in re yum! brands, inc. securities litigation 13-cv-00463

Case 3:13-cv-00463-CRS Document 72 Filed 08/05/13 of 104 PageID #: 628

UNITED STATES DISTRICT COURT WESTERN DISTRICT OF KENTUCKY

LOUISVILLE DIVISION

: CLASS ACTION IN RE YUM! BRANDS, INC. SECURITIES LITIGATION

: NO. 3:13CV-463-CRS

: DEMAND FOR JURY TRIAL

CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS

LABATON SUCHAROW LLP RANSDELL & ROACH PLLC

Jonathan M. Plasse Eric J. Belfi Stephen W. Tountas Wilson Meeks 140 Broadway New York, New York 10005 Tel: (212) 907-0700 Fax: (212) 818-0477 [email protected] [email protected] [email protected] [email protected]

Lead Counsel for Lead Plaintiff and the Proposed Class

John C. Roach W. Keith Ransdell S. Chad Meredith 176 Pasadena Drive, Building One Lexington, Kentucky 40503 Tel: (859) 276-6262 Fax: (859) 276-4500 [email protected] [email protected] [email protected]

Liaison Counsel for Lead Plaintiff and the Proposed Class


TABLE OF CONTENTS

I. NATURE OF THE ACTION ................................................................................................ 1

II. JURISDICTION AND VENUE............................................................................................5

III. THE PARTIES....................................................................................................................... 6

A. Lead Plaintiff ................................................................................................................ 6

B. Defendants ....................................................................................................................6

1. The Company.......................................................................................................... 6

2. The Individual Defendants...................................................................................... 7

IV. SUBSTANTIVE ALLEGATIONS .....................................................................................10

A. Background................................................................................................................. 10

1. The Success Of Yum! China Was Critically Important To The Company’s Global Profitability And Corporate Success .....................................10

2. Maintaining Food Safety Is Critical To Yum!’s Success .....................................11

3. Yum! China Presents Unique Risks To Global Profitability................................13

4. Defendants Continually Assured Investors That Yum! China Adhered To Yum!’s Global Food Safety And Quality Standards........................14

5. Novak Assured Investors That KFC China Did Not Purchase Tainted Chicken From Local Suppliers................................................................17

B. Defendants Fraudulently Concealed That KFC Chicken Repeatedly Failed Third-Party Safety Tests Between 2010 And 2011 ........................................18

1. Documentary Evidence Confirms That Yum! Continued To Purchase Tainted Chicken From The Same Supplier Even Though It Failed Eight Separate Safety Tests For Numerous Banned Chemicals.............................................................................................................. 18

2. While Concealing the Materially Adverse SIFDC Findings, Defendants Misled Investors About Yum!’s Food Safety....................................22

3. Defendants’ Purported Excuse for Not Publicly Disclosing the SIFDC’s Materially Adverse Findings Is Simply Not Plausible..........................25

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C. Defendants Also Knew Or Recklessly Disregarded That Yum!’s Food Safety And Testing Procedures Were Drastically Inadequate....................................27

1. Yum! China’s Testing System Was Terribly Broken...........................................27

2. Yum!’s System For Evaluating Suppliers Allowed For Unlimited Failed Tests For Prohibited Chemicals................................................................. 29

3. Yum!’s Safety And Testing Procedures Failed To Reasonably Address The Known Risks Presented By Small Farmers and Local Suppliers...............................................................................................................31

D. Investors Learn The Truth About Yum!’s Failure To Adhere To Its Global Safety Standards And Its Resulting Impact On Global Profitability................................................................................................................. 32

1. Yum! Investors Learn That One Of KFC’s Chicken Suppliers Used Hormone Stimulants to Accelerate the Growth Cycle..........................................32

2. The Foreseeable Risk Of Yum!’s Failure to Adhere To Global Safety Standards Begins to Materialize, as Yum! Drastically Lowers Its Projections For Same Store Sales.......................................................33

3. Investors Begin To Question The Validity Of Yum!’s Purported Explanation For Reducing Its Guidance............................................................... 34

4. Investors Learn That Yum!’s Safety Issues Are Not Limited To Shanxi, And Begin To Learn About The Liuhe Violations.................................. 36

5. Investors Learn That Yum! Knew About Liuhe’s Repeated Use Of Prohibited Chemicals Between 2010 and 2011 ....................................................39

6. The Foreseeable Risk Of Yum!’s Failure To Adhere To Its Global Safety Standards Continues to Materialize, As Yum! Again Reduces Its Prior Guidance On KFC’s Same Store Sales ....................................42

7. Defendant Su Apologizes For Yum!’s “Many Shortcomings”............................. 43

E. On January 25, 2013 The Shanghai Authorities Reprimanded Yum! For Its Actions And Confirmed That Amadantine Was Found In Yum! Chicken.......................................................................................................................44

F. The Foreseeable Risk Of Yum!’s Failure To Adhere To Its Global Safety Standards Fully Materializes, As Defendants Reveal That Concerns Over Yum!’s Food Safety Will Negatively Affect Yum!’s 2013 Earnings .............................................................................................................45

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V. POST-CLASS PERIOD EVENTS FURTHER REVEAL THE FINANCIAL EFFECTS OF CONSUMER CONCERNS OVER FOOD SAFETY AT YUM!................................................................................................................................... 46

VI. ADDITIONAL ALLEGATIONS ESTABLISHING DEFENDANTS’ SCIENTER..........................................................................................................................47

A. Corporate Scienter Is Established By Yum!’s And Su’s Admissions ........................47

B. Yum! China is the Company’s Core Business Segment And KFC China Is the Core Brand in that Segment.................................................................... 48

C. The Individual Defendants Closely Monitored the Supply Chain And Related Food Safety Issues at KFC China.................................................................. 50

D. Defendants Were Motivated To Conceal KFC’s Food Safety And Quality Problems Because Disclosure Threatened Yum!’s Business Model..........................................................................................................................52

1. KFC China’s Business Model Depends On Charging Premium Prices for Cheaply Sourced Local Poultry............................................................ 53

2. Defendants Knew That The SIFDC’s Adverse Findings Threatened To Reveal That Yum!’s Supply Chain Had Been Compromised......................... 56

E. The Individual Defendants Were Motivated To Achieve Yum!’s Global Sales And EPS Targets To Receive Lucrative Performance-BasedCompensation................................................................................................... 57

1. The Defendants’ Cash-Based Incentive Compensation Over 2011 and2012................................................................................................................ 59

2. Incentive Based Stock Option Compensation....................................................... 60

3. Long Term Incentive Based Compensation.......................................................... 63

VII. DEFENDANTS’ MATERIAL MISSTATEMENTS AND OMISSIONS..........................69

VIII. LOSS CAUSATION............................................................................................................ 89

IX. CLASS ACTION ALLEGATIONS ....................................................................................90

X. PRESUMPTION OF RELIANCE UNDER THE AFFILIATED UTE DOCTRINE AND/OR, IN THE ALTERNATIVE, THE FRAUD ON THE MARKET DOCTRINE .......................................................................................................92

XI. CAUSES OF ACTION........................................................................................................ 93

XII. PRAYER FOR RELIEF ......................................................................................................98

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Lead Plaintiff Frankfurt-Trust Investment GmbH (“Lead Plaintiff”), individually and on

behalf of all other persons and entities who purchased or acquired Yum! Brands Inc.’s (“Yum!”

or the “Company”) publicly traded securities during the period between February 6, 2012 and

February 4, 2013, inclusive (the “Class Period”), and who were damaged thereby, hereby alleges

the following based upon personal knowledge as to itself and its own acts, and upon information

and belief as to all other matters.

Lead Plaintiff’s allegations are based on Lead Counsel’s investigation, which included,

among other things, a review and analysis of: (i) Yum!’s public filings with the U.S. Securities

and Exchange Commission (“SEC”); (ii) research reports issued by financial analysts concerning

Yum!; and (iii) other public information concerning Yum! and its senior officers and directors,

including David C. Novak (“Novak”), Jing-Shyh S. Su (“Su”) and Richard T. Carucci

(“Carucci”) (collectively, the “Individual Defendants” and, together with Yum!, “Defendants”).

Many of the facts supporting Lead Plaintiff’s allegations are known only by Defendants, or are

exclusively within their custody and control. Lead Plaintiff believes that substantial additional

evidentiary support will be revealed after a reasonable opportunity for discovery.

I. NATURE OF THE ACTION

1. Yum! is the world’s largest restaurant company by virtue of its ownership and

franchise of more than 39,000 Kentucky Fried Chicken (“KFC”), Pizza Hut, and Taco Bell

restaurants in more than a hundred countries.

2. This case arises from a series of material misleading statements and omissions

concerning the most crucial aspect of Yum!’s business: the safety of its food. By the first day

of the Class Period, a third-party laboratory, the Shanghai Institute for Food and Drug Control

(“SIFDC”) had alerted Yum! on at least eight separate occasions between 2010 and 2011 that

the Company had purchased, and continued to purchase , toxic chicken from the same


supplier . Among the prohibited chemicals found in these test results were: (1)

Chloramphenicol, an antibiotic drug that may cause bone marrow toxicity, an increased risk of

childhood leukemia, and iosyncratic aplastic anemia, which is generally fatal ; and (2)

Furaltadone, a mutagen/carcinogen, which may cause bone marrow toxicity and systemic

toxicity (tremors, convulsions, and gastrointestinal disturbances) .

3. Despite their knowledge of these material, adverse facts, Defendants fraudulently

concealed them from investors, while concurrently concealing that Yum!’s global food safety

and quality standards were patently inadequate to address the known risks in its food supply.

Moreover, Defendants falsely trumpeted that all of Yum!’s suppliers and restaurants adhered to

Yum!’s global food safety and quality standards, “regardless of ... location” and “without

compromising the standards,” and that any risk of food tampering by suppliers was not “within

[their] control.” These sentiments were also echoed in Defendants’ public filings with the SEC,

were reiterated by Defendants during investor conferences, and were highlighted in corporate

documents that were publically accessible on the Company’s corporate website.

4. In fact, in March 2012 – just one month into the Class Period – an analyst bluntly

questioned Defendant Carucci about the safety and quality standards of Yum!’s food in China.

Yet, despite Defendants’ knowledge of (i) the eight SIFDC adverse test results, (ii) broken

testing of Yum!’s local suppliers, and (iii) the Company’s continued purchase of chicken from a

supplier that failed the SIFDC’s tests at least eight times, Carucci fraudulently claimed that

“we’ve spent a lot of time and energy getting that right and having the right suppliers . ”

5. Such assurances about Yum!’s food safety were of vital interest to investors

because the market understood that a food safety scandal can have a massive negative affect on

restaurant sales, and thus Yum!’s bottom line. Indeed, each of the Individual Defendants had

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personal knowledge of these dire effects from other food scares that arose during their tenure as

senior executives. For example, in 2005, a media and consumer firestorm erupted when the

market discovered that KFCs in China were using Sudan Red Dye – a known and prohibited

carcinogen – in the seasoning of its chicken, causing Yum!’s sales to drop immediately and

remain depressed for months thereafter. Further, in 2007, Yum!’s reputation, and bottom line,

took a severe hit when E.coli was found in food sold by several Taco Bell restaurants in the U.S.

6. Critically, investors also understood that Yum! China – which was widely

regarded as the primary driver of the Company’s global profitability, representing 42% of

Yum!’s profits in 2012 – was especially vulnerable to the occurrence of a food scandal. In fact,

as Defendants knew and consistently acknowledged, not only is the food supply chain in China

particularly fraught with food safety risks, but Chinese consumers are hypersensitive to the

issue, having been continually rocked by food safety scandals for years. Thus, Defendants’

fraudulent concealment of the SIFDC’s adverse test results not only helped maintain and

preserve the global perception of Yum!’s safety and quality standards, but enabled the Company

to continue to reap substantial profits from KFC and its core Chinese business segment.

7. When the public eventually learned in December 2012 that Yum! had continued

to purchase tainted chicken, and concealed the SIFDC’s adverse test results, it reacted with

shock. For example, a Deputy Director with China’s food safety office asserted that once Yum!

received the SIFDC’s adverse reports, it “should have taken action as soon as it found problems

in its raw materials. It should have reported to the city government, tightened management of its

supplier or just stopped purchasing products from it.” Yet Defendants did none of the above.

8. Instead, Defendants not only fraudulently concealed each of the SIFDC’s eight

adverse reports from investors, regulators, and consumers over a 2-year period, but continued to

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buy hundreds of tons of chicken from the same supplier during that timeframe , and then

presumably sold such chicken to consumers. Shockingly, Defendant Su has admitted that Yum!

decided not to disclose the SIFDC’s adverse findings because it did not want to tarnish the

supplier’s reputation, and because of its purported opinion that the banned chemicals would not

“pose[] an immediate threat to the human body” In other words, Yum! placed the supplier’s

reputation before the interests of its shareholders, consumers, and regulators.

9. It is not plausible that these actions are in accordance with Yum!’s global

standard for food safety and quality – indeed, after all, these specific chemicals were prohibited

because of the severe risks they pose upon consumption. Defendants’ receipt of the SIFDC’s

adverse reports, and their concealment of all of them, demonstrates their actual knowledge that

Yum!’s food safety practices in China did not adhere to its purportedly global standards.

