, through the issuance of Subordinated


53

Secured Convertible Notes.” The Company also issued four-year warrants to

purchase an aggregate of 875,000 shares of Common Stock at an exercise price of

$1.32 per share to the purchasers of the Notes.

97. On July 23, 2003, the Company filed its annual report on Form 10-K

for its fiscal 2003 year ended April 30, 2003 (the “2003 Form 10-K”). The 2003

Form 10-K was signed and certified by defendant Gaon. In addition, defendant

Deloitte issued an unqualified opinion appended to the 2003 Form 10-K, stating

that its audit was conducted in accordance with GAAS and that Datatec’s

financials were presented in accordance with GAAP, which statements were untrue

for the reasons set forth herein. The Management Discussion and Analysis

(“MD&A”) section of the 2003 Form 10-K contained the following statements

regarding the Company’s critical revenue recognition policies:

Critical Accounting Policies and Use of Estimates

Revenue Recognition

. . .

Services from deployment activities are performed primarily under long-term contracts, but may be performed under short-term workorders or time and material arrangements. The Company's typical long-term contract contains multiple elements designed to track the various services required under the arrangement with the customer. These elements are used to identify components of progress billings, but are combined for revenue recognition purposes. The Company recognizes revenue earned under long-term


54

contracts utilizing the percentage of completion method of accounting by measuring a contract's percentage of completion as determined by the percentage of total costs incurred to date to total estimated costs. Contracts are reviewed at least quarterly and if necessary, revenue, costs and gross margin are adjusted prospectively for revisions in estimated total contract value and total estimated contract costs. Estimated losses are recognized when identified. Payment milestones differ according to the customer and the type of work performed. Generally, the Company invoices customers and payments are received throughout the deployment process and, in certain cases, in advance of work performed if a substantial amount of up front costs are required. In certain cases payments are received from customers after the completion of site installation. However, revenue and costs are only recognized on long-term contracts to the extent of the contracts’ percentage of completion. Costs and estimated earnings in excess of billings, which is classified as a current asset, is recorded for the amount of revenue earned in excess of billings to customers. Deferred revenue is recorded as a current liability for the amount of billings in excess of revenue earned. The Company records payments received in advance and services to be supplied in the future under contractual agreements as billings in excess of costs and estimated earnings until such related services are supplied. [Emphasis supplied.]

98. The statements in the preceding paragraph were materially false and

misleading when made for the following reasons:

(a) The statement that “revenue and costs are only recognized on long-term contracts to the extent of the contracts’ percentage of completion” was false and misleading because Individual Defendants were causing Datatec to employ unreasonably overstated gross profit margins to significantly understate


55

operating costs, and materially and artificially inflate revenues, gross profits, and net income on long-term contracts. Defendants directed and knew about, or recklessly disregarded, such practices, and knew, or recklessly disregarded that Datatec’s stated accounting recognition policy was continually being violated.

(b) The statement that “Generally, the Company invoices

customers and payments are received throughout the deployment process and, in certain cases, in advance of work performed if a substantial amount of up front costs are required” failed to disclose that Individual Defendants in fact were causing Datatec to place phantom “pre-invoices” on its accounts receivable prior to the deployment process, or the appropriate stage in the deployment process, and well in advance of work being performed regardless of the up front costs required. Defendants directed and knew about, or recklessly disregarded, the Company’s pre-invoicing of work prior to deployment, to obtain fraudulent accounts receivable financing in order to meet payroll and vendor bills.

99. The MD&A in the 2003 Form 10-K also contained a chart purporting

to summarize Datatec’s defaults in its financial covenants (e.g., “net profit to

revenue” and “annual revenue to working capital” ratios) with IBM Credit during

each fiscal quarter, beginning in the fiscal quarter ended as of January 31, 2001,

which IBM Credit had waived. For instance, the chart listed the following

financial covenants with which Datatec had failed to comply for quarters ending in

2003:

Period Covenant Requirement Actual


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Jan. 31,

2003

Annual revenue to working capital

Greater than 5.0 to 1.0 and equal to or less than 25.0 to 1.0

(126.9) to 1

Jan. 31,

2003

Debt service ratio Equal to or greater than 2.0 to 1.0

0.2 to 1

Apr. 30,

2003

Debt service ratio Equal to or greater than 1.25 to 1.0

(1.73) to 1

Apr. 30,

2003

Net profit to

revenue

Equal to or greater than 0.10 percent

(3.38%)

The introductory material to the chart in the 2003 Form 10-K explained that: “The

Company and IBM Credit entered into an Acknowledgement, Waiver and

Amendment to the Inventory and Working Capital Financing Agreement as of the

end of each quarter since January 31, 2001 by which IBM Credit has waived the

Company’s defaults.”

100. The statements in the introductory material and chart referenced in the

preceding paragraph were materially false and misleading when made for the

following reasons:

(a) The default ratios for items involving revenues (such as “annual revenue to working capital” and “net profit to revenue”) summarized in said chart were more serious than stated, because Individual Defendants had caused Datatec to use


57

inflated gross margins to significantly understate operating costs and materially and artificially inflate revenues, gross profits, and net income.

(b) The statement that IBM had waived the Company’s defaults with its financial covenants failed to disclose that Individual Defendants had caused Datatec to engage in a pervasive fraudulent invoicing scheme to obtain the IBM Credit financing.

101. The 2003 Form 10-K also contained the following description of

Datatec’s “deployment services”:

The Company utilizes internally developed Web-enabled implementation tools that differentiate its deployment services. These tools, together with its proprietary processes, allow the Company to rapidly and efficiently deliver high quality and cost effective large-scale technology deployment solutions to its clients, which it does primarily on a fixed time/fixed cost basis. The components of the Company's implementation model are made up of a combination of people, processes and technology that include: • The utilization of eDeploy®, a Web-based software tool

that provides collaboration capabilities for remote planning and design, communication capabilities through fax, voice, data, or digital photographs and monitoring capabilities, ensures that best practices are employed and that mission critical milestones or timelines are escalated to supervisory levels if missed by the responsible parties. These features and others are designed to enhance the speed, accuracy and productivity of the deployment process.




58

(a) The statements that that “The Company utilizes internally developed Web-enabled implementation tools that differentiate its deployment services” and that “These tools, together with its proprietary processes, allow the Company to rapidly and efficiently deliver high quality and cost effective large-scale technology deployment solutions to its clients” were false and misleading because, instead of favorably differentiating Datatec’s deployment services, Datatec’s internally developed Web-enabled implementation tools (such as eDeploy, the first tool listed in the 2003 Form 10-K) were rudimentary, hindered Datatec’s services, and were generally not used by Datatec’s personnel, who refused to utilize these tools due to their inefficiency.

(b) The statements regarding eDeploy’s capabilities and the

statement that “These features and others are designed to enhance the speed, accuracy and productivity of the deployment process” were false and misleading because eDeploy was essentially a poorly-designed web-based spread sheet, which Datatec’s own personnel refused to utilize because it was more cumbersome than traditional methods.

103. In a press release dated July 23, 2003, issued in connection with the

filing of the fiscal 2003 Form 10-K, Datatec stated that it had reported $125.1

million in sales for fiscal 2003, a 66% increase compared to fiscal 2002. Reported

operating income for fiscal 2003 was $5.1 million compared to an operating loss of

$245,000 for the prior year. Reported net income was $1.4 million or $0.04 per

share in fiscal 2003 compared to a net loss of $2.7 million or $0.08 per share in

fiscal 2002.


59

104. In the July 23, 2003 press release, Datatec “reiterated fiscal 2004

revenue guidance of $120 to $125 million and EPS guidance of $0.14 to $0.16,

based upon 41 million shares outstanding.” Gaon again told the public:

Our primary objectives for fiscal 2004 are to improve gross margins by being more selective with respect to the projects we undertake and to increase the focus on our suite of Asset Lifecycle Software products now integrated under the Asset Guardian brand name. In the short time we have been marketing the capabilities of Asset Guardian, which incorporates IW2000, eDeploy and I-Care and their attendant services, we are very encouraged with the response and traction this offering is having with both existing clients and prospects alike. The Asset Guardian web enabled solution has a high gross margin potential and should grow at significantly higher rate than other parts of the business.

105. In the press release Gaon went on to say:

Datatec is continuing to penetrate into new major OEM organizations with the expectation of securing their deployment services and we are also working diligently to increase our exposure to government opportunities through existing relationships. The Company expects to close its first government opportunity with Q2. At this time, we appear to be on track with the fiscal 2004 forecast that was announced on June 26. [Emphasis supplied.]

106. The statements in the preceding three paragraphs were materially false


(a) The statements setting forth Datatec’s financial results for fiscal 2003 were materially false and misleading because they (i) failed to disclose that the results were based on the use of inflated gross margins which significantly understated


60

operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills.

(b) The statements reiterating Datatec’s positive revenue and

earnings guidance for fiscal 2004 and claiming that “At this time, we appear to be on track with the fiscal 2004 forecast that was announced on June 26” lacked any reasonable basis and were materially false and misleading because they (i) failed to disclose that the guidance was based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting and could only continue to meet its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew


61

about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills, and knew, or recklessly disregarded that the revenue and earnings guidance had no basis in reality.

(c) The statements that “In the short time we have been marketing

the capabilities of Asset Guardian, which incorporates IW2000, eDeploy and I-Care and their attendant services, we are very encouraged with the response and traction this offering is having with both existing clients and prospects alike” and that “The Asset Guardian web enabled solution has a high gross margin potential and should grow at significantly higher rate than other parts of the business” had no reasonable basis and were materially false and misleading because the Asset Guardian software was essentially “pie in the sky” and did not have “high gross margin potential.” Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

107. Five days later, on July 28, 2003, Datatec announced that it had “sold

3,696,621 shares of newly issued common stock to institutional and other

accredited investors for gross proceeds of $3.49 million. Investors will also


62

receive five-year warrants to purchase 1,848,306 shares of common stock at a

strike price of $1.3637 per share.”

108. On July 29, 2003, Datatec filed an amendment to a Form S-1

Registration Statement (File No. 333-105654) for the sale of 8,226,247 shares of

stock by certain selling shareholders. Four million shares pertained to a private

placement of Datatec common stock in April 2003, through which Datatec had

raised $5 million; two million shares pertained to conversion of warrants sold in

connection with the same private placement; 480,000 shares pertained to

conversion of warrants issued to a financial adviser in connection with the April

2003, private placement, and over 1.5 million shares were in connection with

Datatec’s acquisition of Millennium Care, Inc.