10. Moreover, based on the known risks posed by Yum!’s continual purchase of

tainted chicken over a 2-year time period, Defendants knew or were at least reckless in not

knowing that the Yum! supplier that violated at least eight SIFDC tests could be just the tip of

the iceberg, and that Yum!’s food safety practices in China were patently inadequate to address

that known risk. In fact, Defendants knew that Yum! China’s supply chain included thousands

of small chicken farmers, at least 1,000 of which the Company deemed “high risk” of using

banned and dangerous chemicals, including prohibited hormones. As stated by Su, “ [Yum!]

ha[s] been in China for many years now, so we can’t say that we haven’t known this. ”

11. Indeed, during the Class Period, the market learned that other suppliers were, in

fact, providing tainted chicken to Yum!, including the Yingtai Group, Tengzhou-based Wintop

Food, and the Shanxi Suhai Group. The banned chemicals used by these suppliers included a

steroid hormone with side effects including ulceration of the esophagus, stomach, and

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psychiatric disturbances . In December 2012, the Shanghai FDA also conducted a check on

chicken at a Yum! distribution site, and found that it was tainted with a drug used to treat

Parkinson’s disease, with severe side effects affecting the central nervous system,

exacerbation of seizure disorders, psychiatric symptoms, and suicidal ideation .

12. As explained herein, Defendants knew or were reckless in not knowing that these

startling events occurred because: (i) Yum! did not have a policy or protocol for disclosing its

adverse tests results; (ii) Yum! did not sufficiently test its chicken for hormones; (iii) Yum!

shipped chicken from suppliers to restaurants before any testing was conducted; and (iv) Yum!’s

protocol for assessing and evaluating its chicken processing factories virtually disregarded its

lab tests when assessing whether it should continue doing business with such suppliers.

13. When investors learned between November and December 2012 that the

Company was purchasing tainted chickens from numerous Yum! suppliers, and that Defendants

had deliberately concealed the SIFDC’s adverse findings, confidence in Yum! and KFC began to

crumble. Not only did investors question Yum!’s adherence to its purportedly global food safety

and quality standards, but consumers stayed away from KFCs in droves, sharply reducing sales.

14. Ultimately, Defendants revealed after trading on February 4, 2013 that Yum!’s

2013 earnings growth would be decimated by the chicken scandal, and confirmed that Chinese

authorities had censured Yum! for its food safety failures. In response, by the close of trading

on February 5, Yum!’s share price fell to $62.08, marking a total share price decline of $12.39

since the trading day prior to the first corrective disclosure ( i.e. , November 29, 2012).

II. JURISDICTION AND VENUE

15. The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a)

of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. §§ 78j(b) and 78t(a), and

Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5.

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16. The Court has jurisdiction over the subject matter of this action pursuant to

28 U.S.C. § 1331 and Section 27 of the Exchange Act, 15 U.S.C. § 78a(a).

17. This Action was consolidated and transferred to this venue by order of the

Honorable Josephine Staton Tucker, U.S. District Judge for the Central District of California

(Dkt. # 42). Venue is proper in this District pursuant to Section 27 of the Exchange Act and 28

U.S.C. § 1391(b). Yum!’s principal place of business resides in this District at 1441 Gardiner

Lane, Louisville, Kentucky 40213, and many of the acts charged herein, including the

preparation and dissemination of materially false and misleading information, occurred in

substantial part in this District.

18. In connection with the acts alleged herein, Defendants, directly or indirectly, used

the means and instrumentalities of interstate commerce, including but not limited to the mails,

interstate telephone communications, and the facilities of the national securities markets.

III. THE PARTIES

A. Lead Plaintiff

19. On May 1, 2013, the Court appointed FRANKFURT-TRUST Investment GmbH

as Lead Plaintiff for this consolidated litigation. (Dkt. # 42). Lead Plaintiff is an institutional

investor that manages approximately €16 billion in assets. As set forth in the certification

attached hereto as Exhibit A, Lead Plaintiff purchased publicly traded shares of Yum! during the

Class Period at artificially inflated prices and suffered damages as a result of the violations of the

Exchange Act alleged herein.

B. Defendants

1. The Company

20. Defendant Yum! is the world’s largest restaurant company by virtue of its

ownership and franchise of over 39,000 KFC, Taco Bell, and Pizza Hut restaurants in more than

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130 countries and territories. Yum! is incorporated in North Carolina and maintains its

corporate headquarters in Louisville, Kentucky. Nearly half of Yum!’s global profits are

generated by the Company’s Shanghai, China division (“Yum! China”). The Company’s

securities are publicly traded on the New York Stock Exchange (“NYSE”).

21. During the Class Period, Yum! (1) disseminated false and misleading information

to investors (a) on November 23, 2012 on its official corporate microblog in China which the

Company used to communicate directly with the market, (b) on December 7, 2012 on its

corporate microblog, and (c) on December 18, 2012 on its corporate microblog, and (2) issued

numerous false and misleading SEC filings, including (a) a press release on February 6, 2012,

subsequently filed with the SEC on Form 8-K, announcing the financial results for the quarter

and year ended December 31, 2011, (b) Yum!’s fiscal year 2011 Form 10-K, filed with the SEC

on February 20, 2012, (c) an Notice and Proxy Statement on Schedule 14(a) (the “2012 Proxy

Statement”) filed with the SEC on April 6, 2012, (d) a press release issued on April 18, 2013,

subsequently filed with the SEC on Form 8-K, announcing the results for Yum!’s first quarter

ended March 24, 2012, (e) Yum!’s First Quarter 2012 Form 10-Q filed with the SEC on April

25, 2012, (f) a press release issued on July 18, 2012, subsequently filed with the SEC on Form

8-K, announcing the results for Yum!’s second quarter ended June 16, 2012, (g) Yum!’s Second

Quarter 2012 Form 10-Q filed with the SEC on July 23, 2012, (h) a press release issued on

October 9, 2012, subsequently filed with the SEC on Form 8-K, announcing the results for the

third quarter ended September 8, 2012, and (i) Yum!’s Third Quarter 2012 Form 10-Q filed with

the SEC on October 15, 2012.

2. The Individual Defendants

22. Defendant Novak is, and at all times relevant to this Complaint has been,

Chairman of the Board and Chief Executive Officer (“CEO”) of the Company. Novak became

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Chairman of the Board on January 1, 2001, and CEO of Yum! on January 1, 2000. He was also

President of Yum! from October 1997 to May 2012. Novak previously served as Group

President and Chief Executive Officer, KFC and Pizza Hut from August 1996 to July 1997, at

which time he became acting Vice Chairman of Yum! During the Class Period, Novak signed

and certified the Company’s false and misleading SEC filings, including (a) Yum!’s fiscal year

2011 Form 10-K, filed with the SEC on February 20, 2012, (b) Yum!’s First Quarter 2012 Form

10-Q filed with the SEC on April 25, 2012, (c) Yum!’s Second Quarter 2012 Form 10-Q filed

with the SEC on July 23, 2012, and (d) Yum!’s Third Quarter 2012 Form 10-Q filed with the

SEC on October 15, 2012.

23. Defendant Su is, and at all relevant times has been, Vice Chairman of the Board

and Chairman and CEO of Yum! China. Su became Chairman & CEO of Yum! China in May

2010. Su previously served as President of Yum! China since 1997. During the Class Period,

Su signed the Company’s false and misleading Yum!’s fiscal year 2011 Form 10-K, filed with

the SEC on February 20, 2012.

24. Defendant Carucci is President of the Company. Carucci was Chief Financial

Officer (“CFO”) of the Company from the beginning of the Class Period until he was appointed

President, effective May 1, 2012. Carucci served as the Company’s CFO since 2005. During

the Class Period, Carucci disseminated false and misleading information to investors during a

March 2012 investor conference, and signed and certified the Company’s false and misleading

SEC filings, (a) Yum!’s fiscal year 2011 Form 10-K, filed with the SEC on February 20, 2012,

and (b) Yum!’s First Quarter 2012 Form 10-Q filed with the SEC on April 25, 2012.

25. During the Class Period, the Individual Defendants, as senior executive officers

of Yum!, were privy to confidential and proprietary information concerning the Company, its

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operations, finances, financial condition, and present and future business prospects. The

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

Yum, as discussed below. In addition, the Individual Defendants were involved in drafting,

producing, reviewing and/or causing the dissemination of the false and misleading statements

and omissions alleged herein, and were aware, or at the very least recklessly disregarded, that

such misstatements were being issued to investors in violation of the federal securities laws.

26. As officers and controlling persons of a publicly-held company whose shares are

registered with the SEC and traded on the NYSE, the Individual Defendants had a duty to

promptly disseminate, accurate and truthful information with respect to Yum!, and to correct any

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

price of the Company’s publicly traded securities would be based upon truthful and accurate

information. The Individual Defendants violated these specific requirements and obligations

during the Class Period.

27. The Individual Defendants are liable as participants in a fraudulent scheme and

course of business that operated as a fraud or deceit on purchasers of Yum!’s publicly traded

securities by disseminating material misstatements and/or concealing material adverse facts, as

set forth herein. The scheme: (i) fraudulently concealed from investors that a third-party agency

determined on at least eight separate occasions – between 2010 and 2011 – that Yum! not only

purchased, but continued to purchase, tainted chicken from the same supplier; (ii) deceived and

misled investors as to Yum!’s compliance with its purported global food safety and quality

standards; (iii) enabled Yum! to generate more than $14.4 billion of revenue from sales in China

between the first quarter of 2010 and the third quarter of 2012; and (iv) caused Lead Plaintiff

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and other members of the Class to purchase Yum!’s publicly traded securities at artificially

inflated prices.

IV. SUBSTANTIVE ALLEGATIONS

A. Background

1. The Success Of Yum! China Was Critically Important To The Company’s Global Profitability And Corporate Success

28. Yum! owns and franchises over 39,000 KFC, Taco Bell, and Pizza Hut

restaurants in more than 130 countries and territories, making it the world’s largest restaurant

company. Since 1997, when the Company was spun-off from Pepsi Co., Yum! has focused

much of its growth and business strategy on China.

29. The resulting expansion was overseen by Defendant Su – the Board’s Vice

Chairman and President of Yum! China – who has enabled the Company’s profit growth for the

past decade. Indeed, as a Yum! executive explained to investors in March 2012, “ the profit

growth has been tremendous, from $66 million ten years ago to almost $1 billion last year .

Our expectation is, definitely, to surpass $1 billion in operating profit in China this year.”

30. The primary reason that the Company’s profits soared from “$66 million ten

years ago” to over a $1 billion in 2012 is the exponential growth of KFC. Specifically, as

Defendant Novak explained during a December 6, 2012 investor conference, during the period

between 2000 and 2011, “ 85% of [Yum! China’s restaurant] growth has been generated by

KFC. KFC has been a big powerhouse .” In fact, the number of KFCs in China have increased

from 1,000 in 2004 to over 4,200 in 2012 – a factor of four in only eight years .

31. KFCs now comprise over 80% of the restaurants in Yum! China that contribute

meaningfully to Yum!’s global profits. Indeed, it is the growth in the number of KFC stores,

over any other factor, that has driven the Company’s global profitability. Yum! expressly

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recognized this fact in its 2011 10-K, stating that, “[i]n 2011, the increase in China Company

sales and Restaurant profit associated with store portfolio actions was primarily driven by the

development of new [restaurants] ,” the majority of which were KFCs.

32. Importantly, unlike the rest of Yum!’s global operations, restaurants in Yum!

China are largely Company-owned, and thus have higher margins, resulting in greater

profitability. As a Yum! executive explained during a March 6, 2012 investor conference:

China is 42% of our profits today. It’s the biggest division at YUM!. ... And it is the biggest profit contributor . One other significant factor for China versus the rest of the business with YUM! Restaurants International and in the United States is that, here, we own the vast majority of our restaurants. Over 90% of our restaurants in China are Company owned, whereas, in the rest of the world, we're about 90% franchised owned .

According to Yum’s 2011 10-K, the margins for Yum! China’s stores averaged 21% in 2009,

22% in 2010, and 19% in 2011. In contrast, during the same timeframe, the margins for the

Company’s U.S. operations were 13% in 2009, 14% in 2010, and 12% in 2011.

2. Maintaining Food Safety Is Critical To Yum!’s Success

33. As Defendants recognized in the Company’s 2010 Form 10-K, maintaining a

reputation for safe food is vital to Yum!’s continued success:

Concerns regarding the safety of food ingredients or products that we source from our suppliers could cause customers to avoid purchasing certain products from us. Lost confidence on the part of our customers would be difficult and costly to reestablish.

34. The Economic Research Service of the USDA put a finer point of the dangers that

food safety scandals pose to branded restaurant chains like Yum!:

Not only do branded firms have more equity investment at risk than unbranded firms if they are associated with an outbreak, they also have a higher probability of being identified and held liable in the case of food safety problems. Name brand recognition is a double-edged sword: it allows consumers (and regulators) to identify and reward firms that produce high-quality, safe

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products, but it also increases their chances of identifying firms that are guilty of safety lapses .

35. Indeed, as long-term members of Yum!’s senior executive team, each of the

Individual Defendants have personal knowledge that a food safety scare presents a significant

risk of causing a long-term, material downward reduction of the Company’s global profitability.

Specifically, in March 2005, a carcinogenic substance called Sudan Red Dye No. 1 was

discovered in the seasoning for chicken sourced to KFC China by a local supplier. As stated in

Yum!’s First Quarter Form 10-Q for 2005, the scandal cratered the Company’s same store sales:

As a result of this issue, system sales growth in Period 4 for our China Division, excluding the impact of foreign currency translation, was 10% versus our annual target growth rate of at least 22% . Additionally, we expect Period 5 system sales for the China Division to be down about 5% from the previous year with continued impact during Period 6. Currently, we expect system sales to recover late in the second quarter or during the third quarter. We estimate that this issue will negatively impact operating profit in the China Division for the quarter ended June 11, 2005 by $20 million to $25 million versus our previous expectations.

36. Consumers did not regain their confidence quickly. As a Yum! executive

explained during a September 8, 2005 investor conference:

I can tell you, if you look at just -- alone, if you look at our sales leading into that time frame, you can see that we were moving along at very nice pace. And there definitely is an impact. Our sales dropped immediately. So there was quite a bit of negative press coverage around that. And there was basically an immediate consumer reaction to that. We have been slowly recovering from that. We think it’s a slow but sure process.

37. In addition, Yum! endured a “difficult and costly” food safety scandal at Taco

Bell in 2007. As The Wall Street Journal reported on February 13, 2007, a breakout of E.coli at

several Taco Bell restaurants caused U.S. revenue to fall 10%:

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Incurring every restaurateur’s nightmare, U.S. revenue fell 10%, and Taco Bell sales in stores open more than a year dropped significantly after E.coli-related illness struck stores in five Northeast states late last year. “The low point of the Taco Bell sales decline occurred during the third week of December, and sales have begun to recover from that point,” the company said. Same-store Taco Bell sales slid 5% in the quarter from a year earlier, and the episode is expected to hurt first-quarter results, too. Taco Bell has been the company’s most profitable U.S. brand. Before the outbreak, the chain had posted five straight years of rising same-store sales.

3. Yum! China Presents Unique Risks To Global Profitability

38. One of the primary reasons why Yum!’s KFC China stores maintain such a large

profit margin is because they save on the cost of goods by sourcing locally, which reduces costs

and greatly enhances the profitability of each store. By way of example, according to Yum!’s

2007 10-K, approximately 36% of Yum!’s overall operating costs were for food and paper, and

40% of those costs in mainland China alone was on chicken.

39. Defendants knew, however, that local sourcing presented a significant safety risk,

and prompted numerous food safety scandals. This risk was particularly acute to KFC, as Yum!

often purchased its chicken from small farmers. In fact, Yum! admitted that as recently as

January 2013 it still had as many as 4,700 small farmers providing chicken to Yum!’s supply

chain. 1 Remarkably, of that amount, Yum! deemed 1,000 of those farmers – or roughly 21% –

to be “high risk.” As discussed below, Defendants did not remove these 1,000 farmers from

Yum!’s supply chain until February 2013, following news reports that certain suppliers had sold

tainted chicken to Yum!, and then subsequently terminated the remaining 3,700 in July 2013

because they were purportedly “unqualified.”

1 See ChinaDaily, Li Woke, “Yum won't chicken out from expansion,” July 26, 2013.

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40. In addition, as reflected in Yum!’s 2008 and 2009 White Papers, and its 2008

Corporate Responsibility Report (as defined and discussed more fully in ¶46, below),

Defendants knew that Chinese consumers are hypersensitive to food safety. Defendants tried to

offset this hypersensitivity by branding KFC as a safe place to eat, where food is prepared in

accordance with the Company’s global safety and quality standards. For example, in 2010, a

Harvard Case Study prepared by Harvard Business school professor David Bell and

Agribusiness Program director Mary Shelman (the “2010 Harvard Case Study”), quoted

Defendant Su as saying that “[f]ood safety has always been a key feature of the KFC offering.

An important feature of what we are selling is peace of mind .”

41. In addition, on April 21, 2009, Defendant Su acknowledged that “drug residues”

in “chicken” was one of Yum!’s “biggest problems” with food safety in China, but assured the

public that Yum! implemented “risk prevention and treatment measures” by: (i) using “large-

scale breeding houses”; (ii) “control[ling] raw materials from the source”; and (iii) “carry[ing]

out the strongest control at places where risks are expected to appear.” 2

4. Defendants Continually Assured Investors That Yum! China Adhered To Yum!’s Global Food Safety And Quality Standards

42. Given the exponential growth of Yum! China – and its sizeable contribution to

global profits – it is unsurprising that Defendants have continually emphasized the importance of

food safety to its China operations. Indeed, as explained in the 2010 Harvard Case Study, Yum!

claimed to “work all the way back through the system to the farmer, and even before – with the

animal feed companies and other input suppliers – to ensure that our products are safe.”

43. In addition, following the Sudan Red Dye scandal, a Yum! executive assured

investors that a similar incident would not happen again:

2See “Localization is not a problem. Effectiveness is the key point,” 21st Century Economic Report, published April 21, 2009. Original text and certified translation attached hereto as Exhibit B.

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We’ve also taken a number of measures ... We decided to do something unique in China that we don’t do anywhere else in the world, and that’s put a laboratory of our own in basically at our level to test all of our products coming from all of our suppliers for any nonapproved ingredients , such as Sudan Red . And that’s a couple million dollars’ investment. 3

44. Further, in March 2008, before the Summer Olympics in China, Yum! published

a “White Paper on Food Safety Policy” (the “2008 White Paper”). 4 Defendant Su’s cover letter

to the 2008 White Paper specifically assured the market that Yum! “always adhere[s] to the

principles of food safety,” and touted that Yum! “is the first responsible person for food safety”

and that the “reputation of a company is its blood line”:

Since 1987 when it entered China, Yum! Brands, Inc., in the light of “keeping a foothold in China and stepping into life”, has been making every effort in merging its brands into Chinese people and building a complete set of food supply chain systems entitled “From Farm-land to Dinner Table”,... we have been holding onto the principle of “food safety first”, trying to introduce top companies worldwide as our suppliers ; in the meantime, we have been helping domestic manufacturers with certain credentials improve technical standards and management abilities to become our suppliers. .. In our opinion, an enterprise is the first responsible person for food safety. The reputation of a company is its bloodline . As a catering business, we are duty-bound to provide clean and safe catering products to consumers. 5

45. Thereafter, Defendant Su spoke with reporters regarding the 2008 White Paper,

asserting that each of Yum! China’s suppliers could attain Yum!’s global standards for safety. 6

3 Tim Jerzyk, head of Yum’s Investor Relations, September 8, 2005 Prudential Equity Group “Back-to-School Consumer Conference.”

4 Original text and certified translation attached hereto as Exhibit C. The Corporate Responsibility Report asserts that the 2008 White Paper was Published in 2008. However, other sources state that the 2008 White Paper was published in 2007.

5 Exhibit C. Su then specifically noted the following: “In addition to the “Sudan chili sauce” incident, incidents such as “Malachite Green China” for aquatic products, “Clenbuterol” for pork, “Red Yolk Duck Egg” and “Golden Apple Snail” happened in China one after another over the past few years have enabled us to have a deeper under-standing of the actual situation of food safety in China.”

6 See Chinaview.cn, Xinhua, Yum! Brands confident of its Chinese suppliers, March 26, 2008.

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46. Additionally, in 2008, Yum! released a seventy-page Corporate Responsibility

Report (the “Corporate Responsibility Report”), which was available on Yum!’s corporate

website. The Corporate Responsibility Report referred repeatedly to the 2008 White Paper in a

section titled “Managing Food Safety Risks In Our Supply Chain,” and specifically highlighted

the safety of Yum!’s food supply and products in China:

This white paper is expected to raise the awareness and understanding of common food safety problems, and give our consumers the assurance along with our commitment that we will keep the safest food supply and products in China .

47. The Corporate Responsibility Report also described Yum! as regulating all of its

supply chains, both domestic and abroad, in accordance with the same stringent safety standards:

All of our restaurants, regardless of their ownership structure and location, must adhere to our strict food quality and safety standards. The guidelines are translated to local market requirements and regulations where appropriate and without compromising the standards .

48. Moreover, the Corporate Responsibility Report hyped a proprietary “global”

audit system dubbed “STAR,” short for Supplier Tracking Assessment and Recognition.

According to the report, “ [A]ll of our suppliers are monitored for food safety and quality using

either the global STAR system or the ‘Precheck’ system , which is used only for new suppliers

that provide products with limited time offerings.”

49. Yum! re-published its White Paper in 2009 (the “2009 White Paper”). Defendant

Su again wrote a cover letter acknowledging the market’s ongoing concerns over food safety,

but claimed that Yum! had “ been making every effort in building a complete set of food supply

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chain systems entitled ‘From Farmland to Dinner Table’ to provide delicious, safe and

healthy food to consumers. ”7

50. The 2009 White Paper then asserted that Yum!’s global STAR audit system had

been successful in ensuring the safety of food from all of Yum!’s suppliers:

Yum! “Supplier Tracking, Assessment and Recognition” (STAR,): it is a system for tracking, assessment and recognition of suppliers. It is a management system used uniformly by Yum! globally including China to conduct omnibearing evaluation on suppliers. Food safety/quality is one of the most important parts in the evaluation process. The system has been operated globally and successfully for many years, playing a significant role in ensuring product quality and safet y. ... The assessing targets of STAR: applicable to suppliers providing products for Yum!, for instance, suppliers of food raw materials or finished products, suppliers of package materials or products, suppliers of equipments/facilities and instruments and suppliers of storage and transportation and so on. 8

5. Novak Assured Investors That KFC China Did Not Purchase Tainted Chicken From Local Suppliers

51. Notably, during a February 2008 appearance on “Mad Money,” a CNBC

television show hosted by celebrity stock picker Jim Cramer, Defendant Novak assured investors

that Yum!’s global food safety standards applied to all of its restaurants, including KFC China. 9

52. Cramer observed that China was the predominant story for Yum!, and asked

Novak point-blank whether Yum! China adhered to the same food safety standards regarding its

chicken as those used in the U.S.:

Cramer: Now we have been reading articles about Chinese chickens and how pumped up they are and they have way too

7 Original text and certified translation attached hereto as Exhibit D. 8 Original text and certified translation attached hereto as Exhibit E. 9 A copy of this interview can be accessed at the following link as of August 2, 2013:

http://www.youtube.com/watch?v=ZLZSy1P-ze0.

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many steroids. Do you use the same standards here in our country over there so you wouldn’t get that bad chicken? 10

Novak: Absolutely we use the same high standards and our food is absolutely outstanding over there .

53. In short, Cramer voiced investors’ concerns regarding Yum!’s purported

adherence to its global safety and quality standards, particularly in light of Yum!’s rapid

expansion in China. In response, Novak comforted investors that Yum!’s food was safe because

Yum! China adhered to the same purportedly strict food safety standards abroad as in the U.S.

B. Defendants Fraudulently Concealed That KFC Chicken Repeatedly Failed Third-Party Safety Tests Between 2010 And 2011

1. Documentary Evidence Confirms That Yum! Continued To Purchase Tainted Chicken From The Same Supplier Even Though It Failed Eight Separate Safety Tests For Numerous Banned Chemicals

54. In 2005, Yum! retained a third party laboratory, the SIFDC, to conduct bi-

monthly tests on the food products that were provided by the Company’s suppliers in China.

One such supplier was the Shandong Liuhe Group (“Liuhe”), which, according to Liuhe’s

website, is “one of the leading companies in [the] animal industry in China,” including animal

feed manufacturing, animal breeding, and animal reproduction.

55. The SIFDC provided its test results directly to Yum!, and did not transmit them to

regulatory agencies or local authorities. Thus, if the SIFDC notified Yum! that its tests

uncovered a food safety issue, then the burden fell on Yum! to take corrective action with its

supplier(s) and notify investors, consumers, and the applicable regulatory authorities.

10 Cramer appears to have been referring to a New York Times report published before the 2008 Olympic games that: “When a caterer working for the United States Olympic Committee went to a supermarket in China last year, he encountered a piece of chicken — half of a breast — that measured 14 inches. ‘Enough to feed a family of eight,’ said Frank Puleo, a caterer from Staten Island who has traveled to China to handle food-related issues. ‘ We had it tested and it was so full of steroids that we never could have given it to athletes. They all would have tested positive .’” New York Time, Ben Shpigel, “Wary U.S. Olympians Will Bring Food to China,” February 9, 2008.

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56. Between 2010 and 2011, the SIFDC conducted tests on nineteen batches of

chicken that Yum! purchased from Liuhe, eight of which indicated that KFC chicken tested

positive for a variety of drugs and chemicals that are prohibited by law . For example, as

reflected in Exhibit F, 11 on August 11, 2010, Yum! asked the SIFDC to test a batch of chicken

that was purchased from Liuhe. The SIFDC subsequently alerted Yum! that the batch tested

positive for enrofloxacin, a chemical that has been banned for poultry use in the U.S. and China

since 2005. One potential side effect of enrofloxacin is permanent blindness and vision loss .

57. Further, as reflected in Exhibit G, 12 on November 9, 2010, the SIFDC alerted

Yum! that chicken purchased from Liuhe tested positive for at least the following banned

substances:

Furaltadone , a type of Nitrofurans, which the FDA classifies as a mutagen/carcinogen,

the consumption of which may cause bone marrow toxicity and systemic toxicity

(tremors, convulsions, peripheral neuritis, gastrointestinal disturbances, repression of

spermatogenesis) . Indeed, the European Union banned the use of nitrofurans in food

producing animals by classifying it as a pharmacologically active substances for which

no maximum residue limits can be fixed. The Food and Drug Administration (“FDA”)

of the United States has prohibited the use of furaltadone since February 1985.

Chloramphenicol , a broad-spectrum antibiotic drug, which is used to treat life-

threatening infections in humans, usually when other alternatives are not available. The

use of this antibiotic is limited because of its severe side effects, including bone marrow

toxicity, an increased risk of childhood leukemia, and iosyncratic aplastic anemia,

which is generally fatal . The Federal Food, Drug, and Cosmetic Act, therefore considers

11 Original text and certified translation attached hereto. 12 Original text and certified translation attached hereto.

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food products containing chloramphenicol to be adulterated, and prohibits their sale in,

and importation to, the U.S.

58. Moreover, as reflected in Exhibit H, 13 the SIFDC completed a test on December

20, 2010, finding that chicken purchased from Liuhe again contained chloramphenicol and

furaltadone metabolities. Thereafter, throughout 2011, chicken that Yum! purchased from Liuhe

tested positive for numerous prohibited chemicals up to five additional times. 14

59. Additionally, in 2012 numerous Yum! suppliers were caught by news agencies

and regulators using antibiotics and hormones, including steroids, in their chicken. 15 Among

the prohibited chemicals was the steroid hormone dexamethasone: 16

Dexamethasone , a potent synthetic member of the glucocorticoid class of steroid

hormones, poses side effects including, but not limited to, ulceration of the esophagus

and stomach ; significant weight gain, complications with diabetes and glucose

intolerance, psychiatric disturbances including mania and mood swings , muscle

atrophy, elevated liver enzymes, fatty liver degeneration. and pronounced night sweats.