109. On July 31, 2003, Datatec filed a Form S-1 Registration Statement

(File No. 333-107502) for the sale of another 9,546,250 shares of stock held by

certain selling shareholders. The shares were previously issued to the selling

shareholders upon conversion of $4.9 million aggregate principal amount of

subordinate secured convertible notes issued in a private placement in July 2003.

110. On August 13, 2003, Individual Defendants announced that Datatec

was awarded a $5.8 million wireless deployment project. Individual Defendants

told the public that Datatec would receive $5.8 million to deploy “wireless


63

technologies at 170 retail locations nationwide” and that “[w]ork is scheduled to

start immediately and will be completed by October 31, 2003, coinciding with the

end of Datatec=s fiscal 2004 second quarter.” However, Individual Defendants did

not reveal the identity of the purported customer who had awarded the alleged

contract.

111. On September 9, 2003, Individual Defendants issued a press release

stating that it had been awarded a contract valued at $11.6 million “to deploy new

LAN-based security technologies at more than 500 retail locations across North

America.” According to the press release, the project would “start up immediately

and is scheduled for completion by January 31, 2004, coinciding with the end of

Datatec=s fiscal 2004 third quarter.” The press release also claimed that the

Company’s “Millennium Care division will play a pivotal role during both the

planning and implementation phases . . . .” Individual Defendants again did not

name the customer who purportedly contracted for these services.

112. On September 12, 2003, the Company filed a Registration Statement

on Form S-1 (File No. 333-108737) for the sale of another 8,071,611 shares of

stock by certain selling shareholders in the secondary market, including 5.5 million

shares issued in a July 28, 2003 private placement through which Datatec received

$3.49 million in proceeds. Thus, by September 12, 2003, the Company had


64

registered a total of in excess of 15 million shares for sale in the secondary market,

or nearly half of the Company=s issued shares. These secondary stock offerings

were being made on behalf of several companies that had provided financing for

the Company in exchange for common stock, such as The Palladin Group, and

others.

113. On September 15, 2003, Individual Defendants issued a press release

reporting Datatec’s results for the first quarter of fiscal 2004 ended July 31, 2003,

and reiterated “fiscal 2004 revenue guidance of $120 to $125 million and EPS

guidance of $0.12 cents based upon 50 million shares outstanding.”

114. Individual Defendants reported in this press release that Datatec’s

operating profits for the first fiscal quarter of 2004 were $613,000 compared to a

loss of $89,000 in the prior quarter. The net loss for the quarter was $175,000 or

$0.00 per share, compared to a net loss of $1,133,000 or $0.03 per share in the

prior quarter.

115. Defendant Gaon also stated in the September 15, 2003 press release

that: “Despite having achieved a break-even quarter compared to a loss in Q4 in

what is a continuing difficult economic environment,” he was still “reiterating the

same guidance of 12 cents per share that we gave three months ago.”

116. The September 15, 2003 press release expounded on fiscal 2004:


65

Mr. Gaon continued, >Some 12 months ago we stated that our primary objectives were to return to profitability and to strengthen the balance sheet following the debilitating effect of the technology slow down. We fully expect to sustain the profitability that we attained in fiscal 2003, and today, our balance sheet is stronger than ever. We are committed to improving the balance sheet even further without recourse to the capital markets through a combination of operational and marketing initiatives that should start positively impacting operations from Q3 onwards. These include anticipated Government revenues to provide greater critical mass and economies of scale, the full launch of Asset Guardian software and its attendant services that we expect will generate $7m in revenues this year climbing to $15m-$18m next year at a combined gross margin of around 50%, and finally, the automation and centralization of certain internal processes and functions to reduce costs.= [Emphasis supplied.]

117. The statements in the preceding four paragraphs were materially false


(a) The statements setting forth Datatec’s financial results for first quarter of fiscal 2004 and claiming that “today, our balance sheet is stronger than ever” were materially false and misleading because they (i) failed to disclose that the results were based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew about, or


66

recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills.

(b) The statements again reiterating Datatec’s positive revenue and

earnings guidance for fiscal 2004, and Gaon’s insistence that he was reiterating “the same guidance of 12 cents per share that we gave three months ago” lacked any reasonable basis and were materially false and misleading because they (i) failed to disclose that the guidance was based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting and could only continue to meet its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills, and knew, or recklessly


67

disregarded that the revenue and earnings guidance had no basis in reality.

(c) The statements that “operational and marketing initiatives . . .

should start positively impacting operations from Q3 onwards” and that these initiatives included “the full launch of Asset Guardian software and its attendant services that we expect will generate $7m in revenues this year climbing to $15m-$18m next year at a combined gross margin of around 50%” had no reasonable basis and were materially false and misleading because the Asset Guardian software was essentially “pie in the sky” and would not have a “full launch” anytime in the foreseeable future. Nor could Asset Guardian generate the revenues which Individual Defendants claim they “expected,” nor could it achieve a “combined gross margin of 50%.” Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

118. On September 15, 2003, Individual Defendants filed Datatec’s Form

10-Q for the quarterly period ended July 30, 2003. The Form 10-Q was signed by

defendant Gaon.

119. The Form 10-Q described Datatec’s purported revenue recognition

policies as follows (similarly to the description of these policies in the 2003

Company’s 10-K):

Critical Accounting Policies:

Revenue Recognition


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The Company generates revenue from: (1) providing technology deployment services, including configuring Internetworking and computing devices to meet the specific needs of its customers, integrating these devices as well as operational and application software with a customer's existing hardware and software, and physically installing the technology on the customer's network and (2) from licensing its software to third parties.

Services from deployment activities are performed primarily under long-term contracts, but may be performed under short-term workorders or time and material arrangements. The Company's typical long-term contract contains multiple elements designed to track the various services required under the arrangement with the customer. These elements are used to identify components of progress billings, but are combined for revenue recognition purposes. The Company recognizes revenue earned under long-term contracts utilizing the percentage of completion method of accounting by measuring total costs incurred to total estimated costs. Under the percentage of completion method of accounting, revenue, costs and gross margin are recognized as work is performed based on the relationship between total costs incurred and total estimated costs.

Contracts are reviewed at least quarterly and, if necessary, revenue, costs and gross margin are adjusted prospectively for revisions in estimated total contract value and total estimated contract costs. Estimated losses are recognized when identified.

Payment milestones differ according to the customer and the type of work performed. Generally, the Company invoices customers and payments are received throughout the deployment process and, in certain cases, in advance of work performed if a substantial amount of up front costs is required. In certain cases payments are received from customers after the completion of site installation. However, revenue and costs


69

are only recognized on long-term contracts to the extent of the contracts' percentage of completion. Costs and estimated earnings in excess of billings, which is classified as a current asset, is recorded for the amount of revenue earned in excess of billings to customers. Accrued costs or deferred revenue is recorded as a current liability for the amount of billings in excess of revenue earned.

Revenue earned under short-term workorders and time and material arrangements is recognized as the work is completed. Billings under these arrangements are typically done when the work is completed. [Emphasis supplied.]

120. The statements concerning revenue recognition in the Form 10-Q set

forth in the preceding paragraph were false and misleading for the reasons set forth

in ¶ 98.

121. The same Form 10-Q also set forth the partial information regarding

Datatec’s liquidity difficulties:

Liquidity

The net loss of $19.4 million for the fiscal year ended April 30, 2001 and the net loss of $2.7 million for the fiscal year ended April 30, 2002 resulted in a strain on the Company's cash resources. Although the Company realized net income of $1.4 million for fiscal year ended April 30, 2003 and took dramatic measures to cut costs and to manage cash, it is still experiencing a significant strain on cash resources. The primary reason for the strain on resources is the increased requirements for expenditures for field personnel, job expenses and materials related to the increased revenue. As a result, the working capital financing line regularly remains at or close to its maximum allowable levels and the average days outstanding on trade


70

payables have extended beyond normal credit terms granted by vendors. Achievement of the Company's fiscal 2004 operating plan, including maintaining adequate capital resources, depends upon the timing of work performed by us on existing projects, our ability to gain and perform work on new projects, our ability to maintain positive relations with our key vendors and our ability to raise permanent capital and replace our current working capital financing line within the timeframe required to meet our spending requirements. Multiple project cancellations, job performance related losses, delays in the timing of work performed by us on existing projects, our inability to gain and perform work on new projects, or our inability to raise permanent capital and replace our current working capital financing line in a timely fashion could have an adverse impact on our liquidity and on our ability to execute our operating plan.

The Company has taken a variety of actions to ensure our continuation as a going concern. A summary of recent events and our completed or planned actions are as follows:

• The Company initiated and completed substantial cost saving measures during the fiscal years ended April 30, 2001 and 2002 and now believes it has a cost structure in line with our expected revenue.

• As a result of the increase in demand for our services and the cost reduction measures initiated over the past two years, we achieved profitability during the fourth quarter of fiscal 2002 and during fiscal 2003. We expect to be profitable throughout fiscal 2004.

• In April 2003, the Company raised aggregate gross proceeds of $5.0 million in a private placement of our common stock and warrants. The proceeds were raised for working capital purposes.


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• In June 2003, we extended our credit facility with IBM Credit to August 2004 from August 2003 and lowered the interest charges on the debt from prime rate plus 4.25% to prime rate plus 1.75%.

• On July 3, 2003, the Company raised an additional $4.9 million by issuing subordinated secured convertible notes and warrants to one of its existing lender groups. The proceeds are being used to pay down the IBM credit facility and for working capital purposes.

• On July 28, 2003, the company raised an additional $3.49 million aggregate gross proceeds in a private placement of our common stock and warrants. The proceeds were raised for working capital purposes.

• On August 29, 2003, the Company entered into an agreement with Christopher J. Carey, by which it agreed to pay down amounts owed to Mr. Carey in equal monthly amounts of $316,666.67, plus interest, beginning September 2003 and ending February 2004. At its option, the Company may pay such monthly amounts in cash or in shares of the Company's common stock determined using a five day average prior to the monthly payment date. The agreement with Mr. Carey also requires the Company to register the shares of common stock issuable to Mr. Carey.

• Management continues to seek to replace our working capital financing line and raise additional permanent capital to support our growth in business. However, management believes that if it is unable to replace our working capital financing line and raise additional capital, it may not be able to continue as a going concern.

IBM Credit, the Company's working capital lender, has notified the Company that it does not intend to renew its working capital line beyond August 2004 (see Note 6 of the Notes to the


72

Condensed Consolidated Financial Statements). As a result, the company is seeking replacement financing for its credit facility. [Emphasis supplied.]

122. The statements in the Form 10-Q set forth in the preceding paragraph

were false and misleading when made for the following reasons:

(a) The statements that “As a result of the increase in demand for our services and the cost reduction measures initiated over the past two years, we achieved profitability during the fourth quarter of fiscal 2002 and during fiscal 2003” were materially false and misleading because they (i) failed to disclose that the 2003 results were based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills.