60. Notwithstanding Yum!’s actual knowledge of the SIFDC’s reports, it kept

purchasing chicken from Liuhe through August 2012 . As reflected in Exhibit I, 17 Yum!

expressly admitted this fact on December 18, 2012. And, remarkably, much of Liuhe’s chicken

was subsequently sold to KFC consumers without any additional testing, as the contract between

13 Original text and certified translation attached hereto. 14 See Beijing News, Shanghai Reported the Fast Grown Chicken Incident: YUM! Has Made False

Reports on 8 Batches of Sub-Standard Products, December 21, 2013. 15 See Bloomberg News, “Yum! Brand’s KFC Investigating China Supplier Food Safety Report,"

November 23, 2012; South China Morning Post, “CCTV report says KFC chickens are being fattened with illegal drugs,” Alice Yan, December 19, 2012; ChinaDaily.com , “KFC supplier used excessive additives in chicken feed,” Wang Hongyi, December 21, 2012.

16 See Beijing News, “KFC’s Statements about ‘Fast Grown’ Chicken Challenged: KFC Has Not Requested Inspection of Hormones,” Yang Yuguo, December 20, 2012.

17 Original text and certified translation attached hereto.

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Yum! and the SIFDC only required the Company to send its products for testing every other

month . 18 In total, “Liuhe reportedly s[old] 40 tonnes [sic] of chicken a month to KFC.” 19 Thus,

even assuming a low estimate, it is plausible that Yum! purchased hundreds of tons of chicken

from Liuhe between 2010 and 2011, despite the SIFDC’s adverse test results.

61. Moreover, Yum! failed to test any of the Chicken that it purchased from Liuhe in

2012 .20 In fact, over that time span, Yum! purchased, and sold to consumers, 176,370 pounds

(80,000 kg) of chicken from Liuhe in 2012, including more than 66,140 pounds (30,000 kg)

chicken in May 3, 2012 alone. 21

62. Defendant Su subsequently admitted that the batches of chicken that tested

positive for prohibited chemicals may have been sold to KFC consumers, and that Yum! was

“very worried.” Indeed, as Defendant Su explained in a May 2013 interview, it was Yum!’s

practice to purchase chicken and ship it to KFC restaurants before the testing was concluded :

Su: ... [Yum! was not] able to detect defective products earlier and prevent any of them from entering our supply chain.

PRESENTER: You mean that with your previous testing method, even after sample testing was complete, the chicken may have already been shipped out?

Su: Yes, we’re just too late right now. Too late. The chicken has already entered our logistics system. So once any problems are found, the chicken has unfortunately already entered the system and we are very worried . We need to conduct testing before the chicken enters the logistics system. 22

18 See SinaEnglish, “KFC chicken sample tested positive of admantadine,” December 21, 2012. 19 See The South China Morning Post, “Illegal drugs in KFC chickens: CCTV report Birds also

made to eat non-stop so they grow faster and fed 18 types of antibiotics,” December 19, 2012. 20 See , First Financial Daily, Punishment Likely for KFC for ‘Cover-up’ Related to Liuhe Products

That Failed Tests 8 Times in 2 Years,” Dec. 21, 2012. 21 See CCTV, December 19, 2013 televised news report. See China Network Television, December

21, 2012 televised news report. 22 Original text and certified translation attached hereto as Exhibit J.

- 21 -


2. While Concealing the Materially Adverse SIFDC Findings, Defendants Misled Investors About Yum!’s Food Safety

63. Even though Yum!’s tainted batches of chicken “entered [its] logistics system”

before the SIFDC completed each respective safety test, Defendants fraudulently concealed the

subsequent conclusions of such reports from investors, regulatory authorities and the Company’s

consumers, while continuing to tout Yum!’s purported adherence to its global safety standards.

64. Specifically, throughout the Class Period, Defendants made numerous

misstatements to assure investors that Yum!’s global operations were reasonably insulated from

a food scandal, including in China. For example, consistent with the assurances in the

Company’s Corporate Responsibility Report (¶¶ 46 and 47), the Company’s Form 10-K for 2011

filed on February 20, 2012 – signed by Defendants Novak, Su and Carucci – represented that

“all” of Yum!’s food adhered to its global quality and safety standards, “regardless of . . .

location”:

All restaurants, regardless of their ownership structure or location, must adhere to strict food quality and safety standards . The guidelines are translated to local market requirements and regulations where appropriate and without compromising the standards .

65. In the Company’s 2011 Form 10-K, Defendants also assured investors, consistent

with the 2008 and 2009 White Papers and the Corporate Responsibility Report ( See

section IVA.4), that its global suppliers were required to meet equivalent safety standards,

regardless of their location:

The Company purchases food, paper, equipment and other restaurant supplies from numerous independent suppliers throughout the world. These suppliers are required to meet and maintain compliance with the Company’s standards and specifications.

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66. Further, Defendants indicated that no risks to food safety were known or within

Yum!’s ability to control: “instances of food-borne illness, food tampering and food

contamination solely involving our suppliers... may not be within our control.” Each of the

Form 10-Qs that Defendants issued during the Class Period reiterated this assertion.

67. Moreover, each of the 8-Ks pertaining to Yum!’s earnings announcements press

releases, contained the following statement made similarly misleading by Defendants’ omission

of the SIFDC results: “Factors that can cause our actual results to differ materially include, but

are not limited to: food borne-illness or food safety issues[.]”

68. Throughout this timeframe, Yum! investors were keenly aware of Yum!’s growth

in China and, on at least one occasion, directly questioned whether Yum! China adhered to the

same global safety and quality standards. Specifically, during a Bank of America investor

conference in March 2012 – i.e. , just one month into the Class Period – Defendant Carucci

acknowledged that Yum! knew that “there’s probably more risk” in China, but falsely claimed

that Yum! “spent a lot of time and energy getting that right and having the right suppliers”:

Q. ... what do you do about controlling food quality and making sure there isn't any problem there?

A. .... In terms of food supply, that's something that we spend a lot of time and energy on. And we’'ve had some issues in the distance past on that. ... So I think the amount of time and attention we've put in China is probably higher than anywhere in the world. But realistically, we know there’s probably more risk there than there is in places like Western Europe and the US in terms of just the way the food chain works. But we’ve spent a lot of time and energy getting that right and having the right suppliers .

69. Finally, Yum!’s 2012 Proxy Statement pointed investors to a corporate “Code of

Conduct” posted on Yum!’s official company website. The Code of Conduct expressly

“applie[d] to the Board of Directors” – including Novak (Chairman) and Su (Vice Chairman) –

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and also to “all employees of the Company, including the principal executive officer [Novak]

and the principal financial officer [Carucci].” The 2012 Proxy Statement specifically

represented that Yum!’s “directors and the senior-most employees in the Company” were

“required to regularly... certify in writing that they have read and understand the Code of

Conduct.” Yum!’s Code of Conduct assured investors that Yum! “[a]dheres to a strict food

safety testing program.” And it also claimed that Yum! “[m]aintains strict specifications for raw

products which meet or exceed government requirements,” and that “[a]ny product suspected to

be unsafe must immediately be pulled from distribution until safety can be assured.”

70. As discussed in detail in Section VII, each of these statements was false and

misleading for numerous reasons, among them because, by the start of the Class Period, Yum!

had received eight separate adverse SIFDC reports between 2010 and 2011 , demonstrating that

Yum! had not only purchased – but continued to purchase – tainted chicken from the same

supplier. Defendants’ fraudulent concealment of this material information enabled Yum! to

maintain and grow its global profitability and continue its exponential growth in China.

71. Indeed, according to Yum!’s 2011 Form 10-K, filed on February 20, 2012, the

$908 million of 2011 profits from Yum! China represented approximately 42% of the

Company’s global profit . greatly exceeding the $589 million from U.S. operations and the $673

million in profits generated by Yum!’s other international operations combined (“YRI”). 23

72. Further, Yum! continually trumpeted the profits of KFC stores in China as its

primary engine for growth. For example, Novak stated during a fiscal 2009 year-end earnings

call held February 4, 2010 that “our most successful business in the world is KFC in China[.]”

23 2010 was the first year that the profits from Yum!’s China operations, $755 million, outpaced profits from the U.S., $668 million. Yum!’s profits from China constituted 37% of global profits that year.

- 24 -


And, during Yum!’s fiscal 2010 year-end earnings call held February 3, 2011, Novak affirmed

China’s centrality to Yum!’s global profit strategy and emphasized KFC China’s “cash

paybacks” and “absolutely rock solid” business.

73. Securities analysts consistently highlighted Yum! China as a key component of

the Company’s investment model. For example, in a November 20, 2012 analyst report,

Macquarie observed that Yum! “China continues to be the main growth driver via store addition;

we think that the risk of drastic margin deterioration due to food inflation is low, given YUM’s

strong local sourcing and upstream control.” Although Macquarie noted that China presented a

“key investment risk” due to “rampant food inflation and food safety,” it specifically stated that,

“[t]o mitigate this risk, YUM has developed strong local sourcing capability over the years.”

3. Defendants’ Purported Excuse for Not Publicly Disclosing the SIFDC’s Materially Adverse Findings Is Simply Not Plausible

74. Defendants’ supposed logic for failing to disclose this material information is

baffling. As Defendant Su admitted on May 25, 2013, the Company chose not to disclose this

information because it was trying to protect Liuhe’s reputation:

PRESENTER: Many people would question why you didn’t disclose it to the public , why you didn’t disclose it to the relevant authorities.

Su: ... After you come out and discover it, what would you do about it? Would you really want to hang Liuhe out to dry? This is a really tough call to make. And besides, this drug, honestly, even if people added it to the chicken, you can’t really say that it would take away people’s lives or that it would be so harmful to their bodies. It’s just a question of people developing a resistance to antibiotics as a result of eating too much chicken. This is not something that poses an immediate threat to the human body...it’s not a very serious food safety crisis. So in light of these circumstances, as a company, should we carelessly disclose

- 25 -


someone’s violations, ruining his or her goodwill and even their business? Do we have this power? 24

75. The message was clear: Defendants made a calculated decision to put Liuhe’s

reputation before the investments of its shareholders and the safety of its consumers. Even more

disturbing is Defendant Su’s assertion that Yum! did not disclose the SIFDC’s reports because

the chemicals identified therein would not “pose[] an immediate threat to the human body,” even

though they were expressly prohibited by numerous regulatory authorities. And it is also telling

that Defendant Su misleadingly downplayed the severity of Liuhe’s 2-year history of failing

eight separate SIFDC tests as just “one violation.”

76. In contrast, in December 29, 2012, Defendants, to blunt the impact of the food

safety scandal on the market, had told a different story, claiming that Yum! did not disclose the

results because “national laws and regulations do not request companies to report the results of

self-inspections to the government or to disclose them to the public.” 25 Not surprisingly, Yum!’s

regulators disagreed. For example, on December 21, 2012, the Deputy Director with Shanghai’s

“food safety office” asserted that Yum! “ should have taken action as soon as it found problems

in its raw materials. It should have reported to the city government, tightened management of

its supplier or just stopped purchasing products from it .”26

24 Exhibit J. 25 See Yum! clarification letter, Yum!, December 29, 2012, original text and certified translation

attached hereto as Exhibit K. 26 SinaEnglish, “Yum knew chicken tainted from 2010,” December 21, 2012. Similarly, Yan

Zuqiang, Director of Shanghai Food Safety Office, told journalists “We think Yum! Group shall release relevant information based on facts in a responsible manner,” and “Now what we know for sure is that we have already obtained original copies of 8 testing reports of disqualification, and all testing reports of disqualification have already been sent to Yum! Group by the testing agency immediately. Yum! should acknowledge these facts.” CBN Daily, Punishment Likely for KFC for “Cover-up” Related to Liuhe Products That Failed Tests 8 Times in 2 Years, December 21, 2012. Original text and certified translation attached hereto as Exhibit L.

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77. Remarkably, even when the Company ultimately terminated Liuhe in

August 2012, it did not do so because of the SIFDC’s eight adverse findings or the hazards

posed by Liuhe’s toxic chickens. Rather, as a Quality Manager of Yum! China admitted on

December 19, 2012, Yum! did not stop working with Liuhe because of the quality of Liuhe’s

material: “the performance of Liuhe is acceptable ... their termination of cooperation with

Liuhe is not attributable to the quality problems with the raw materials, but is attributable to

the service, price, supply capacity and other factors of the supplier .”27

C. Defendants Also Knew Or Recklessly Disregarded That Yum!’s Food Safety And Testing Procedures Were Drastically Inadequate

78. As explained in Section IVB, above, in violation of the federal securities laws,

Defendants consistently withheld material information regarding contemporaneous, known facts

about the safety of chicken purchased from Yum!’s supply chain, despite their public statements

to the contrary. Furthermore, in view of this material, adverse information, Defendants failed to

take any meaningful corrective action, thus enabling Yum! to maintain and grow its global

profitability in spite of its woefully inadequate safety and testing procedures.

1. Yum! China’s Testing System Was Terribly Broken

79. As Defendants knew, despite ostensibly relying upon Yum!’s suppliers to test its

food and follow the applicable regulatory safety standards, Yum! was primarily and directly

responsible for ensuring the safety of its food supply. Indeed, Defendants specifically

acknowledged in the Company’s White Papers that the Company had adopted its regime of self-

27 See Southern Metropolis Daily, “Banned Drug Suspected in Chicken Samples from KFC Parent Company,” December 22, 2012. Original text and certified translation attached hereto as Exhibit M.

- 27 -


testing following the Sudan Red Dye scare because Yum! could not trust its direct or upstream

suppliers to adhere to the applicable safety procedures and requirements. 28

80. As Defendant Su acknowledged during a February 2013 press conference:

KFC China follows different practices in food safety from KFC USA ... KFC USA does not need to conduct self-inspections, because all the links in the supply chain are on the right track , so the catering enterprises at the end of the supply chain do not need to make checks on chickens. 29

81. In other words, Yum! implemented self-testing because it was well-known that

certain links in its non-U.S. global supply chain were entirely unreliable. Further, Yum! did not

require the SIFDC to sufficiently test its chicken for banned hormones, 30 and at least one banned

hormone – dexamethasone – was subsequently found to be used by one of Yum!’s local chicken

suppliers. 31

82. Shockingly, after the public learned about the SIFDC’s adverse test results of

Yum! chicken in December 2012, the Shanghai Food and Drug Administration conducted its

own tests on eight batches of Yum! chicken. Of those eight batches, one tested positive for

admantadine, an antiviral drug that is used to treat Parkinson’s disease : 32

28 Defendants were well aware, of course, that Chinese regulators themselves ordinarily did not test for prohibited chemicals, and that the regulators relied on private enterprises like Yum! to conduct self testing. Su admitted as much in numerous public statements, including his February 25, 2013 interview.

29 Original text and certified translation attached hereto as Exhibit N. 30 See “Shanghai Reported the Fast Grown Chicken Incident: YUM! Has Made False Reports on 8

Batches of Sub-Standard Products,” Beijing News , Dec. 21, 2012 (Yum’s SIFDC “inspection items did not cover hormones, so it is unable to know the hormone residues in Liuhe chickens”).

31 Beijing News , “KFC’s Statement about ‘Fast Grown’ Chicken Challenged: KFC Has Not Requested Inspection of Hormones,” Yang Yuguo, Dec. 20, 2012 (“some chicken breeding farms use dexamethasone hormones that are banned by the State. However, such banned substances have not been identified in KFC’s inspection reports, meaning that KFC has not requested its suppliers to inspect such illegal and banned substances.”); Financial Network, “Supplier: KFC Never Asked for Examination for Steroids Drug Dexamethasone (December 19, 2012).

32 See SinaEnglish, “KFC chicken sample tested positive of admantadine,” Dec. 21, 2012.

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~ Amantadine, a drug used as an antiviral and an antiparkinsonian drug, poses severe side

effects including adverse affects on the central nervous system, nervousness, anxiety,

agitation, insomnia, difficulty in concentrating, and exacerbations of pre-existing seizure

disorders and psychiatric symptoms in patients with schizophrenia or Parkinson’s

disease, severe skin rashes and suicidal ideation.

83. In comparison, it is telling that McDonald’s – one of Yum!’s biggest global

competitors – tests every batch of its locally supplied chicken. On the heels of the news

regarding Yum!’s faulty safety and testing practices, McDonalds affirmed that “ [e]ach batch of

chicken used by McDonald’s is tested to meet standards at a third-party laboratory.” 33

2. Yum!’s System For Evaluating Suppliers Allowed For Unlimited Failed Tests For Prohibited Chemicals

84. Beyond Yum!’s woefully inadequate “self-testing” every other month, Yum! did

not institute any meaningful safeguards to exclude repeat violators from its local supply chain.

As demonstrated by Liuhe’s failure of eight separate SIFDC tests between 2010 and 2011, Yum!

did not automatically terminate its contracts with repeat violators, nor did it increase the

frequency or stringency of its “self-testing.”

85. In addition, as reflected in an internal Yum! document, titled “Assessment

Method for Comprehensive Performance of Chicken Factories,” revised on December 21, 2011

(“Yum!’s Assessment Protocol”), the Company’s local suppliers were evaluated based on a wide

variety of factors. A copy of Yum!’s Assessment Protocol is attached hereto as Exhibit O. 34

Yum!’s Assessment Protocol demonstrates that Yum!’s lab tests are the least important

33 Bloomberg News, “Yum, McDonald’s Pledge Food Safety After China Report on Poultry,” Dec. 19, 2012.

34 Original text and certified translation attached hereto.

- 29 -


component Yum!’s purported review and oversight of its suppliers. Specifically, as depicted in

Yum!’s Assessment Protocol, lab tests account for just 10% of a supplier’s overall “score”:

Recovery, Lab Test 15%

10% _______

TII 30%

- i STAR Audit, Cutting,

30% 15%

86. In other words, a supplier like Liuhe could fail every test conducted by Yum!

China and still receive a 90% mark. From 2010 through 2011, Liuhe in fact failed eight of its

nineteen tests – i.e., 42% – yet remained a chicken supplier for Yum! through August 2012.

This fact also corroborates the statement provided on December 19, 2012 by Yum! China’s

Quality Manager, discussed in ¶ 77, who admitted that “the performance of Liuhe is acceptable

... their termination ... is not attributable to the quality problems with the raw materials, but is

attributable to the service, price, supply capacity and other factors of the supplier.”

87. Further, contrary to Defendants’ representations that Yum!’s STAR audit

“successfully” ensured Yum!’s food safety (¶ 50), Exhibit O demonstrates that STAR (discussed

more fully in ¶¶ 42 through 50 and 155) actually comprised only 30% of a supplier’s overall

score. In contrast, “cutting” (examination of product quality and errors, such as the inclusion of

bones, in cut pieces of chicken) comprised 15%, “Recovery” (the ability to replace bad chicken)

comprised 15%, and PQNC (general cleanliness of the production plant, etc.) comprised 30%.

88. Moreover, contrary to Defendants’ assertion that STAR was “global” and applied

to “all” of Yum!’s suppliers (see ¶¶42 through 50 above), Exhibit O plainly shows that it applied

only to those suppliers that directly supplied chicken to Yum! China. Thus, most, if not all, of

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Yum!’s upstream suppliers – i.e. , those that supplied chicken to Yum!’s direct suppliers,

including thousands of small farmers – were unmonitored by the “global” audit program.

3. Yum!’s Safety And Testing Procedures Failed To Reasonably Address The Known Risks Presented By Small Farmers and Local Suppliers

89. As discussed above in ¶¶42 through 50 a Defendants have consistently

acknowledged – including during investor conferences, in the 2008 and 2009 White Papers, and

the Corporate Responsibility Report – that China presented unique risks to a key segment of its

global profitability, particularly its “unreliable,” and potentially unsafe, local supply chain. 35

90. As recently as January 2013, Yum! admitted that as many as 4,700 small farmers

still provided chicken to Yum!’s supply chain. Remarkably, of that amount, Yum! deemed

1,000 of those farmers – or roughly 21% – to be “high risk,” yet continued to purchase chicken

from them until terminating their business in February 2013, following the market’s outcry over

Yum!’s adherence to its global food safety and quality standards.

91. On February 25, 2013, following Yum!’s termination of the 1,000 “high risk”

farmers, Defendant Su admitted that such farmers were terminated because “ Some of these

smaller and not-as-well-managed chicken-house operators may resort to improper use of

antibiotics or other drugs, especially if illness (in chickens) occurs. ”36 Tellingly, Su also

admitted that “ [t]he fundamental problems that sparked concern over the quality of the

company’s chicken reside in China’s meat industry, which relies on small-scale farms and is

vulnerable to risk ,” and acknowledged that “[Yum!] ha[s] been in China for many years now, so

35 Indeed, China has been continually plagued by food safety issues, including many that implicate Yum! As reported in a May 6, 2013 Reuters article titled “Yum says not affected by China mutton scandal,” it was reported in China that rat meat had been sold to restaurants as mutton. Yum!’s Little Sheep restaurants were reportedly named as purchasers of some of the mislabeled meat.

36 China Daily, “KFC China announces measures to regain trust,” February 26, 2013.

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we can’t say that we haven’t known this .”37 Of course, these small farmers always posed a

heightened risk, yet Yum! did not take any corrective action until after the market learned that

Yum! concealed the SIFDC’s adverse test results, and reasonably understood the implications of

those tests on Yum!’s global profitability and compliance with applicable safety standards.

92. In conjunction with Su’s February 25, 2013 press conference, Yum! shared a

presentation with investors, which graphically acknowledged the inherent “high risk” that was

historically posed by Yum!’s purchase of chicken from these small farmers.

93. Most recently, on July 25, 2013, Defendant Su announced that the remaining

3,700 upstream suppliers were terminated from Yum!’s supply chain on the grounds that those

farmers also presented a high risk of selling contaminated chickens to Yum!. 38 Again, Yum! did

not take any action until after investors had learned that Yum! deliberately withheld the

SIFDC’s adverse test results, and reasonably understood their implications on Yum!’s global

profitability and compliance with all applicable safety standards.

D. Investors Learn The Truth About Yum!’s Failure To Adhere To Its Global Safety Standards And Its Resulting Impact On Global Profitability

1. Yum! Investors Learn That One Of KFC’s Chicken Suppliers Used Hormone Stimulants to Accelerate the Growth Cycle

94. On November 23, 2012, Bloomberg News carried a story reported by Xinhua (the

“November 23 Report”), revealing that one of KFC’s chicken suppliers, the Shanxi Suhai Group

(“Shanxi”), had “flouted food safety rules” when it:

used hormone stimulants to accelerate the growth of the fowl , citing company advertisements saying it could accelerate the growth of chicks to chickens in 45 days. Shanxi Suhai also kept the chickens in unhygienic conditions, packing 5,000 chickens in a coop, an environment which easily bred disease.

37 “Yum Cuts Off Some China Suppliers,” The Wall Street Journal , Feb. 25, 2013. 38 See ChinaDaily, Li Woke, “Yum won't chicken out from expansion,” July 26, 2013.

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95. Defendants monitored the situation closely and immediately responded to the

November 23 Report on Yum!’s microblog, assuring the market that KFCs products were safe,

while touting the “food safety management measures” and “spot checks” that purportedly

ensured the compliance of “all chicken suppliers”:

KFC always attaches importance to food safety, requesting all chicken suppliers to adopt complete food safety management measures. It also makes spot checks on their products . Shanxi Suhai Group is a relatively small regional supplier within KFC’s chicken supply system, supplying only about 1% of the chickens for KFC, and it has maintained a normal food safety record in the past. KFC will carry out investigations according to the media reports, enhance inspections and mete out punishments according to the results of the investigations.

Tellingly, although the November 23 Report specifically addressed Shanxi’s use of hormone

stimulants, Yum!’s public response omitted to state that neither Yum! nor the SIFDC

sufficiently tested for prohibited hormones.

96. Notwithstanding Yum!’s false assurances, “consumer concerns about the safety

of KFC chicken had been circulat[ed] widely on the Internet ... ‘[y]ou tell me who would be

willing to eat it after this,’ said one user. ‘KFC farewell,’ wrote another.” 39

2. The Foreseeable Risk Of Yum!’s Failure to Adhere To Global Safety Standards Begins to Materialize, as Yum! Drastically Lowers Its Projections For Same Store Sales

97. On November 29, 2012, less than one week after the November 23 Report, Yum!

issued a press release updating its projected fourth quarter same store sales for Yum! China to

negative 4%. This updated guidance fell significantly below Yum!’s prior guidance,

anticipating flat or single-digit same store sales. The following trading day, November 30, 2012,

39 Wall Street Journal, “KFC’s China Flap Holds Lessons for Investors,” Julie Jargon and Laurie Burkitt, January 11, 2013.

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Yum!’s share price dropped over 10% from $74.47 to $67.08 per share, the largest one-day

drop in the Company’s share price in ten years .

98. Following the Company’s announcement, Oppenheimer reported on the

disconnect between the announced numbers, and expectations: “YUM now expects -4% China

SSS in 4Q12, below Street’s +2.5%. This represents a disappointing and unexpected high-single

digit traffic decline which equates to a 2-year traffic deceleration of [about] 17% sequentially.”

99. Similarly, Susquehanna Financial Group noted the disconnect between the

updated projection and the economic realities in China: “ Despite improving consumer

indicators in China , such as consumer confidence and retail sales, [same store sales] were

negative 4.0% in 4Q12.” 40

100. That same day, Yum! again posted an entry on its microblog to address the

November 23 Report. The microblog entry concentrated on Yum!’s position that the “45-day

growth cycle for white-feather chickens is normal,” while ignoring the allegations relating to the

use of “hormone stimulants” and unsanitary conditions, stating only that “[u]p to now, there is

no evidence showing that Shanxi Suhai Group has operated against the rules in its breeding.” 41

3. Investors Begin To Question The Validity Of Yum!’s Purported Explanation For Reducing Its Guidance

101. On December 6, 2012, Yum! held an investor conference call, hosted by

Defendant Novak, in which Yum! again failed to attribute any of the Company’s reduced sales

projections to the market’s confidence in the safety of KFC’s food.

40 Similarly, on January 11, 2013, The Wall Street Journal observed that Yum!’s failure to address the impact of the market’s concerns over food safety “puzzled some observers, because no obvious shift in China’s economy explained the sudden drop. China’s retail sales rose 14.9% in November from a year earlier, accelerating from 14.5% growth in October.” Id.

41 Original text and certified translation attached hereto as Exhibit P.

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102. Analysts were confused by Yum!’s purported explanation for reducing its

guidance. For example, on December 6, 2012, a Morgan Stanley analyst noted that Yum! did

not “sufficiently address the causes for the recent and unexpected slowing in China”:

Bottom line: YUM’s analyst day again highlighted the substantial and ever broadening global LT opportunities the company faces , but did not sufficiently address the causes for the recent and unexpected slowing in China, which will dominate the stock NT . An immediate answer seems elusive, and perhaps it’s just as mgmt portrays it – macro and tough laps – but there are enough lingering questions that shares will likely stall out NT .