(b) The statements that “We expect to be profitable throughout fiscal

2004” lacked any reasonable basis and were materially false and misleading because they (i) failed to disclose that the guidance was based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated


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revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits and net income on such purchases, and (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting and could only continue to meet its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing. Defendants directed and knew about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills, and knew, or recklessly disregarded that the revenue and earnings guidance had no basis in reality.

(c) The statements regarding Datatec’s liquidity were false and

misleading because they did not reveal that Datatec was resorting to fraudulent invoicing to obtain financing in order to meet payroll and vendor bills, and that the Company’s liquidity problems were thus actually worse than portrayed in the Form 10-Q.

123. The same Form 10-Q also contained a chart purporting to summarize

Datatec’s defaults of its financial covenants (e.g., “net profit to revenue” and

“annual revenue to working capital” ratios) under the IBM Credit facility, for each

fiscal quarter, beginning in the fiscal quarter ended as of January 31, 2001, which

IBM Credit had waived. For instance, the chart listed the same financial covenants


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with which Datatec had failed to comply for quarters ending in 2003 which are

listed in ¶ 61 of this Complaint, plus the following additional item:

Period Covenant Requirement Actual

July 31,

2003

Net profit to revenue

Equal to or greater than 0.10%

(0.05%)

The introductory material to the chart in the Form 10-Q explained that: “The

Company and IBM Credit entered into an Acknowledgement, Waiver and

Amendment to the Inventory and Working Capital Financing Agreement as of the

end of each quarter since January 31, 2001 by which IBM Credit has waived the

Company’s defaults.” Following the chart, the Form 10-Q advised that: “IBM

Credit, the Company’s working capital lender, has notified the Company that it

does not intend to renew its working capital line beyond August 2004. As a result,

the Company is seeking replacement financing for its credit facility.”

124. The statements in the introductory material and chart and following

the chart, referenced in the preceding paragraph were materially false and


(a) The default ratios for items involving revenues (such as “annual revenue to working capital” and “net profit to revenue”)


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summarized in said chart were more serious than stated, because Defendants had caused Datatec to use inflated gross margins to significantly understate operating costs and materially and artificially inflate revenues, gross profits, and net income.

(b) The statement that IBM had waived the Company’s defaults

with its financial covenants and would not renew beyond August 2004 failed to disclose that Individual Defendants had caused Datatec to engage in a pervasive fraudulent invoicing scheme to obtain the IBM Credit financing.

125. On September 26, 2003, Individual Defendants issued the following

press release, touting its Asset Guardian product and a business partnership

purportedly entered into for the purpose of enhancing Datatec’s Asset Guardian

Service, as follows:

[Datatec] entered into a partnership with Network Physics to accelerate and simplify enterprise deployments of advanced network services such as IP Telephony, Wireless and Virtual Private Networking (VPN).

Datatec will utilize the Network Physics’ NP/BizFlow product as a cornerstone for its “Day 2” Asset Guardian® service, and Network Physics has selected Datatec’s Millennium Care division as its service desk partner for frontline help desk operations, providing tier one support for Network Physics customers.

Datatec’s Asset Guardian service focuses on the monitoring, maintenance, and administration of critical network services. Network Physics will provide three vital capabilities to Datatec’s Asset Guardian service: -- end-to-end service visibility from an end-user perspective


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-- business impact alerting that identifies which business users and what applications are affected by network performance issues

-- rapid problem resolution for hard failures and hard-to-find performance degradations.

“Understanding the ongoing performance of your key assets is an integral part of the operations and maintenance of today’s IT environments,” said Michael Lazar, Datatec Vice President of Technology and Development. “By adding Network Physics as an offering to our Asset Guardian service, we can measure in real-time the key performance indicators (KPI’s) of an enterprise’s most strategic assets, including business critical applications and vital network connections across WAN, LAN, VPN, wireless, and Internet telephony deployments. The Network Physics product provides the right mix of end-to-end business application performance and deep network visibility to capture the end user experience and truly manage inside the network cloud.”

“The synergy between Datatec and Network Physics drove us to select Datatec as our frontline Help Desk delivery partner,” said David Jones, President and CEO of Network Physics. “Both Datatec’s and Network Physics’ customer bases are facing enormous challenges in the deployment (Day 1) and management (Day 2) of critical new network initiatives. Asset Guardian’s seamless approach to the full service chain made Datatec a natural choice as our Level One service desk partner for 24 x 7 customer support.”



(a) The statement that “Datatec’s Asset Guardian service focuses on the monitoring, maintenance, and administration of critical


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network services” was materially false and misleading because the Asset Guardian software was essentially “pie in the sky” and therefore could not “focus on” or otherwise assist with “monitoring maintenance and administration of critical network services.” Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

(b) Similarly, the statement that “By adding Network Physics as an

offering to our Asset Guardian service . . .” falsely and misleadingly implied that Asset Guardian was a functional service to which additional capabilities were being “added.” Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

127. On October 21, 2003, Datatec held its Annual Shareholders= Meeting

for the year ended April 30, 2003. In pertinent part, Defendant Gaon made the

following disclosures with respect to Datatec=s prospects for fiscal 2004:

Finally, on the issue of growth, we believe Asset Guardian will start to make a contribution to top and bottom lines by the fourth quarter of this year. We expect to have a prototype of the product by the middle of November when beta testing will commence. The general launch to the market will take place mid January to early February 2004. This software product has truly unique capabilities that will allow companies to capture, manage, monitor, analyze and account for all their assets from cradle to grave. This development is a mammoth undertaking for a company of our


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size and limited resources, but our development team is rising to the occasion and I have every faith that they will meet or exceed all our expectations. . . . We will be providing the product primarily through an ASP hosting offering thereby making it affordable and easy to license for CAPEX restricted organizations and it will also provide Datatec with an increasing recurring and very high margin revenue stream. The product is also positioned to be deep rather than wide in applications, therefore providing greater practical assistance to management thereby allowing for a quick payback and significant R.O.I. . .

Institutional investors would understand where we are in our lifecycle and I think would be excited about our prospects especially now with our imminent launch of Asset Guardian. However, following the meltdown of the market in 2000/2001 and the subsequent dislocation of our business, we have not reached out to attract institutional support as we had much to do internally to get our business back on a sound footing. With operating performance and our balance sheet now both on firmer ground and economic prospects looking somewhat brighter although still very fragile, I believe the time is right to proceed with a program to increase the share of institutional holdings in our stock, which is currently very small. To help us with this effort and the launch of Asset Guardian, we will be engaging both an IR and PR firm.

In summation, I believe we are taking all the right steps to position this company to take full advantage of the technology recovery which many have anticipated is finally upon us and appears to have some greater momentum to it this time round.



(a) The statement that Asset Guardian “has truly unique capabilities that will allow companies to capture, manage,


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monitor, analyze and account for all their assets from cradle to grave” was materially false and misleading because the Asset Guardian software was essentially “pie in the sky” and did not have any of the “unique capabilities” which Individual Defendants claimed it had. Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

(b) Similarly, the statements that “We expect to have a prototype of

the product by the middle of November when beta testing will commence” and “The general launch to the market will take place mid January to early February 2004” and the statement referring to the “imminent launch of Asset Guardian” falsely and misleadingly implied that Asset Guardian was close to a launch as a functional service. Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

(c) In addition, the statements that “We believe Asset Guardian

will start to make a contribution to top and bottom lines by the fourth quarter of this year” had no basis in reality, and falsely and misleadingly implied that Asset Guardian was close to a launch as a functional service. Individual Defendants knew, or recklessly disregarded, that the Asset Guardian software could not and would not contribute to Datatec’s revenues, did not work and was not achievable without a commitment of resources far in excess of anything Datatec was capable of, and that Datatec had no viable plan for the development, financing and commercialization of the Asset Guardian software.

(d) The statement that “operating performance and our balance sheet [are]

now both on firmer ground was false and misleading because they (i)


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failed to disclose that Datatec’s financials were based on the use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income, (ii) failed to disclose that revenues, gross profits, and net income were materially and artificially inflated by employing the practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases, (iii) failed to disclose that Datatec’s finances were so dire that the Company was meeting its semi-monthly payroll and its bills from Datatec’s vendors with fraudulently-obtained accounts receivable financing, and (iv) failed to disclose that Datatec’s finances were continuing to worsen and were clearly not on “firmer ground.” Defendants directed and knew about, or recklessly disregarded, the Company’s use of inflated gross margins which significantly understated operating costs, and materially and artificially inflated revenues, gross profits, and net income. Defendants also directed and knew about, or recklessly disregarded, the Company’s practice of purchasing excess raw materials and improperly recognizing fictitious revenues, gross profits, and net income on such purchases. In addition, Individual Defendants were directly involved with using fraudulent pre-invoices to obtain financing in order to meet payroll and vendor bills to an ever-increasing extent.

129. On December 5, 2003, Datatec filed a Form S-3 Registration

Statement (File No. 333-110935) to reregister the shares that had previously been

registered as alleged above, namely: 8,226,247 shares declared effective July 31,

2003 (File No. 333-107502); 9,546,250 shares declared effective 10/30/03 (File

No. 333-107502); 8,071,611 shares declared effective 11/26/03 (File No.

333-108737).

130. On December 5, 2003, in a partial revelation of the truth, Datatec

unexpectedly announced that Gaon had stepped down as Chairman and CEO, and


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that Mark Berenblut had resigned as a board member. According to Datatec, Gaon

would be replaced by Raul Pupo as Chief Executive Officer. The Company said it

was Afinalizing the terms of [Pupo=s] employment,” and thus implying that the

executive search to replace Gaon had begun substantially earlier. Datatec also

retracted its previously-announced earnings estimates for fiscal year 2004 and

instead stated that it expected a net loss for the second quarter of fiscal 2004 and an

overall loss for all of fiscal 2004. Datatec=s stock price dropped 34%, from $1.16

on December 4, 2003 to close at $0.77 on December 5, 2003.

131. The Class Period ended on December 16, 2003. Before the opening

of trading on December 17, 2003, Datatec announced the extent of its earnings

retraction:

Datatec Systems, Inc. (Nasdaq: DATC), a leading provider of technology deployment software, services and post-implementation customer care solutions, today announced that it expects the loss for the fiscal quarter ended October 31, 2003 to be approximately $10 million. The Company also intends to take a restructuring charge of approximately $4.5 million in the following fiscal quarter in connection with its decision to eliminate the commercialization of certain software applications and to refocus the business on its core strengths of configuration and deployment. The Company also announced that it will delay the filing with the Securities and Exchange Commission of its Quarterly Report on Form 10-Q for the fiscal quarter ended October 31, 2003 and has decided, through its Audit Committee, to hire


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outside counsel to conduct an independent review of the valuation of long-term contracts. (Emphasis added).

132. Datatec =s stock price dropped another 15% on the news from $0.68 in

the prior day=s trading to close at $0.58 on December 17, 2003 on extremely heavy

volume of 2,348,000 shares compared to the average daily volume of Datatec stock

for the prior 3 months which was approximately 908,863 shares.

Relevant Post-Class Period Events

133. Throughout the class period, Datatec was not in compliance with

certain required covenants under its credit facility with IBM Credit. On December

18, 2003, Datatec filed a Form 8-K with the SEC disclosing, among other things,

that on December 12, 2003, IBM Credit informed Datatec that IBM Credit would

not provide the Company with a written waiver of Datatec=s default under its credit

facility with IBM Credit, for the fiscal quarter ended October 31, 2003. The 8-K

stated, in pertinent part, as follows:

Default Upon Senior Securities The Company maintains a credit facility with IBM Credit in the amount of approximately $25 million. For the fiscal quarter ended October 31, 2003, the Company was not in compliance with certain required financial covenants, and as a result, the Company is in default of the credit facility with IBM Credit. Since the fiscal quarter ended January 31, 2001, through and including the fiscal quarter ended July 31, 2003, the Company


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has had similar financial covenant defaults. For each of these fiscal quarters, IBM Credit had provided to the Company a written default waiver. On December 12, 2003, IBM Credit informed the Company that it would not provide the Company with a written waiver for the fiscal quarter ended October 31, 2003. The Company also has outstanding $4.9 million Subordinated Secured Convertible Notes which were issued to funds managed by the Palladin Group L.P. Pursuant to certain cross-default provisions of these notes, the Company has defaulted on these notes, as a result of its default of the IBM Credit facility and failure to obtain a waiver from IBM Credit on such default.

134. On December 17, 2003, the new CEO Pupo held a conference call

with analysts. An individual investor on the call was furious with Datatec for

giving positive earnings guidance to the public, only to announce a $10 million

loss for the quarter. The investor wanted to know, in substance, how defendant

Gaon could have given such guidance repeatedly to the public during the Class

Period when the Company=s earnings were obviously headed toward the substantial

losses the Company ultimately announced. Pupo was courteous to the investor, but

was careful not to answer any of the questions about Gaon=s conduct.

135. On December 23, 2003, Datatec announced that the Nasdaq Listings

Qualification Department had notified the Company that it violated Marketplace

Rule 4310(c)(14) by failing to file its Form 10-Q for the period ended October 31,


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2003, and that consequently, the Company=s securities would be delisted from the

Nasdaq Stock Market at the opening of business on December 31, 2003.

136. On January 21, 2004, the Company announced the appointment of

two new independent directors to the Datatec board, John W. Adams and Per-Olof

Loof, to serve on the Audit Committee.

137. On October 20, 2004, Traxi LLC (“Traxi”) was retained by Datatec to

examine and understand the Company’s business, and prepare financial

information about Datatec for prospective buyers. On November 17, 2004, Traxi

presented a confidential presentation to IBM Credit and the Palladin Group, L.P.,

which contained an “Adjusted Statement of Operations” covering Datatec’s

operations from 2001 through 2004, based on information in the Eisner Report. In

the “Adjusted Statement of Operations,” Datatec’s revenue for 2004 was reduced

by approximately $10 million to write off unbilled revenue at April 30, 2004, and

Datatec’s revenue for 2003 was reduced by approximately $15 million (to $109.8

million) “to reflect adjustments recorded in FY2004 which are believed to relate to

FY2003.” Traxi’s “Adjusted Statement of Operations” thus confirms that

Datatec’s revenues were materially over-stated during the Class Period.

138. On December 14, 2004, Datatec filed voluntary petitions for

bankruptcy under Chapter 11 of the Bankruptcy Code, in the District of Delaware.


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ADDITIONAL SCIENTER ALLEGATIONS

139. As alleged herein, Individual Defendants acted with scienter in that

Defendants directed and participated in the fraudulent schemes described herein.

As detailed herein, Defendants had actual knowledge, or at a minimum recklessly

disregarded the fact that Datatec and Individual Defendants engaged in the phony

invoicing and phantom products and contract income and revenue recognition

overstatement schemes detailed herein. Among other things, Koch continually

utilized unrealistic over-estimates of gross profit margins to inflate net income and

revenues while knowing the true state of Datatec’s contract costs and percentage of

completion from, inter alia, the project managers who reported to Koch, and Ms.

Kittel’s reports to Koch.

140. Gaon was well aware of Datatec’s precarious finances, as evidenced

by his telephone conversations with IBM Credit in which he asserted that Datatec’s

employees could not show up for work without additional funds. Gaon himself

frequently called Company managers and ordered them to post phantom invoices

to the Company’s accounts receivable. Gaon was often overheard to say, “We

need to pre-bill $100,000 of the project today.” Gaon also attended the vendor

meetings which concerned getting funds to Datatec’s vendors, who were

threatening to cut off sending needed supplies to Datatec – and Gaon “resolved”


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these difficulties by ordering more pre-invoicing. Gaon was also informed of the

Company’s inability to meet payroll, and also “resolved” these problems by

ordering more pre-invoicing. Gaon was also advised by employees that the Asset

Guardian software was not feasible with Datatec’s limited resources. Despite this

knowledge, Individual Defendants touted the product, knowing full well that

Datatec could not make the product functional or commercially feasible.

141. In addition, Defendants knew or recklessly disregarded that the public

documents and statements issued or disseminated in the name of the Company

were materially false and misleading; knew that such statements or documents

would be issued or acquiesced in the issuance or dissemination of such statements

or documents as primary violations of the federal securities laws. Defendants, by

virtue of their receipt of information reflecting the true facts regarding Datatec,

their control over, and/or receipt and/or receipt of information of Datatec=s

allegedly materially misleading misstatements and/or their associations with the

Company which made them privy to confidential proprietary information

concerning Datatec, participated in the fraudulent scheme alleged herein.

142. In addition, Individual Defendants were motivated to commit the

fraud alleged herein -- and in particular, Individual Defendants’ use of the phony

invoicing scheme detailed herein -- to obtain desperately needed funds and


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maintain the Company=s financing from IBM Credit. The Company has had a

history of limited working capital. As a result, it was critical to the survival of

Datatec that the Company have sufficient accounts receivable in order to induce

IBM Credit to extend financing, as well as to induce investors to purchase Datatec

securities which were being offered during the Class Period. As of June 2003,

Datatec had borrowed the maximum available under its credit facility with IBM

Capital. According to Datatec, on April 14, 2003, IBM Credit agreed to amend the

credit facility to: A(i) extend the expiration date of the facility to August 2004 from

August 2003; (ii) provide a maximum availability of (a) $29 million until May 31,

2003; (b) $25 million until December 31, 2003; (c) $20 million until March 31,

2004; and (d) $15 million until August 1, 2004; (iii) lower the charges to prime

plus 1.75% from prime plus 4.25% and (iv) alter certain financial covenants.”

(Form S-1A, filed 10/2/03). IBM Credit subsequently informed Datatec, at least as

early as April 30, 2003, that it was Anot prepared to extend [Datatec=s] credit

facility beyond August 2004.” (SEC Form S-1A, filed 10/2/03). Individual

Defendants were motivated to engage in the fraudulent scheme alleged herein in

order to conceal Datatec’s viability in repaying its credit facility with IBM Credit.

143. In addition, Individual Defendants were motivated to engage in the

fraudulent scheme alleged herein in order to enable the Company to raise much-


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needed capital through the issuance of Subordinated Secured Convertible Notes

and through newly issued common stock to institutional and other accredited

investors, as detailed herein. In total, the Company was able to raise more than

$13.39 million in proceeds. See Complaint ¶¶ 106, 107 and 110.

144. In addition, Individual Defendants were motivated to engage in the

fraudulent scheme alleged herein to enable Datatec to pay vendors who were

threatening to stop providing supplies, which would have closed down the

Company, as detailed above.

145. Also, Individual Defendants were motivated to continue the

substantial compensation, bonuses and perquisites they were receiving or due to

receive from Datatec, inasmuch as publicly admitting that the Company was

effectively insolvent and reliant on fraudulently-obtained financing would end all

of these substantial benefits. Defendant Gaon’s employment agreement (which

commenced on May 1, 2003 and was originally scheduled to end on April 30,

2006) provided him with a $400,000 base salary plus consumer price index

adjustments; a cash incentive bonus based on Datatec’s net consolidated after-tax

profits; a cash incentive bonus based on cumulative stockholder return; a

discretionary cash incentive bonus; stock options; and medical, life, health, dental

and disability insurance, among other perquisites.


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VIOLATIONS OF GAAP AND SEC REPORTING RULES

146. During the Class Period, Defendants materially misled the investing

public, thereby inflating the price of the Company’s common stock, by publicly

issuing false and misleading statements and omitting to disclose material facts

necessary to make Defendants’ statements, as set forth herein, not false and

misleading. These statements and omissions were materially false and misleading

in that they failed to disclose material adverse information and misrepresented the

truth about the Company and the accounting, reporting, and financial condition of

the Company in violation of the federal securities laws and GAAP.

147. The GAAP provisions violated by Defendants, and discussed in detail

below, were not new or untested provisions of GAAP and did not involve complex

accounting issues. Additionally, Defendants committed these GAAP violations

repeatedly, both before and during the Class Period.

148. The true nature of Datatec and Individual Defendants’ improper

accounting for contracts and revenue recognition practices were not revealed

during the Class Period. According to information related by Plaintiffs’

confidential sources set forth in this Complaint, Datatec’s improperly recognized

revenues consisted of estimated revenues on estimated, not-yet-performed future


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work, which were recognized contrary to Datatec and Individual Defendants’

stated revenue recognition policies as well as GAAP.

149. The SEC requires that publicly traded companies present their

financial statements in accordance with GAAP. 17 C.F.R. § 210.4-01(a)(1).

GAAP consists of those principles recognized by the accounting profession as the

conventions, rules, and procedures necessary to define accepted accounting

practices at the particular time. Regulation S-X, to which the Company is subject

as a registrant under the Exchange Act, 17 C.F.R § 210.4-01(a)(1), 65 provides that

financial statements filed with the SEC that are not prepared in compliance with

GAAP are presumed to be misleading and inaccurate. Accounting Series Release

(“ASR”) 4, codified at SRA 34.