103. Further, some market participants explicitly questioned whether Yum! reduced its

same store sales projections due to soft sales that resulted from the November 23 Report. For

example, on December 6, 2012, Forbes published an article questioning point blank whether

Yum! reduced its sales projection due to the November 23 Report:

So the “China slowdown” catchall, while somewhat valid, is unlikely to tell the entire story behind KFC China’s dimming prospects. With no other notable factors on the horizon, the toxic 45-day chicken hullaballoo emerges as a possible culprit.

104. Tellingly, one day later on December 7, 2012, Yum! again posted an entry on its

microblog to address the market’s concerns over its food safety. The entry yet again defended

KFC’s use of white chickens – those with a claimed growth cycle of only 45 days. The entry

then made the following assertion to assure consumers about the safety of KFC chicken: “KFC

hereby reaffirms as follows: . . . . All chickens will undergo inspection by the government,

suppliers and KFC before entering KFC. ”42 This supposed reaffirmation of Yum!’s practices

was misleading given that Yum! (i) only “spot tested” suppliers every other month, (ii) sent

products from local suppliers into its distribution chain before testing, and (iii) failed miserably

to test adequately for hormones.

42 Original text and certified translation attached hereto as Exhibit Q.

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105. That same day the Financial Times published an article questioning Yum!’s

placing the blame for its “sales stumble on the slowdown in the Chinese economy.” 43 The

article noted that “McDonald’s and Starbucks, have continued to see sales grow in China,” and

that the real reason for Yum!’s sales deterioration could be the effect of the “toxic chicken

accusations” on Yum! customers. 44

4. Investors Learn That Yum!’s Safety Issues Are Not Limited To Shanxi, And Begin To Learn About The Liuhe Violations

106. On December 18, 2012, China’s state-owned television station, Chinese Central

Television (“CCTV”), broadcast an extensive report based on a year of undercover work,

revealing deep flaws in the safety of Yum! China’s supply chain. 45 The article revealed that:

• poultry farmers in China’s Shandong Province, including Liuhe, had fed at least 18 kinds of unapproved antibiotics to chickens supplied to KFC ;

• the antibiotics were administered to keep the birds alive, due to the unsanitary and overcrowded conditions of their pens;

• CCTV interviewed a worker at Yum’s Shanghai-based logistics center, which received chickens from suppliers. The Yum! worker admitted that the center did not conduct any checks before sending the chicken to KFCs and Pizza Huts ; and

• the records describing the conditions under which the chickens were raised were fabricated.

43 Financial Times, “KFC in China: it’s not just the economy,” Pan Kwan Yuk, December 7, 2012. 44 Id. A December 19, 2012 article in the Wall Street Journal similarly recognized that “[r]umors of

the toxins ... may have already had an impact on sales,” over the previous weeks, quoting an analyst from Raymond James as crediting the earlier disclosure of food safety issues at Yum! as “a plausible explanation for the sudden sales collapse at KFC China.” KFC Criticized Over Suppliers in China, Colum Murphy, December 19, 2012.

45 A certified translation of this news report is attached herto as Exhibit R. A televised English version of the CCTV report published on December 20, 2012 can be found at http://www.youtube.com/watch?v=fw_ZS5y4myg.

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107. Once again, the same day that the market learned about these material adverse

facts, Yum! issued a statement on its microblog, reciting the Company’s purported food safety

practices and claiming to have fired Liuhe for being “inferior”:

According to the report by CCTV News Channel today, a few domestic chicken companies may have shortcomings in product quality. For this reason, KFC hereby make[s] the following statement:

1. All the chicken suppliers engaged by KFC are of good standing in China and have become our suppliers only after undergoing strict assessment by KFC. KFC inspects its suppliers every year, including their breeding journals and drug use records, and reviews their qualification on an annual basis.

2. The suppliers shall obtain a Certificate of Animal Quarantine for each batch of chickens both before and after slaughter, and before the chickens leave their facilities.

3. KFC requires all the suppliers to conduct drug residue inspections of their chicken products supplied to KFC.

4. KFC Logistics Center reviews and keeps the Certificates of Animal Quarantine and drug residue inspection reports when accepting the chicken products.

5. KFC makes spot checks on drug residues in all the chickens purchased.

6. On the principle of keeping the superior and eliminating the inferior suppliers, KFC has stopped purchasing chickens from our former supplier Liuhe Group effective from August. 46

108. Shortly thereafter, also on December 18, 2012, Bloomberg News picked up the

story and reported to U.S. investors that:

Yum’s chain responds to report on CCTV that it used tainted Chicken in China, co. says in Chinese on official Weibo microblog account. CCTV said today that Chinese KFC supplier Liuhe Group fed antiviral drugs, growth hormones to chickens sold to chain * KFC says on Weibo it stopped buying from Liuhe in Aug.

46 Exhibit I.

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* KFC has strict rules to ensure product quality, will “harshly” punish irregular activities buy suppliers.

109. On December 19, 2012, before the market opened, The South China Morning

Post published an article in English titled “Illegal drug in KFC chickens,” 47 revealing that the

Chinese government would investigate KFC because of the CCTV report, and that “similar

breaches” to what CCTV had reported were found to have occurred at another Yum!’s supplier:

Fast-food giant KFC says it will co-operate with a government investigation into the chicken sold in its outlets after a China Central Television programme last night revealed that some of KFC’s suppliers in Shandong had put illegal drugs in chickenfeed to make the birds gain weight faster....Farmers said their chickens were bought by the Liuhe Group, which is based in Qingdao and supplies KFC. Liuhe reportedly sells 40 tonnes of chicken a month to KFC . Its Pingdu branch is under investigation. Similar breaches have been found at another major supplier to KFC and McDonald's, Tengzhou-based Wintop Food , state media reported.

110. Later that day, Bloomberg News offered the next link in the news chain,

revealing that yet another KFC supplier, the Yingtai Group, was also implicated for using

prohibited chemicals to accelerate the growth cycle of its chickens:

Liuhe Group Co. and Yingtai Food Group Co., suppliers to customers including KFC and McDonald’s, didn’t properly inspect chickens they bought from farmers in Shandong province before delivering the poultry, the state broadcaster reported yesterday . The chickens may have been given unapproved antibiotic drugs and growth hormones by the farmers, CCTV said... ... [Yum!]’s e-mailed statement and microblog didn’t say if it uses poultry from Yingtai.

111. Later on December 19, 2012, Bloomberg News reported further that officials had

closed some of the plants and farms implicated by the stories:

47 The full title of the article is “Illegal drugs in KFC chickens: CCTV report Birds also made to eat non-stop so they grow faster and fed 18 types of antibiotics.”

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Shandong prov. food-safety officials close suppliers to KFC, McDonald’s mentioned in a CCTV report as allegedly excessive users of antibiotics, growth hormones: China News Service, citing prov. food-safety office. * Police shut Yuanjiazhuang, Xiaochijiacun farms, question managers * Liuhe slaughtering plant shut; all materials, products on site confiscated. * Yum and McDonald said in response to CCTV report that they are working with Chinese suppliers to ensure food safety

112. In response to the December 19, 2012 disclosures, Yum!’s stock price declined

nearly 3% from the prior day, falling from $69.05 to $67.16.

5. Investors Learn That Yum! Knew About Liuhe’s Repeated Use Of Prohibited Chemicals Between 2010 and 2011

113. On December 20, 2012, before the market opened, Bloomberg News reported that

“Shanghai [SIFDC] found substandard samples of chicken ... in checks of products made

between 2010-2011 of Yum! Brands supplier Liuhe Group ... .” That same day, Bloomberg

BusinessWeek expanded on this report and revealed that Yum! had contemporaneous knowledge

that the SIFDC’s third-party tests repeatedly determined Yum! was purchasing tainted chicken

from Liuhe between 2010 and 2011:

The Shanghai Food and Drug Administration said tests conducted by a third-party agency from 2010-2011 found eight batches of chicken supplied to Yum by Liuhe Group Co. had levels of antibiotics that didn’t meet prescribed standards. Yum, which operates the KFC and Pizza Hut chains in China, was made aware of these results, the agency said on its website yesterday .

114. Later that day, an analyst with Morgan Stanley responded to this disclosure by

noting that the decline in KFC sales was likely attributable to the tainted chicken scandal, while

also cautioning investors about Yum!’s future prospects:

Recent news reports surrounding some of YUM’s chicken suppliers in China likely contributed to recent deceleration in [same store sales], in our view . As in any food quality related issue, perception is more important than reality, esp in China where there has been a history of food tainting scandals. We think the situation is still fluid. A worst-case scenario would be a

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reaction similar to 2005’s red dye scare, where comps declined as much as 25% in a month, though recovered as the year unfolded . YUM’s supply chain and ability to handle adverse publicity have been much improved since then. What's new: Certain chicken suppliers of YUM’s KFCs in China are being investigated on suspicions that they are excessively feeding chickens antibiotics.

115. In response to this news, on December 20, 2012, the Company’s share price fell

by a further 1%, closing at $66.49

116. On December 21, 2012, prior to market close, Yum! filed a press release with the

SEC attached to a Form 8-K, admitting that two of the suppliers named in the recent news

articles had in fact supplied Yum! with tainted chicken. In addition, the Company expressly

acknowledged that even though these two suppliers “represent an extremely small

percentage” ofKFC’s product, the revelation still “resulted in moderate sales declines” :

In response to recent publicity, the Company is providing the following statement: We’re cooperating fully with the Chinese government's review of two poultry suppliers who provided chicken with unapproved levels of antibiotics to KFC . These suppliers represent an extremely small percentage of product to KFC. As such, we do not anticipate a shortage of product supply. Recent publicity has resulted in moderate sales declines the past few days. We take food safety very seriously and the China team is diligently working to resolve this issue.

117. Other news reports on December 21, 2012 revealed additional facts that

Defendants previously misrepresented to the market. For example, The Shanghai Daily reported

that Yum! admitted that it had not reported the SIFDC’s 2010-2011 adverse findings regarding

Liuhe and, contrary to the Company’s assertion that it stopped purchasing from Liuhe in 2011,

had instead kept purchasing large amounts of chicken from Liuhe through at least May 3, 2012:

Back in 2010, Yum Brands Inc, the world’s largest restaurant company and owner of KFC, found excessive antibiotics in chicken from a supplier but didn't report it and kept on buying the tainted chicken, Shanghai’s food safety office said yesterday . .... KFC told STV they had found unqualified products from the supplier in 2010 and they had been returned or sealed up to be

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destroyed. It said it stopped purchasing from Liuhe in 2011 . However, an STV investigation found KFC was still buying chicken from the company on May 3 this year - more than 30,000 kilograms of chicken wings in 1,000 boxes, according to its purchasing reports . It was not known whether the chicken wings were sold to customers or sealed, STV reported.

118. An article by SinaEnglish, also published on December 21, 2012, further noted

that Yum! had conducted 19 tests on Liuhe, and that the supplier failed 8 of them :

Yum Brands Inc signed a contract with SIFDC in August 2005 to serve as a third-party inspection body to test the quality of raw produce from suppliers. The company sent samples to the institute every two months and paid several million yuan a year for the service, Shanghai Television reported. The food safety office report said that from 2010 to 2011, a total of eight out of 19 batches of chicken the company purchased from the Shandong Liuhe Group were found to have excessive levels of antibiotics .

As discussed in ¶ 82, above, the SinaEnglish article further reported that batches of chicken

taken by the Chinese regulatory authorities after the December 18, 2012 CCTV report, had

tested positive for admantadine, an antiviral drug used to treat Parkinson’s disease .

119. Another news article reported that Yum! in an email to the publication had

admitted that it knew that one of the suppliers, Yingtai, had sold to Yum! tainted chicken before:

“KFC's e-mail added that in 2010, excessive amounts of antibiotics were found in raw chicken

supplied by the Liuhe Group and Yingtai Co.” 48

120. In response to the revelations on December 21, 2012, Yum!’s share price

continued to fall, dropping 4%, from $66.49 to $63.88.

121. A December 23, 2012 analyst report issued by Bank of America Merrill Lynch

observed that the impact of these revelations presented an “ongoing uncertainty” regarding the

safety of Yum!’s suppliers and its related impact on the Company’s sales:

48 ChinaDaily.com, “KFC supplier used excessive additives in chicken feed,” Wang Hongyi, December 21, 2012.

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The shares traded down about 6% last week on escalation of a China supplier issue into a potential safety concern. There is ongoing uncertainty about the supplier issue and a pre-supplier issue slowdown in sales leading Yum to guide in late November for 4Q China comps to be down 4%, versus a 21% same store sales gain in 4Q 2011.

6. The Foreseeable Risk Of Yum!’s Failure To Adhere To Its Global Safety Standards Continues to Materialize, As Yum! Again Reduces Its Prior Guidance On KFC’s Same Store Sales

122. On January 7, 2013, after the market closed, Yum! issued a press release attached

as an exhibit to Form 8-K, which the Company filed with the SEC, revealing the “significant

impact” that the revelation of Yum!’s food safety issues had on sales:

Due to adverse publicity associated with a government review of China poultry supply - and the corresponding significant impact on KFC China sales during the last two weeks of December - we now expect China Division same-store sales to be -6% for the fourth quarter of 2012, versus our previous forecast of -4%. The Company expects full-year 2012 earnings per share, excluding Special Items, of approximately $3.24. We do not anticipate providing any further updates or commentary until our scheduled earnings release on February 4, 2013.

123. On January 8, 2013, in response to the disclosures on January 7, the Company’s

stock again plunged, falling 4%, from $67.89 to $65.04.

124. Later that day, after the market closed, Bloomberg News published an article

discussing the impact of the chicken scandal on Yum!’s reputation and quality control. In

pertinent part, the article quoted Shaun Rein, managing director of China Market Research in

Shanghai, regarding Chinese consumer response:

The trust in KFC was so high that now the anger is high ... People tend to trust Western brands, they think these brands have better quality control over the supply chain and they are not going to cut corners.