150. As set forth in Financial Accounting Standards Board (“FASB”)

Statement of Financial Accounting Concepts (“SFAC”) No. 1, one of the

fundamental objectives of financial reporting is to provide accurate and reliable

information concerning an entity’s financial performance during the period being

presented. SFAC No. 1, ¶42 states:

Financial reporting should provide information about an enterprise’s financial performance during a period. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors’ and creditors’ expectations about future enterprise


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performance, those expectations are commonly based at least partly on evaluations of enterprise performance.

151. Additionally, Section 13 of the Exchange Act requires, in part, that

companies like Datatec:

devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that - -

* * *

transactions are recorded as necessary (i) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (ii) to maintain accountability for assets;

15 U.S.C. § 78m(b).

152. Defendants’ representations that Datatec’s financial statements were

presented in accordance with GAAP and other SEC reporting requirements were

materially false and misleading because, as alleged in this Complaint, Defendants:

(1) engaged in the fraudulent revenue recognition practices detailed in this

Complaint, which materially overstated the Company’s reported revenues, gross

profits, net income, and other financial results; and (2) failed to disclose material

trends in sales and invoicing practices that would have a significant, adverse effect

on future results. Each of these misrepresentations, material omissions and

fraudulent revenue recognition practices, standing alone, was a material breach of


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GAAP or applicable SEC regulations, as well as the Company’s own accounting

policies.

Improper Accounting For Contracts

153. AICPA Statement of Position (“SOP”) 81-1, entitled “Accounting for

Performance of Construction-Type and Certain Production-Type Contracts,”

provides the GAAP requirements relating to accounting for long-term contracts.

SOP 81-1.22 provides for use of the percentage-of-completion method and

describes its advantages:

The percentage-of-completion method recognizes the legal and economic results of contract performance on a timely basis. Financial statements based on the percentage-of-completion method present the economic substance of a company's transactions and events more clearly and more timely than financial statements based on the completed-contract method, and they present more accurately the relationships between gross profit from contracts and related period costs. The percentage-of-completion method informs the users of the general purpose financial statements of the volume of economic activity of a company.

SOP 81-1.22.

154. Furthermore, Accounting Research Bulletin ("ARB") No. 45: Long-

Term Construction-Type Contracts, indicates that the principal advantage of the

percentage-of-completion method is the periodic recognition of income currently.

ARB No. 45 states in relevant part, as follows:


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The percentage-of-completion method recognizes income as work on a contract progresses. The committee recommends that the recognized income be that percentage of estimated total income, either: (a) that incurred costs to date bear to estimated total costs after giving effect to estimates of costs to complete based upon most recent information, or (b) that may be indicated by such other measure of progress toward completion as may be appropriate having due regard to work performed.

155. The requirement that estimates used for the percentage-of-completion

method be dependable is emphasized in SOP 81-1.23 and 81-1.24:

Circumstances Appropriate to the Method

.23 The use of the percentage-of-completion method depends on the ability to make reasonably dependable estimates. For the purposes of this statement, ‘the ability to make reasonably dependable estimates’ relates to estimates of the extent of progress toward completion, contract revenues, and contract costs. The division believes that the percentage-of-completion method is preferable as an accounting policy in circumstances in which reasonably dependable estimates can be made and in which all the following conditions exist: • Contracts executed by the parties normally include provisions that clearly specify the enforceable rights regarding goods or services to be provided and received by the parties, the consideration to be exchanged, and the manner and terms of settlement. • The buyer can be expected to satisfy his obligations under the contract. • The contractor can be expected to perform his contractual obligations. .24 For entities engaged on a continuing basis in the production and delivery of goods or services under contractual arrangements and for whom contracting represents a significant part of their operations, the


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presumption is that they have the ability to make estimates that are sufficiently dependable to justify the use of the percentage-of-completion method of accounting. Persuasive evidence to the contrary is necessary to overcome that presumption. The ability to produce reasonably dependable estimates is an essential element of the contracting business. For a contract on which a loss is anticipated, generally accepted accounting principles require recognition of the entire anticipated loss as soon as the loss becomes evident. An entity without the ability to update and revise estimates continually with a degree of confidence could not meet that essential requirement of generally accepted accounting principles. (Emphasis added)

156. Defendants violated GAAP because Datatec’s financials did not

recognize anticipated losses, or use estimates based on reality and historical

experience (as opposed to the need to report profits), as required by SOP 81-1.

Instead, Defendants applied inflated estimates to distort reported net income and

revenues.

Improper Revenue Recognition

157. Under GAAP, revenue should not be recognized until it is both earned

and

collectible. SFAC No. 5, ¶¶ 83-84. These paragraphs indicate the following:

83. Further guidance for recognition of revenues and gains is intended to provide an acceptable level of assurance of the existence and amounts of revenues and gains before they are recognized. Revenues and gains of an enterprise during a period are generally measured by the exchange values of the assets (goods or services) or liabilities involved, and recognition involves consideration of two factors (a) being


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realized or realizable and (b) being earned, with sometimes one and sometimes the other being the more important consideration.

a. Realized or realizable. Revenues and gains generally are not

recognized until realized or realizable. Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Readily convertible assets have (i) interchangeable (fungible) units and (ii) quoted prices available in an active market that can rapidly absorb the quantity held by the entity without significantly affecting the price.

b. Earned. Revenues are not recognized until earned. An entity's

revenue-earning activities involve delivering or producing goods, rendering services, or other activities that constitute its ongoing major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. Gains commonly result from transactions and other events that involve no "earning process," and for recognizing gains, being earned is generally less significant than being realized or realizable.

84. In recognizing revenues and gains:

a. The two conditions (being realized or realizable and being earned) are usually met by the time product or merchandise is delivered or services are rendered to customers, and revenues from manufacturing and selling activities and gains and losses from sales of other assets are commonly recognized at time of sale (usually meaning delivery).

b. If sale or cash receipt (or both) precedes production and

delivery (for example, magazine subscriptions), revenues may be recognized as earned by production and delivery.


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c. If product is contracted for before production, revenues may be

recognized by a percentage-of-completion method as earned—as production takes place—provided reasonable estimates of results at completion and reliable measures of progress are available.

d. If services are rendered or rights to use assets extend

continuously over time (for example, interest or rent), reliable measures based on contractual prices established in advance are commonly available, and revenues may be recognized as earned as time passes.

e. If products or other assets are readily realizable because they

are salable at reliably determinable prices without significant effort (for example, certain agricultural products, precious metals, and marketable securities), revenues and some gains or losses may be recognized at completion of production or when prices of the assets change. Paragraph 83(a) describes readily realizable (convertible) assets.

f. If product, services, or other assets are exchanged for

nonmonetary assets that are not readily convertible into cash, revenues or gains or losses may be recognized on the basis that they have been earned and the transaction is completed. Gains or losses may also be recognized if nonmonetary assets are received or distributed in nonreciprocal transactions. Recognition in both kinds of transactions depends on the provision that the fair values involved can be determined within reasonable limits.

g. If collectibility of assets received for product, services, or other

assets is doubtful, revenues and gains may be recognized on the basis of cash received.

SFAC No. 5, ¶¶ 83-84 (emphasis added).


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158. For companies like Datatec that sell mostly services, revenue is

recognized when the services are received and accepted by Datatec’s customers.

As detailed herein, Defendants violated GAAP by repeatedly causing Datatec to

recognize revenue for services which were not yet performed and billable, or based

on grossly unreasonable estimates.

159. These same straight-forward accounting principles were reflected in

Datatec’s own stated revenue recognition policy. Datatec’s 2003 Form 10-K

represented the Company’s revenue recognition policy, as set forth in paragraph 97

of this Complaint. Datatec’s Form 10-Q, for the period ending July 31, 2003, set

forth the Company’s revenue recognition policy as set forth in paragraph 119 of

this Complaint.

160. As detailed herein, Defendants repeatedly caused Datatec to violate

both GAAP and its own revenue recognition policies by repeatedly recognizing

revenue before products were shipped or services rendered, and/or where the

purchaser had not yet been billed and had no fixed payment obligation; the

products or services had not been delivered; or collectability was not reasonably

assured. This violated the aforementioned SFAC No. 5, as well as Staff

Accounting Bulletin No. 101 promulgated by the SEC, which adopts the provisions

of SFAC No. 5.


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161. In addition, the recognition of assets was in direct violation of GAAP,

because such items did not meet the definition of assets contained in SFAC 6, ¶¶

25-26. These paragraphs provide as follows:

25. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Characteristics of Assets 26. An asset has three essential characteristics: (a) it embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows, (b) a particular entity can obtain the benefit and control others' access to it, and (c) the transaction or other event giving rise to the entity's right to or control of the benefit has already occurred. Assets commonly have other features that help identify them—for example, assets may be acquired at a cost and they may be tangible, exchangeable, or legally enforceable. However, those features are not essential characteristics of assets. Their absence, by itself, is not sufficient to preclude an item's qualifying as an asset. That is, assets may be acquired without cost, they may be intangible, and although not exchangeable they may be usable by the entity in producing or distributing other goods or services. Similarly, although the ability of an entity to obtain benefit from an asset and to control others' access to it generally rests on a foundation of legal rights, legal enforceability of a claim to the benefit is not a prerequisite for a benefit to qualify as an asset if the entity has the ability to obtain and control the benefit in other ways.

SFAC ¶¶ 25-26. Regulation S-K Violations

162. Item 7 of Datatec’s 2003 Form 10-K and Item 2 of Datatec’s Form 10-

Q for the quarter ending July 31, 2003, Management’s Discussion and Analysis of

Financial Condition and Results of Operations (“MD&A”), required Individual


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Defendants to furnish information required by Item 303 of Regulation S-K, 17

C.F.R. § 229.303. In discussing results of operations, Item 303 of Regulation S-K

says a registrant must:

Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.

The Instructions to Paragraph 303(a) add:

The discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results.

163. In its May 18, 1989 Interpretive Release No. 33-6835, the SEC

indicated that registrants should employ the following two-step analysis in

determining when a known trend or uncertainty is required to be included in the

MD&A disclosure pursuant to Item 303 of Regulation S-K:

A disclosure duty exists where a trend, demand, commitment, event or uncertainty is both presently known to management and is reasonably likely to have material effects on the Registrant’s financial condition or results of operations.

164. Defendants knew or recklessly disregarded that Item 303 of

Regulation S-K required Datatec to disclose that it lacked internal controls

necessary to prevent revenue recognition abuses, and that the absence of such

internal controls was reasonably likely to have a material adverse effect on the


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Company’s operating results. Disclosure of this information was necessary for a

proper understanding evaluation of Datatec’s operating performance and in making

an informed investment decision.

Additional Violations of GAAP

165. In addition to the accounting violations described above, Defendants

allowed Datatec to present its financial statements in a manner that violated, among

others, the following GAAP principles:

(a) the principle that a conservative approach be taken to ensure that uncertainty and risks inherent in business situations are adequately considered, and that errors in measurement be in the direction of understatement rather than overstatement of net income and net assets. (See SFAC No. 2 ¶¶ 91-97);

(b) the principle that the financial information presented should be

complete. (See SFAC No. 2, ¶¶ 79-80);

(c) the principle of fair presentation (“presents fairly”). (See SFAC No. 1, ¶33);

(d) the principle of adequacy and fairness of disclosure. (See SFAC

No. 1, ¶34 and SFAC No. 5, ¶¶7, 12);

(e) the principle of materiality concerning information that is significant enough to affect the judgment of a reasonable person. (See SFAC No. 2, ¶132);

(f) the principle that the financial statements contain and disclose

relevant and timely information for the economic decisions of the user. (See SFAC No. 2, ¶¶ 47, 48, 52, 56);


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(g) the principle that the financial statements provide reliable financial information that represents the economic conditions or events that it purports to represent. (See SFAC No. 2, ¶¶ 58, 62);

(h) the principle that financial information should be comparable

and consistent with similar information about other enterprises and with similar information about the same enterprise for some other period or some other point in time. (See SFAC No. 2 ¶¶ 111, 115, 117, 120);

(i) the principle that financial information should be neutral, or

free from bias towards a predetermined result. (See SFAC No. 2 ¶¶ 98, 99);

(j) the principle that financial reporting should provide information

about the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events, and circumstances that change resources and claims to those resources. (See SFAC No. 1 ¶40);

(k) the principle that financial reporting should provide information

that is useful to users of the financial statements in making rational investment, credit, and similar decisions. (See SFAC No. 1 ¶34);

(l) the principle that accounts receivable must be reported in the

financial statements at net realizable value. (See ARB 43, Chapter 3A); and

(m) the principle that disclosure of an entity’s accounting policies

should identify and describe the accounting principles followed by the reporting entity and the methods of applying those principles that materially affect the determination of financial position, changes in financial position, or results of operations because information about the accounting policies adopted by a reporting entity is essential for financial statement users. (See APB 22, ¶8, 12).


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166. In filing financial statements with the SEC which failed to conform to

the requirements of GAAP, Defendants repeatedly disseminated or permitted the

dissemination of financial statements that were presumptively misleading and

inaccurate. Indeed, the accounting improprieties detailed herein evidence

Individual Defendants’ intent to deceive investors during the Class Period and

misrepresent the truth about the Company and its business, operations and financial

performance to the detriment of those who relied on them.

167. Defendants were required to disclose, in the Company’s financial

statements, the existence of the material facts described herein and to appropriately

recognize and report assets, revenues, and expenses in conformity with GAAP.

The Company failed to make such disclosures and to account for and to report its

financial statements in conformity with GAAP. Defendants knew, or were reckless

in not knowing, the facts which indicated that all of the Company’s financial

statements during the Class Period, including press releases, public statements, and

filings with the SEC, which were disseminated to the investing public during the

Class Period, were materially false and misleading for the reasons set forth herein.

Had the true financial position and results of operations of the Company been

disclosed during the Class Period, the Company’s common stock would have

traded at prices well below its posted price.


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DELOITTE IGNORED INFORMATION INDICATING DATATECS’S LACK OF VIABILITY AS A GOING CONCERN AND

FAILED TO FOLLOW GENERALLY ACCEPTED AUDITING STANDARDS

168. CS-8 related that on virtually a daily basis during the Class Period,

Company controller Simon Jethwani or an accounting manager such as Chris

Benyak called IBM Credit to wire additional funds to Datatec’s bank account, at

the request of defendant Gaon. Approximately every two weeks, IBM Credit

responded that it would not wire any further funds. Gaon then told IBM, “I don’t

know what you want me to do. We need the money to pay our employees to

complete the jobs. If you don’t make the money available, our guys won’t show

up in the morning on the Home Depot job.” Inasmuch as IBM Global Services

was the general contractor on the Home Depot job, IBM Credit then relented, and

wired funds for current daily bills.

169. On several occasions commencing in March 2003, CS-8 called

Deloitte audit partner Mark Davis, related the foregoing conversations, and

described Datatec’s lack of funds. The lack of funds, and IBM’s statements to

Datatec officials that it would not advance further funds provided Deloitte with

actual notice of Datatec’s insolvent condition and viability as a going concern.


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170. Datatec’s cost overruns on the majority of its contracts also put

defendant Deloitte on notice regarding Datatec’s lack of viability. The Company’s

recorded costs, including salaries, insurance, and self-insured medical costs (which

were climbing), were all kept current on the general ledger, and available to

Deloitte. CS-8 observed Deloitte request certain items from the general ledger,

which were promptly furnished to Deloitte by Datatec’s accounting staff.

171. CS-8 also reported that Deloitte’s audit took place in June and July

2003, and was “mechanical.” Deloitte seemed unconcerned with Datatec’s

massive borrowing from IBM Credit, or how Datatec would find the cash to go

forward. Despite Datatec’s years of losses, lack of sustainable profits, borrowings

in excess of available credit limits, continuing lack of cash and inability to reduce

debt despite millions of dollars of private placements (which was a clear sign of

enormous continuing “cash burn” and unprofitability), Deloitte knowingly, or at a

minimum, extremely recklessly failed to ask the questions about the Company’s

viability or engage in the normal audit procedures compelled by Datatec’s

circumstances.

172. As indicated in the Eisner report, as described by CS-8, Deloitte

improperly relied upon defendant Koch’s totally unrealistic, excessive gross profit

margin estimates which inflated net income and revenues, despite Koch’s history


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of continually providing excessive gross profit margin estimates. According to

CS-8, during Deloitte’s audit in June-July 2003, and as set forth in paragraph 41

above, Deloitte simply discussed with Koch what the gross profit margin estimate

should be on a list of contracts, and merely reduced the gross profit margin by

approximately one percent. Deloitte did not properly verify the gross profit margin

and percentage of completion with third parties, or by contacting project managers

regarding the remaining work and examining the costs of performing such

remaining work.

173. Moreover, although historical information and the historical accuracy

of estimates are critical for assessing the accuracy of current estimates, and

Deloitte had all the historical information available in the prior years’ work papers,

Deloitte did not compare the estimated versus actual gross profit margins used on

Datatec’s projects until December 2003.

174. Despite Deloitte’s lack of proper audit procedures to reasonably

assure that Datatec’s financial statements were free of material misstatement,

Deloitte issued an unqualified opinion to the public, in its Independent Auditors’

Report, filed with Datatec’s 2003 Form 10-K file on July 23, 2003 as follows:

We conducted our audits in accordance with the auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial


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statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the company as of April 30, 2003 and 2002, and the results of their operations and their cash flows for each of the tree years in the period ended April 30, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statements schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

175. During the end of October 2003 through the beginning of November

2003, while stating to put together materials for Datatec’s 10-Q for the period

ending October 31, 2003 (which 10-Q ultimately never was filed), Deloitte, Koch,

Gaon and other Datatec officers had several discussions during this period

regarding the lack of any possible profit on the Home Depot project, and were

aware that the expectations for gross profit would not be realized. Deloitte arrived

at Datatec’s premises for a two-week review from November 15 to 30, 2003,

during which time CS-8 again brought to Deloitte’s attention the concerns

regarding Koch and the fact that gross profit expectations would not be realized.


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176. On approximately December 1, 2003, CS-8 arranged a phone call with

Mark Davis from Deloitte, Datatec General Counsel Rick Davis, Datatec board

member Bob Friedman, the head of Datatec’s audit committee Ollie Magard, and

the other two members of Datatec’s audit committee. During the call, CS-8 stated

that Datatec would have a significant loss, rather than the gain which Defendants

had led investors to expect. CS-8 and Deloitte thereafter, during conversations in

approximately January 2004, discussed the fact that Datatec had never made a

profit – and that reported profits had been generated by establishing high estimated

gross profit margins.

VIOLATIONS OF GAAS

Deloitte’s Failure To Adequately Audit Material Management Estimates

177. To perform an audit in accordance with GAAS, the auditor is required

to apply certain procedures with respect to significant management estimates

embodied in the financial statements. Deloitte was responsible:

for evaluating the reasonableness of accounting estimates made by management in the context of the financial statements taken as a whole. As estimates are based on subjective as well as objective factors, it may be difficult for management to establish controls over them. Even when management's estimation process involves competent personnel using relevant and reliable data, there is potential for bias in the subjective factors. Accordingly, when planning and performing procedures to evaluate accounting estimates, the auditor should consider, with an attitude of professional skepticism, both the subjective and objective factors.


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AICPA Professional Auditing Standard (“AU”) 342.04.

178. Moreover, historical experience and other factors need to be

considered by the auditor when evaluating the estimates’ reasonableness:

In evaluating the reasonableness of an estimate, the auditor normally concentrates on key factors and assumptions that are— a. Significant to the accounting estimate.

b. Sensitive to variations.

c. Deviations from historical patterns.

d. Subjective and susceptible to misstatement and bias.

The auditor normally should consider the historical experience of the entity in making past estimates as well as the auditor's experience in the industry. However, changes in facts, circumstances, or entity's procedures may cause factors different from those considered in the past to become significant to the accounting estimate.

AU 342.09 (emphasis added).

In evaluating reasonableness, the auditor should obtain an understanding of how management developed the estimate. Based on that understanding, the auditor should use one or a combination of the following approaches: a. Review and test the process used by management to develop the

estimate. b. Develop an independent expectation of the estimate to

corroborate the reasonableness of management's estimate.


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c. Review subsequent events or transactions occurring prior to completion of fieldwork.

AU 342.10.

Review and test management's process. In many situations, the auditor assesses the reasonableness of an accounting estimate by performing procedures to test the process used by management to make the estimate. The following are procedures the auditor may consider performing when using this approach: d. Identify whether there are controls over the preparation of

accounting estimates and supporting data that may be useful in the evaluation.

e. Identify the sources of data and factors that management used

in forming the assumptions, and consider whether such data and factors are relevant, reliable, and sufficient for the purpose based on information gathered in other audit tests.

f. Consider whether there are additional key factors or alternative

assumptions about the factors.

g. Evaluate whether the assumptions are consistent with each other, the supporting data, relevant historical data, and industry data.

h. Analyze historical data used in developing the assumptions to

assess whether the data is comparable and consistent with data of the period under audit, and consider whether such data is sufficiently reliable for the purpose.

i. Consider whether changes in the business or industry may

cause other factors to become significant to the assumptions.

j. Review available documentation of the assumptions used in developing the accounting estimates and inquire about any


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other plans, goals, and objectives of the entity, as well as consider their relationship to the assumptions.

k. Consider using the work of a specialist regarding certain

assumptions (section 336, Using the Work of a Specialist).

l. Test the calculations used by management to translate the assumptions and key factors into the accounting estimate.