The article then paraphrased Rein as follows: “Food safety is a big worry for many Chinese

consumers and it may take at least three to six months for them to start returning to KFC stores.”

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7. Defendant Su Apologizes For Yum!’s “Many Shortcomings”

125. On January 10, 2013, Su issued a public apology to Chinese consumers titled

“Open Letter to Consumers” which included admissions that Yum! had made mistakes in its

self-testing practices, including not firing Liuhe, and also not reporting any of the SIFDC’s eight

adverse findings to the government:

These self-examinations show that we have many shortcomings in our operation . Among them, the operability of our self-inspection process is not perfect; the internal communications in our company are poor; and the adjustment of suppliers is not rapid enough . We have not taken the initiative to report the inspection results to the government ; some of our employees’ views are inappropriate and our communication with people outside our organization is not rapid and transparent enough .49

Defendant Su also claimed that Yum! would take remedial action, including to test products

before they enter Yum!’s distribution system, and to report such tests to the government:

We will draw lessons from these incidents and hereby solemnly promise to all consumers that we will:

1. continue self-inspections that we have conducted since 2005; in addition to the regulatory measures taken by the government, we will require our suppliers to beef up inspection of their products supplied to YUM!; improve our methods for sampling and re-inspection of the products of the suppliers by completing such procedures prior to the delivery of the products by the suppliers, in order to prevent defective products from entering YUM!’s logistics system;

2. enhance communications with competent government agencies, take the initiative to report the problems found in self-inspections and subject ourselves to the supervision and administration by the government;

3. put forward higher requirements for the suppliers’ food safety control capacity, strictly review the qualification of the existing suppliers, and speed up the process of keeping the superior and eliminating the inferior suppliers; and

49 Original text and certified translation attached hereto as Exhibit S.

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4. support chicken suppliers in adopting advanced breeding methods and management patterns.

126. Su’s apology was reported by The Los Angeles Times in a January 10, 2013

article called “Yum Brands apologizes for KFC chicken scare in China.”

E. On January 25, 2013 The Shanghai Authorities Reprimanded Yum! For Its Actions And Confirmed That Amadantine Was Found In Yum! Chicken

127. On January 25, 2013, numerous domestic news agencies carried a story that the

Shanghai agency investigating Yum! found that Yum!’s processes for preventing tainted chicken

from entering its food supply chain were inadequate, and confirmed that amadantine – an anti-

Parkinson’s drug – was found in the chicken the agency tested.

128. For example, on January 25, a Reuters article called “Yum’s chicken in China

contained excessive levels of drugs – Xinhua,” later picked-up by both FOX News and

Bloomberg News, stated that “ The Shanghai Municipal Food Safety Committee said KFC’s

checks on its suppliers were lax , and that it found excessive levels of chemical residue in some

of the fast food chain’s supplies. ”

129. Cowen and Company noted the news in a January 25, 2013 analyst report called

“YUM China’s Chicken Supply Further Scrutinized.” In that report Cowen analysts stated:

Conclusion: We reiterate our Neutral rating on Yum shares today following the latest news in the company’s ongoing chicken supply scandal in China. Today, authorities reported that excessive chemical levels were found in the company’s previous tainted chicken supply.

130. Following the January 25, 2013 disclosures, Yum!’s stock price continued to

plunge 2.7% from $66.39 to $64.63.

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F. The Foreseeable Risk Of Yum!’s Failure To Adhere To Its Global Safety Standards Fully Materializes, As Defendants Reveal That Concerns Over Yum!’s Food Safety Will Negatively Affect Yum!’s 2013 Earnings

131. On February 4, 2013, after the close of the market, Yum! announced its full year

2012 results in a press release appended to a Form 8-K. The release confirmed that same-store

sales for Yum’s China segment had declined by 6% from the previous year on adverse publicity

resulting from the tainted chicken scandal, which caused a decline of operating profit by 5%.

But the grim news did not stop there.

132. Defendants also announced that “ The current negative sales trend in our China

KFC business will adversely impact 2013 EPS .” In the release, Defendant Novak explained

that: “Due to continued negative same-store sales and our assumption that it will take time to

recover consumer confidence, we no longer expect to achieve EPS growth in 2013 .”

133. Moreover, Defendants confirmed the ongoing safety issues in Yum!’s China

operations, admitting that Yum! was reprimanded by the Chinese government for its “poultry

supply chain practices” and was instructed to improve its testing:

On January 25, 2013, the SFDA concluded its investigation and released its recommendations. We appreciate their thorough and diligent review. The SFDA identified issues and provided “Supervisory Recommendations” to Yum! China to strengthen our poultry supply chain practices including refined voluntary self testing procedures, improved reporting and communications and enhanced supplier management . Our team in China has taken a comprehensive review of our current system and is in the process of incorporating all of the SFDA’s recommendations. We have always recognized the importance of building a world-class supply chain in China, which is why we have implemented a wide range of quality assurance and testing practices over the years above legal and regulatory standards. The SFDA’s recommendations will further strengthen those practices. The SFDA did not bring a case against Yum! China and no fine was assessed.

134. The market was stunned to learn that the chicken scandal would continue to

adversely affect Yum!’s earnings growth in 2013. For example, an analyst report issued by

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Deutsche Bank on February 5, 2013 stated that “ we doubt many investors contemplated a -5%

EPS yr. in their ‘worst case’ for YUM’s updated guidance. In fact, we believe many investors

expected YUM to reiterate 2013 guidance of ‘at least 10%’ EPS growth, counting on 2H

recovery and YUM’s track record. So, certainly this guidance is a major surprise. ” Similarly,

on February 5, an analyst with Janney Capital Markets observed that “ investors are likely to

focus their attention laser-like on a bombshell update of the 2013 outlook. ”

135. Following these revelations on February 5, 2013, Yum!’s stock price fell an

additional 2.95%, from $63.94 to $62.08.

V. POST-CLASS PERIOD EVENTS FURTHER REVEAL THE FINANCIAL EFFECTS OF CONSUMER CONCERNS OVER FOOD SAFETY AT YUM!

136. In view of the full scope of Defendants’ revelations, investors remained focused

on Yum!’s purported adherence to its global food safety and quality standards, as well as its

lingering impact on the Company’s overall financial success and profitability. Shortly after

Defendants’ February 5, 2013 revelation of disastrous anticipated EPS growth for 2013, and the

condemnation of Yum!’s food safety practices by the Chinese government, Defendants

commenced an aggressive marketing campaign to reestablish consumer confidence.

137. On February 25, 2013, Defendant Su held a press conference in which he

announced “Operation Thunder,” a list of Yum! initiatives that Su hoped would strengthen

Yum!’s food safety practices and quell consumer concern. Among those initiatives were: (i) an

increase in the frequency and sophistication of self testing; (ii) cutting off a thousand small

chicken suppliers who Yum! already knew had presented a high risk to food safety; (iii) creating

a mechanism to share testing information with the Chinese government; and (iv) a new policy of

zero tolerance in which direct suppliers who do not or cannot control farmers are also

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disqualified from Yum’s food supply chain. Su also announced an aggressive advertisement

campaign intended to lure back consumers.

138. Later that day, The Wall Street Journal published an article, quoting Defendant

Su, who admitted that “ he doesn’t feel that Yum was unfairly blamed for problems in China. ”

139. On July 10, 2013, Yum! Defendants in a press release attached to 8-K, announced

2Q 2013 earnings, acknowledging that Yum!’s slumping second quarter sales were impacted, in

part, by “the residual effect of the December [2012] poultry supply incident.”

VI. ADDITIONAL ALLEGATIONS ESTABLISHING DEFENDANTS’ SCIENTER

140. Facts and allegations establishing Defendants’ scienter are set forth above in the

substantive allegations, ¶¶ 28-139, which are specifically incorporated herein. The below facts

and allegations, in conjunction with the above-referenced Substantive Allegations, individually

and collectively establish that Defendants knew or recklessly disregarded that they disseminated

material misstatements and omissions during the Class Period.

A. Corporate Scienter Is Established By Yum!’s And Su’s Admissions

141. Pursuant to City of Monroe Emps. Ret. Sys. v. Bridgestone Corp ., 399 F.3d 651,

683-84 (6th Cir. 2005), the above allegations support a strong inference that Yum!, as an entity,

acted with corporate scienter in making material misrepresentations and/or omissions throughout

the Class Period. Among the allegations that establish corporate scienter are the following

admissions made both by Yum! and by Defendant Su, who was acting in his capacity as Vice

Chairman of the Board and President of Yum! China, in press releases, press conferences,

television interviews and statements on KFC China’s official corporate media microblog:

• Yum! admitted that “[d]uring 2010-2011, YUM! did detect excessive drug residues in the samples of several batches of products supplied by Liuhe Group,” specifically the eight separate tests performed by the SIFDC between 2010 and 2011 showing that

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chicken purchased by Yum! from Liuhe contained prohibited and dangerous chemicals, including Chloramphenicol, enrofloxacin, and Furaltodone Metabolite. 50

• Yum! continued to purchase hundreds of tons of chicken from Liuhe – 40 tons each month – for two years after receiving adverse test results.

• Defendant Su admitted that “[w]e have not taken the initiative to report the [2010-2011 SIFDC] inspection results [of Liuhe] to the government.” See ¶125.

• Defendant Su admitted that Yum! concealed the test results on the grounds that the banned and prohibited drugs were “not something that poses an immediate threat to the human body,” and that Yum! did not want to “carelessly disclose [Liuhe’s] violations, ruining [its] goodwill and even their business.” See ¶74.

• Defendant Su admitted that Yum! sourced chicken during the Class Period from many thousands of small farmers that posed a “high risk” of using banned chemicals, and that “[w]e’ve been in China for many years now, so we can’t say we haven’t known this.” ¶91.

• Defendant Su admitted knowing that, during the Class Period, Yum! had such a flawed set of safety protocols that it was not possible to prevent contaminated chicken from reaching consumers even after contaminants were detected because the chicken “already entered the system,” and therefore “we’re just too late right now. Too late.” See ¶ 62.

• Defendant Su admitted that Yum! knew during the Class Period that it was necessary to test the Company’s chicken supply for chemicals, given the high risk of purchasing tainted chicken from untrustworthy suppliers: “As far as basic principles of food safety are concerned, the two most important words are ‘source management’ .... No catering company overseas would concern themselves with how chicken farmers raise their chicken. But the current situation in China doesn’t allow us to think that way.” 51

B. Yum! China is the Company’s Core Business Segment And KFC China Is the Core Brand in that Segment

142. Yum! China, and specifically, KFC China, is the core of Yum!’s business by

every meaningful measure. As explained in ¶¶ 28-32, above, Yum! China was the Company’s

most profitable business segment. As illustrated below, leading up to the Class Period in 2010,

Yum! China contributed 36% of the Company’s overall revenues. By the end of Fiscal 2012,

Yum! China accounted for over 50% of the Company’s global consolidated revenue:

50 Exhibit K 51 Exhibit J.

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Fiscal Year Yum! China’s Yum! China’s Percentage of Percentage of Revenue as a Operating Profits Company-Owned Company-Owned

Percentage of as a Percentage Restaurants on a Restaurants at

Global Revenue of Global Global Basis Yum! China Operating Profits

2010 36% 43% 21% 83% 2011 44% 51% 21% 83% 2012 51% 43% 20% 79%

143. Moreover, as discussed in ¶ 32, above, unlike in the U.S., Yum!’s stores in China

were largely owned by the Company, yielding far higher margins. In pursuit of those higher

returns, Yum! has bet heavily and decisively on Yum! China, maintaining an 80% ownership

stake in its China-based restaurants throughout the Class Period. By contrast, the remainder of

Yum’s global portfolio is 80% franchised.

144. Indeed, Yum! has all but abandoned its equity stake in the U.S., which until

several years ago led the rest of the Company in profits and revenues and was once Yum’s core

business. But, by the end of Fiscal 2012, it had reduced its ownership stake in the U.S. to 10%.

As Defendant Carucci explained during a February 3, 2011 earnings call, “[t]his change has also

increased our dependence on China. China is now the largest contributor to profits and has the

most impact to Yum!’s overall growth. ”

145. Whereas Yum! China is Yum’s overwhelmingly dominant business segment,

KFC China is unquestionably the leading brand and driving force behind Yum! China’s success.

Three years ago, when Yum! China still accounted for just 36% of Yum’s global revenues,

Defendant Novak stated during a year-end earnings call held Feb. 4, 2010 to discuss the fiscal

year 2009, that, “our most successful business in the world is KFC in China[.]” And, during

Yum!’s earnings call held Feb. 3, 2011 to discuss the fiscal year 2010, Novak again affirmed

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China’s centrality to Yum!’s global profit strategy and highlighted KFC China’s “cash

paybacks” and “absolutely rock solid” business.

C. The Individual Defendants Closely Monitored the Supply Chain And Related Food Safety Issues at KFC China

146. Consistent with the centrality of Yum! China and KFC to the Company’s overall

success and profitability, the Individual Defendants closely monitored Yum!’s supply chain and

had knowledge of related food safety issues. As a threshold matter, the Company’s own public

disclosures with the SEC consistently acknowledged that its revenues and profitability are

closely tied to the perceived safety of its food. For example, in its Form 10-K for 2010,

Defendants acknowledge that:

• “Any report or publicity linking us or one of our Concept restaurants, including restaurants operated by our franchisees, to instances of foodborne illness or other food safety issues, including food tampering or contamination, could adversely affect our Concepts’ brands and reputations as well as our revenues and profits. ”; and

• “Concerns regarding the safety of food ingredients or products that we source from our suppliers could cause customers to avoid purchasing certain products from us . Lost confidence on the part of our customers would be difficult and costly to reestablish.”