AU 342.11 (emphasis added).

179. Deloitte violated the foregoing standards by, inter alia, failing to

properly evaluate Individual Defendants’ accounting “estimates” and consider

historical experience and data relating to the percentage-of-completion estimates,

which were the lynchpins of the Company’s financial statements.

Deloitte’s Improper Reliance On Management Representations

180. AU § 333 provides auditing guidance for management

representations. This standard provides that while representations from

management are part of the evidential matter that an auditor obtains, they are not a

substitute for the application of auditing procedures considered necessary to

provide a reasonable basis for an opinion. AU § 333.02.

181. Moreover, GAAS requires that, if a representation made by

management is contradicted by other audit evidence, the auditor should use

professional skepticism in investigating the circumstances and consider the

reliability of the representations made. The standard also requires that based on the


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circumstances, the auditor should consider whether reliance on management’s

representations concerning other aspects of the financial statements is justified.

AU § 333.04.

182. Deloitte, in violation of these professional standards, improperly

relied on the gross profit margin estimates provided by defendant Koch, despite

Koch’s history, contained in Deloitte’s work papers, of continually providing

excessive gross profit margins. Indeed, the Eisner Report criticized Deloitte for

this serious lapse.

183. In light of Deloitte’s improper reliance on Koch’s estimates, which

historically were grossly over-estimated, Deloitte also failed to adequately evaluate

the competence and sufficiency of the evidential matter. GAAS requires the

auditor to evaluate evidential matter obtained to ensure that the specific audit

objectives are achieved, to design audit procedures recognizing the possibility that

financial statements may not be fairly presented in conformity with generally

accepted accounting principles, and to consider relevant evidential matter. AU §

326.25. Moreover, “[t]o the extent the auditor remains in substantial doubt about

any assertion of material significance, he or she must refrain from forming an

opinion until he or she has obtained sufficient competent evidential matter to


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remove such substantial doubt, or the auditor must express a qualified opinion or a

disclaimer of opinion.” Id.

Deloitte’s Failure To Adequately Consider Indicia Of Fraud

184. Deloitte was required, under GAAS, to plan its audits to obtain

reasonable assurance that the financial statements it was auditing were free of

material misstatement, whether caused by error or fraud. In fact, Deloitte was

required to specifically assess the risk that Datatec’s financial statements could be

materially misstated as a result of fraud. See, e.g., AICPA-SAS No. 82. SAS No.

82 provides examples of various factors that may be indicative of fraud or motive

to commit fraud at an audit client. Some of the very same examples of “red flags”

of fraud noted in the GAAS literature actually existed at Datatec. Deloitte was

required by these GAAS provisions, among others, to assess the presence of each

of these factors and, therefore, knew of or recklessly ignored these indicia of fraud

at Datatec. In addition to those “red flags” discussed above which put Deloitte on

notice regarding the Company’s lack of viability, including the Company’s lack of

cash for operations, heavy borrowings, and failure to reduce debt despite millions

of dollars of securities placements, Deloitte also knew of or recklessly disregarded

the “red flag” of Datatec’s high management turnover, with numerous Chief


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Financial Officers, and high turnover among its financial personnel, within a short

period of time.

Deloitte’s Failure To Obtain And Evaluate Sufficient Competent Evidential Matter

185. Deloitte also violated GAAS by violating the third standard of field

work which states: “Sufficient competent evidential matter is to be obtained

through inspection, observation, inquiries, and confirmations to afford a reasonable

basis for an opinion regarding the financial statements under audit.” AU 326.01.

Most of the auditor's work in forming an opinion on a Company's financial

statements consists of obtaining and evaluating evidential matter concerning the

assertions in such financial statements.

186. Furthermore, in evaluating the competency of evidential matter, the

standard states:

To be competent, evidence, regardless of its form, must be both valid and relevant. The validity of evidential matter is so dependent on the circumstances under which it is obtained that generalizations about the reliability of various kinds of evidence are subject to important exceptions. If the possibility of important exceptions is recognized, however, the following presumptions, which are not mutually exclusive, about the validity of evidential matter in auditing have some usefulness:

a. When evidential matter can be obtained from independent sources outside an entity, it provides greater assurance of reliability for the purposes of an independent audit than that secured solely within the entity.


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b. The more effective the internal control, the more assurance it

provides about the reliability of the accounting data and financial statements.

c. The independent auditor's direct personal knowledge, obtained

through physical examination, observation, computation, and inspection, is more persuasive than information obtained indirectly.

AU 326.21.

187. Deloitte violated the foregoing standard by failing to obtain competent

evidential matter with regards to, inter alia, Individual Defendants’ estimates of

gross profit margin and percentage of completion, as well as the fictitious

receivables.

Deloitte’s Failure To Properly Evaluate Datatec’s Ability To Continue As A Going Concern, And To Issue A “Going-Concern” Opinion

188. GAAS requires the auditor to evaluate whether there is substantial

doubt about the entity's ability to continue as a going concern for a reasonable

period of time. The professional standards state the following:

a. The auditor considers whether the results of his procedures performed in planning, gathering evidential matter relative to the various audit objectives, and completing the audit identify conditions and events that, when considered in the aggregate, indicate there could be substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time. It may be necessary to obtain additional information about such conditions and events, as well as the appropriate evidential matter to support information that mitigates the


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auditor's doubt.

b. If the auditor believes there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time, he should (1) obtain information about management's plans that are intended to mitigate the effect of such conditions or events, and (2) assess the likelihood that such plans can be effectively implemented.

c. After the auditor has evaluated management's plans, he concludes whether he has substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time. If the auditor concludes there is substantial doubt, he should (1) consider the adequacy of disclosure about the entity's possible inability to continue as a going concern for a reasonable period of time, and (2) include an explanatory paragraph (following the opinion paragraph) in his audit report to reflect his conclusion. If the auditor concludes that substantial doubt does not exist, he should consider the need for disclosure.

AU 341.03

189. Deloitte violated the foregoing standard by failing to properly obtain

information and evaluate whether there was substantial doubt about the entity's

ability to continue as a going concern for a reasonable period of time, and by

failing to issue a “going-concern” opinion.

APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE-MARKET DOCTRINE

190. At all relevant times, the market for Datatec common stock was an

efficient market for the following reasons, among others:


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(a) that Datatec common stock met the requirements for listing, and was listed and actively traded, on the Nasdaq, a highly efficient market;

(b) As a regulated issuer, Datatec filed periodic public reports with

the SEC; (c) Datatec stock was followed by securities analysts employed by

major brokerage firms who wrote reports which were distributed to the sales force and certain customers of their respective brokerage firms. Each of these reports was publicly available and entered the public marketplace; and

(d) Datatec regularly issued press releases which were carried by

national newswires. Each of these releases was publicly available and entered the public marketplace.

191. As a result, the market for Datatec securities promptly digested

current information with respect to Datatec from all publicly-available sources and

reflected such information in Datatec=s stock price. Under these circumstances, all

purchasers of Datatec common stock during the Class Period suffered similar

injury through their purchase of stock at artificially inflated prices and a

presumption of reliance applies.

PLAINTIFFS= CLASS ACTION ALLEGATIONS

192. Plaintiffs bring this action as a class action pursuant to Federal Rule of

Civil Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who

purchased the securities of Datatec during the Class Period who were damaged

thereby. Excluded from the Class are Defendants, the officers and directors of the


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Company, at all relevant times, members of their immediate families and their legal

representatives, heirs, successors or assigns and any entity in which Defendants

have or had a controlling interest.

193. The members of the Class are so numerous that joinder of all members

is impracticable. Throughout the Class Period, Datatec common shares were

actively traded on an efficient market, the NASDAQ. While the exact number of

Class members is unknown to Plaintiffs at this time and can only be ascertained

through appropriate discovery, Plaintiffs believe that there are hundreds or

thousands of members in the proposed Class. Record owners and other members

of the Class may be identified from records maintained by Datatec or its transfer

agent and may be notified of the pendency of this action by mail, using the form of

notice similar to that customarily used in securities class actions.

194. Plaintiffs’ claims are typical of the claims of the members of the Class

as all members of the Class are similarly affected by Defendants= wrongful conduct

in violation of federal law that is complained of herein.

195. Plaintiffs will fairly and adequately protect the interests of the

members of the Class and has retained counsel competent and experienced in class

and securities litigation.


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196. Common questions of law and fact exist as to all members of the

Class and predominate over any questions solely affecting individual members of

the Class. Among the questions of law and fact common to the Class are:

(a) whether the federal securities laws were violated by Defendants= acts as alleged herein;

(b) whether statements made by Defendants to the investing public during

the Class Period misrepresented material facts about the business, operations, and management of Datatec; and

(c) to what extent the members of the Class have sustained damages and

the proper measure of damages.

197. A class action is superior to all other available methods for the fair

and efficient adjudication of this controversy since joinder of all members is

impracticable. Furthermore, as the damages suffered by individual Class members

may be relatively small, the expense and burden of individual litigation make it

impossible for members of the Class to individually redress the wrongs done to

them. There will be no difficulty in the management of this action as a class action.

NO SAFE HARBOR

198. The statutory safe harbor provided for forward-looking statements

under certain circumstances does not apply to any of the allegedly false statements

pleaded in this complaint. The specific statements pleaded herein were not

identified as Aforward-looking statements” when made. To the extent there were


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any forward-looking statements, 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 was made the particular speaker

knew that the particular forward-looking statement was false, and/or the

forward-looking statement was authorized and/or approved by an executive officer

of Datatec who knew that those statements were false when made.

COUNT I

Violations Of Section 10(b) Of The Exchange Act And Rule 10b-5 Promulgated

Thereunder Against All Defendants

199. Plaintiffs repeat and reallege each and every allegation contained

above as if fully set forth herein.

200. During the Class Period, Defendants, and each of them, carried out a

plan, scheme and course of conduct which was intended to and, throughout the

Class Period, did: (a) deceive the investing public, including Plaintiffs and other

Class members, as alleged herein; (b) artificially inflate and maintain the market

price of Datatec=s securities; (c) cause Plaintiffs and other members of the Class to


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purchase Datatec=s securities at artificially inflated prices; and (d) cause losses to

Plaintiffs and other Class members when the truth regarding Datatec’s revenues,

net income, contracts accounting and financial condition emerged at the end of the

Class Period. In furtherance of this unlawful scheme, plan and course of conduct,

Defendants, and each of them, took the actions set forth herein.

201. Defendants (a) employed devices, schemes, and artifices to defraud;

(b) made untrue statements of material fact and/or omitted to state material facts

necessary to make the statements not misleading; and (c) engaged in acts,

practices, and a course of business which operated as a fraud and deceit upon the

purchasers of the Company=s securities in an effort to maintain artificially high

market prices for Datatec=s securities in violation of Section 10(b) of the Exchange

Act and Rule 10b-5. All Defendants are sued either as primary participants in the

wrongful and illegal conduct charged herein or as controlling persons as alleged

below.

202. 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, Defendants

had a duty to promptly disseminate truthful information that would be material to

investors in compliance with the integrated disclosure provisions of the SEC as


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embodied in SEC Regulation S-X (17 C.F.R. Sections 210.01 et seq.) and

Regulation S-K (17 C.F.R. Sections 229.10 et seq.) and other SEC regulations,

including accurate and truthful information with respect to the Company=s

operations, financial condition and earnings so that the market price of the

Company=s securities would be based on truthful, complete and accurate

information.

203. Defendants, individually and in concert, directly and indirectly, by the

use, means or 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 business, operations and future prospects of Datatec.

204. 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 assure investors

of Datatec=s value and performance and continued substantial growth, 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 Datatec and its business operations and future prospects 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


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of business which operated as a fraud and deceit upon the purchasers of Datatec=s

securities during the Class Period.

205. Individual Defendants= primary liability, and controlling person

liability, arises from the following facts: (a) Individual Defendants were high-level

executives and/or directors at the Company during the Class Period; (b) Individual

Defendants were privy to and directly participated in the fraudulent schemes

described herein, and in the creation, development and reporting of the Company=s

internal budgets, plans, projections and/or reports; and (c) Individual Defendants

were aware of the Company=s dissemination of information to the investing public

which they knew or recklessly disregarded was materially false and misleading.

206. Defendants had actual knowledge of the misrepresentations 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. Such Defendants= material misrepresentations and/or

omissions were done knowingly or recklessly and for the purpose and effect of

concealing Datatec=s operating condition and future business prospects from the

investing public and supporting the artificially inflated price of its securities. As

demonstrated by Individual Defendants= overstatements and misstatements of the

Company=s business, operations and earnings throughout the Class Period,


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Defendants, if they did not have actual knowledge of the misrepresentations and

omissions alleged, were reckless in failing to obtain such knowledge by

deliberately refraining from taking those steps necessary to discover whether those

statements were false or misleading.

207. 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 Datatec=s securities was artificially inflated during the Class Period. In

ignorance of the fact that market prices of Datatec=s publicly-traded 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/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 during the Class Period, Plaintiffs and the other members

of the Class acquired Datatec securities during the Class Period at artificially high

prices and were damaged thereby. Defendants’ failures to disclose furthermore

caused Plaintiffs and other Class members’ losses when the truth regarding

Datatec’s revenues, net income, contracts accounting and financial condition

emerged at the end of the Class Period.


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208. At the time of said misrepresentations and omissions, Plaintiffs and

other members of the Class were ignorant of their falsity, and believed them to be

true. Had Plaintiffs and the other members of the Class and the marketplace known

of the true financial condition and business prospects of Datatec, which were not

disclosed by Defendants, Plaintiffs and other members of the Class would not have

purchased or otherwise acquired their Datatec securities, or, if they had acquired

such securities during the Class Period, they would not have done so at the

artificially inflated prices which they paid.

209. By virtue of the foregoing, Defendants have violated Section 10(b) of

the Exchange Act, and Rule 10b-5 promulgated thereunder.

210. As a direct and proximate result of Defendants= wrongful conduct,

Plaintiffs and the other members of the Class suffered damages in connection with

their respective purchases and sales of the Company=s securities during the Class

Period.

COUNT II

Violation Of Section 20(a) Of The Exchange Act Against The Individual Defendants




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212. Individual Defendants acted as a controlling person of Datatec within

the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of

their high-level positions, and their ownership and contractual rights, participation

in and/or awareness of the Company=s operations and/or intimate knowledge of the

statements filed by the Company with the SEC and disseminated to the investing

public, Individual Defendants had the power to influence and control and did

influence and control, directly or indirectly, the decision-making of the Company,

including the content and dissemination of the various statements which Plaintiffs

contend are false and misleading. Individual Defendants reviewed, approved, and

were provided with or had unlimited access to copies of the Company=s 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. Datatec’s public statements were circulated to, commented upon and

approved by Individual Defendants.

213. In particular, Individual Defendants had direct and supervisory

involvement in the fraudulent schemes described herein, and in the day-to-day

operations of the Company and, therefore, are presumed to have had the power to


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control or influence the particular transactions giving rise to the securities

violations as alleged herein, and exercised the same.

214. As set forth above, Datatec and Individual Defendants each violated

Section 10(b) and Rule 10b-5 by their acts and omissions as alleged in this

Complaint. By virtue of their positions each as a controlling person, Individual

Defendants are liable pursuant to Section 20(a) of the Exchange Act. As a direct

and proximate result of Datatec=s and the Individual Defendants= wrongful conduct,

Plaintiffs and other members of the Class suffered damages in connection with

their purchases of the Company=s securities during the Class Period.

COUNT III

Violation By Deloitte of Section 10(b) of the Exchange Act And Rule 10b-5(b) Promulgated Thereunder



216. This Count is brought pursuant to Section 10(b) of the Exchange Act

and Rule 10b-5 promulgated thereunder on behalf of Plaintiffs and the Class

against Deloitte & Touche LLP.

217. Deloitte made untrue statements of material fact and/or omitted to

state material facts necessary to make the statements not misleading, by use of

means or instrumentalities of interstate commerce in order to maintain artificially


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high market prices for Datatec’s securities and create a market therefore in

violation of Section 10(b) of the Exchange Act and Rule l0b-5.

218. During the Class Period, Deloitte made false and misleading

statements of material fact which were intended to and did: (a) deceive the

investing public, including Plaintiffs, as alleged herein; (b) artificially inflate and

maintain the market prices of Datatec's securities; and (c) cause Plaintiffs to

purchase or otherwise acquire Datatec securities at artificially inflated prices. In

furtherance of this unlawful plan, scheme and course of conduct, Deloitte took the

actions set forth herein.

219. Among other things, Deloitte acted as auditors for Datatec. Deloitte

knew and understood that its reports and opinions concerning the financial

statements and reports of Datatec would be released to the investing public and that

investors would rely, and had a right to rely, on their reports and opinions. In its

role as auditors, Deloitte had access to employees of Datatec, and continuing

access to and knowledge of Datatec’s confidential corporate, financial, operating

and business information as well as the accounting manipulations and other

schemes undertaken by themselves and Individual Defendants. Despite this access

and knowledge, Deloitte, inter alia, knowingly or with extreme recklessness


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certified without qualification and publicly represented that Datatec’s financial

reports were free from material misstatements.

220. Deloitte engaged in the fraudulent activity described above knowingly

and intentionally, or in such an extremely reckless manner as to constitute willful

deceit and fraud upon Plaintiffs. Deloitte knowingly or extremely recklessly

caused Datatec’s and their own reports and statements to contain

misrepresentations and omissions of material fact as alleged herein.

221. As a result of the fraudulent activities of Deloitte described above, in

conjunction with the activities of Individual Defendants, the market prices of

Datatec securities were artificially inflated during at least the Class Period, and

Plaintiffs and other Class members were damaged when the truth regarding

Datatec’s revenues, net income, contracts accounting and financial condition

emerged at the end of the Class Period.

222. In ignorance of Datatec’s true financial condition, Plaintiffs, relying

upon the integrity of the market price for Datatec’s securities and/or the statements

and reports of Datatec containing false and misleading information, purchased or

otherwise acquired Datatec securities at artificially inflated prices during the Class

Period.

WHEREFORE, Plaintiffs prays for relief and judgment, as follows:


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(a) Determining that this action is a proper class action, and

certifying Lead Plaintiffs as class representatives under Rule 23 of the Federal

Rules of Civil Procedure and Plaintiffs’ counsel as Lead Counsel;

(b) Awarding compensatory damages in favor of Plaintiffs and the

other Class members against all Defendants, jointly and severally, for all damages

sustained as a result of Defendants= wrongdoing, in an amount to be proven at trial,

including interest thereon;

(c) Awarding Plaintiffs and the Class their reasonable costs and

expenses incurred in this action, including counsel fees and expert fees; and

(d) Such other and further relief as the Court may deem just and

proper.

JURY TRIAL DEMANDED

Plaintiffs hereby demand a trial by jury.

Dated: October 31, 2005

COHEN, MILSTEIN, HAUSFELD & TOLL, P.L.L.C

By: __s/ Daniel S. Sommers_____________ Steven J. Toll (pro hac vice) Daniel S. Sommers (DS-2084) Elizabeth A. Berney (pro hac vice) 1100 New York Avenue, N.W. West Tower, Suite 500


130

Washington, D.C. 20005 Telephone: (202) 408-4600 Facsimile: (202) 408-4699

Lead Counsel for Lead Plaintiffs


COHEN, MILSTEIN, HAUSFELD & TOLL, P.L.L.C

Steven J. Toll (pro hac vice) Daniel S. Sommers (DS-2084) Elizabeth A. Berney (pro hac vice) 1100 New York Avenue, N.W. West Tower, Suite 500 Washington, D.C. 2005 Telephone: (202) 408-4600 Facsimile: (212) 408-4699 Lead Counsel for Lead Plaintiffs

UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY

In Re DATATEC SYSTEMS, INC., SECURTIES LITIGATION This Document Relates to: All cases

.

)))))))

Master File No. 2:04-CV-525 WGB-MCA CERTIFICATE OF NON-ARBITRABILITY

Daniel S. Sommers of full age, certifies that pursuant to L. Civ. R. 201.1 the within matter is not arbitrable, being that the Complaint seeks damages that are in excess of $150,000.

__s/ Daniel S. Sommers_____________ Dated: October 31, 2005


CERTIFICATE OF SERVICE

I certify that on October 31, 2005, I electronically filed the

foregoing with the Clerk of Court using the CM/ECF system, which

will send notification of such filing to counsel of record in this

matter who are registered on the CM/ECF system. Parties whose

counsel are not registered on the CM/ECF system will be served via

process server within the time frame allowed by Rule 4 of the

Federal Rules of Civil Procedure.

/s/ Daniel S. Sommers____ Daniel S. Sommers, Esq.

Case 2:04-cv-00525-GEB-MCA Document 54-2 Filed 10/31/2005 Page 1 of 1

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