147. Indeed, as discussed above in Section IV.A.2, the Company has weathered

several food crises in the last ten years, each of which took an immediate and protracted toll on

sales. Thus, as Yum!’s Head of Investor Relations acknowledged in 2005, following the Sudan

Red Dye crisis, Yum! implemented measures to monitor KFC China’s poultry quality more

closely:

We've also taken a number of measures ... We decided to do something unique in China that we don’t do anywhere else in the world, and that's put a laboratory of our own in basically at our level to test all of our products coming from all of our suppliers for any nonapproved ingredients, such as Sudan Red. And that’s a couple million dollars’ investment.

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148. Defendants have shown they pay close attention to food safety in other ways. As

discussed in ¶¶42-53, above, Defendants published White Papers in 2008 and 2009, in which

Defendant Su pledged to hold Yum!’s suppliers to the strictest standards.

149. Additionally, as discussed in ¶¶42-53, the Corporate Responsibility Report –

which includes an introductory letter by Defendant Novak – avers that Yum! stays “constantly

aware of” food safety issues in part because its “valuable brand reputation” is on the line:

Nothing is more important to us than protecting our customers and our valuable brand reputation by preventing health risks from arising in our restaurants. Our primary objective is to keep our customers safe. The nature of our business demands that we are constantly aware of, and respond to, potential health and safety issues related to the food we serve.

150. Moreover, the Corporate Responsibility Report affirms that Yum! executives

monitored the Company’s food safety in several ways:

(a) STARnet : Under the heading “Supplier Food Safety,” the Corporate

Responsibility Report states that Yum! has a state-of-the art web-based global supply chain

monitoring system allowing the Company to track supply issues anywhere in the world. This

system was implemented by the start of the Class Period, and thus provided Defendants with the

means to follow crises exactly like the one related to this Action:

All suppliers are audited at least once per year, with higher frequency based on risk and performance levels. We have a comprehensive, interactive web-based monitoring system for tracking supplier performance, which was significantly upgraded in 2012-2013 to enhance supplier compliance monitoring and reporting. This highly secure, proprietary system, named STARnet, enables suppliers and Yum! quality managers to specifically manage all facets of their Yum! quality accountabilities from approving product specifications to reviewing and responding to product evaluations and STAR audits.

(b) STAR: Yum! also monitored suppliers through its supplier auditing

program, called STAR. The Corporate Responsibility Report describes STAR as follows:

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Our suppliers are selected, assessed and rewarded through the Supplier Tracking and Recognition (STAR) system. It is a rigorous, industry-recognized audit system that sets and monitors standards for all of our brands’ key suppliers . In 2012, we began testing and integrating the Global Food Safety Initiative (GFSI) system into the STAR system. With this process, suppliers that have been certified under GFSI-benchmarked audit schemes have their performance and compliance monitored by QA personnel in Yum! divisions who review these audits in addition to Yum! Quality Systems audits.

(c) Food Safety Council : in 2005, the Company formed a “Global Food

Safety Council” (the “Council”). Yum’s Chief Operations Officer heads the Council, which is

made up of senior food safety, quality and compliance leaders across all divisions of Yum! The

Council provides corporate oversight of the Company’s food safety and regulatory compliance.

(d) Code of Conduct : Yum also adopted a Company-wide “Code of

Conduct” that expressly applied to all directors and employees, including each of the Individual

Defendants. The Code of Conduct instituted a Company-wide mandate to report Food Safety

problems up the chain to management: “As an employee you are expected to immediately report

any problem with food safety to your supervisor or the next level of management”.

Accordingly, pursuant to this “Code of Conduct,” each of the Individual Defendants would have

been “immediately” apprised of the SIFDC’s eight failed tests (JJ54-77) and Yingtai violations

(J 119) by their subordinates.

D. Defendants Were Motivated To Conceal KFC’s Food Safety And Quality Problems Because Disclosure Threatened Yum!’s Business Model

151. Defendants bet big on China because of the 20%+ margins and virtually limitless

room for expansion. In placing that bet, however, they faced two conflicting facts: (i) for KFC

China to maintain its Company-leading margins, it had to keep buying its raw poultry cheaply

from local farmers, then selling it at a premium mark-up to Chinese consumers willing to pay

extra for food they believed to be free of contaminants; and (ii) that business model would be

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adversely affected, if not rendered unsustainable, if the market learned that Yum! not only

purchased, but continued to purchase, tainted chicken from the same supplier.

1. KFC China’s Business Model Depends On Charging Premium Prices for Cheaply Sourced Local Poultry

152. KFC China minimizes food costs – its single largest sales expense and biggest

drag on margins – by purchasing 100% of its poultry from Chinese suppliers. In his book KFC

in China, Warren Liu, a former Yum! China executive who oversaw the consolidation and

localization of KFC China’s supply chain, discusses how, starting in the late 1990s, “supply

chain localization efforts brought to KFC China ... significantly lower costs compared to

imports[.]” Further, a November 2011 Harvard Business Review article confirmed that it

continues to be the case that “[b]uying locally is essential to keeping costs low[.]”

153. The market understands that localization of food supply boosts margins. In a

November 20, 2012 report, analysts at McQuarrie Research explained that “[llocal sourcing

capability also gives YUM a tighter control over food safety and cost.” McQuarrie further

noted that Yum! China’s localized food supply gave it a key competitive edge, by keeping costs

low and margins high.

Superior local capability to ensure stable profit growth

We attribute YUM’s success to its scale advantage, strong real estate team and local sourcing capability. For example, YUM’s ability to control its gross margin through cost-plus ingredients procurement , and its 1,000-member real estate team is unrivalled by smaller scale players.

* * *

Local sourcing capability also gives YUM a tighter control over food safety and cost.

154. Even as KFC China limits food costs by sourcing locally, it charges a premium

for its fast food because, unlike in the U.S., KFC China is considered a luxury brand and is

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priced accordingly. For example, to demonstrate this disparity, according to Deutsche Bank

analysts, Yum! executives explained at a September 2011 “Investor Day” in Shanghai that just

1/3 of Chinese consumers spend 20 Renminbi (“RMB”) or more on lunch, with the mid-range

being 10-20 RMB, and the low range being less than 10 RMB. At the time of the 2011 Investor

Day, however, KFC’s average lunch check was 26-27 RMB (then about $4.20)—or nearly twice

the 15 RMB median of what a Chinese consumer typically paid for lunch.

155. A year later, despite the introduction of certain “value” offerings to KFC menus,

the head of equity research for a Shanghai investment fund wrote:

KFC foods occupy the premium market segment, meaning that it is somewhere in the range of double to triple the prices of local restaurants with similar menu offerings.

* * *

But luxury comes with a price tag. An average meal there costs about RMB 25 (~$4) per head, placing KFC in the premium fast-food segment of the industry, not in consumer staple but discretionary spending category . 52

156. KFC has thus managed to convince consumers to pay luxury prices for locally-

sourced fast food. In 2010, Defendant Su, explained in the 2010 Harvard Case Study that KFC

can up-charge Chinese consumers because they believe KFC is safer than local fast food. Su

said while “local food products” were “readily available and inexpensive,” China’s repeated

food safety crises were causing consumers “to question the safety—especially of the street

vendors.” While consumers mistrusted street vendors, Su suggested that they trusted KFC

because “[f]ood safety has always been a key feature of the KFC offering.” According to Su,

“[a]n important feature of what we are selling is peace of mind. ”

52 Financial Times, “KFC in China: It’s Not Just the Economy,” Pan Kwan Yuk, Dec. 7, 2012 (quoting Yifeng Mao, Goldpebble Research).

- 54 -


157. As demonstrated by Defendant Su’s statements, Defendants understood that

maintaining the public’s perception of Yum!’s food safety and quality standards is of paramount

importance to Chinese consumers. Indeed, a 2012 survey of 5,000 consumers in fifteen cities

conducted by the China Market Research Group ranked food and product safety at the top of the

list of consumer concerns, ahead of paying for medical bills and children’s education. 53

158. Yum!’s leaders also knew that Chinese consumers reflexively trusted KFC

because it was a Western brand. At a May 2010 food industry symposium, Joaquin Pelaez,

Yum! China’s Senior Vice President and Chief Support Officer in charge of supply chain

management and food safety, observed that Chinese consumers are so trusting of Western brands

that they will save their money simply to be able to afford them:

I’ll tell you what. The Chinese consumer loves Western brands. Why do they love Western brands? Because they trust them. Whether you talk to your friends or your coworkers or anybody in life, they would save some money and they would buy a foreign brand , whether its milk, and whether its Australian beef and I could go on and on. And you ask them, “Why do you buy that?” And they said, “You know why? Because these brands, we can trust them.”

159. As discussed infra. , Defendants have spent years building and reinforcing that

trust by, inter alia, emphasizing Yum!’s strict adherence to the same global food safety and

quality standards in the 2008 and 2009 White Papers, the Corporate Responsibility Report, and

in public statements to investors. This business strategy built on the Chinese consumer’s

preference for Western brands, and, as explained by Warren Liu, was often strategically timed to

follow specific food safety crises:

Together, these public announcements [of white papers and committees to research food safety and nutrition] made in the years 2000, 2003, and 2005 were designed to forge a favorable

53 CNBC, August 2, 2011 news report.

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public opinion about KFC’s commitment to a healthy diet, to fend off criticisms against KFC and other fast-food brands based on health grounds, and to position KFC in the public eye as a socially responsive, caring, and leading advocate for healthier fast food.... The timing of these public relations events was well planned. It was no accident that they took place during periods of public outcry against fast food and public scares over the consumption of chicken. Together, these programs and actions by KFC China were reminiscent of three of the characteristics of the Chinese martial art of taiji, all of which are contrary to the Western way of thinking:

l. React softly to a hard blow when attacked, i.e. “Health Food Policy White Paper”

2. Leverage the force of your opponent in your counterattack, i.e. “KFC Food Health Consultative Committee”

3. Avoid frontal attack through flanking tactics, i.e. “Proposal for New Fast Food”

WARREN K. LIU, KFC IN CHINA (2008).

160. KFC China’s success in charging high prices while minimizing food costs by

sourcing locally has paid off handsomely. According to Deutsche Bank, KFC China notched

restaurant-level margins of 27% in 2010 and 25% in 2011 as of September. By contrast, Yum!

Restaurants International and Yum! U.S. respectively averaged just 12% and 13%.

161. In sum, Defendants knew that maintaining the perception of the Company’s

adherence to strict global food safety and quality standards, while preserving KFC China’s

luxury brand status and ability to source from local chicken farmers were key to maintaining its

wide margins and profitability.

2. Defendants Knew That The SIFDC’s Adverse Findings Threatened To Reveal That Yum!’s Supply Chain Had Been Compromised

162. As explained in Section IV.B above, by the start of the Class Period, Defendants

knew that the SIFDC had determined on eight separate occasions between 2010 and 2011 that

chicken purchased from Liuhe contained numerous prohibited chemicals. At the same time,

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they also knew that Liuhe sourced its poultry from small farms – as was the chicken sourced by

many of Yum!’s other local suppliers – approximately 1,000 of which were deemed “high-risk.”

Thus, in view of the SIFDC’s adverse findings, Defendants knew that they had a serious

problem with “source management” – which, according to Su, was the most important aspect of

food safety – and that even an isolated incident regarding the safety of Yum!’s food could have a

wide-ranging impact on sales. The potential scope of this problem, let alone a potential for

widespread panic, motivated Defendants to fraudulently conceal Liuhe’s repeated violations.

163. Indeed, Defendants were right to fear consumer backlash from such revelations.

As early as December 2, 2012, following the initial late November 2012 45-day “instant

chicken” reports, China’s three leading internet sites conducted informal surveys to test public

opinion of KFC. As demonstrated in the table below, those three surveys found, respectively,

that 69.7%, 75.9% and 92.6% of consumers “will not buy KFC food in the future” : 54

As of 12/2/2012 Internet Co. 1 Internet Co. 2 Internet Co. 3 (Tencent) (Sina) (MSN)

Number of Responses 124,831 130,943 6,043 “will NOT buy KFC food in the future” 69.7% 75.9% 92.6% “will buy KFC food in the future” 12.0% 16.9% 7.4% “KFC food is NOT safe” NA 84.4% 85.2% “KFC food is safe” NA 3.7% 4.0% Surveyee Bias everyone middle-class middle-class

E. The Individual Defendants Were Motivated To Achieve Yum!’s Global Sales And EPS Targets To Receive Lucrative Performance-Based Compensation

164. During the Class Period, Yum! maintained a compensation structure for its top

executives that was closely tied to Company earnings per share (“EPS”) growth. For Defendant

Su, incentive compensation was additionally tied to the operating profits growth for Yum!

China. The Individual Defendants derived most of their compensation from incentive-based pay

54 Financial Times, “KFC in China: it’s not just the economy,” Pan Kwan Yuk, December 7, 2012.

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rather than salaries, making millions each year in incentive based cash and stock compensation.

Further, in order to receive and retain their millions in stock awards and also receive and cash

out their stock appreciation rights, Defendants had to maintain certain EPS growth targets. As a

result of this compensation scheme, Defendants Novak, Carucci, and Su each had a direct

motive to protect the sales of Yum!, and specifically the sales of Yum! China.

165. As explained above, Defendants knew that food safety issues can have

devastating effects on sales. Defendants also knew that Chinese consumers are particularly

sensitive to food safety issues, and that a food safety scandal in China would devastate Yum!

sales there. Profits from China comprised approximately 42% of Yum!’s global profitability

during the Class Period, and 41% of Yum!’s global profitability in 2011. As Defendants

realized, by far the largest portion of the profits from China were derived from Yum!’s KFC

stores, and that because those stores were Company-owned any reduction in sales would have a

particularly acute affect on Yum!’s China segment profits and therefore its overall EPS.

166. As a result, maintaining Yum!’s sales, and the sales of Yum!’s KFCs in China in

particular, were enormously important factors in determining whether Yum! would reach the

profit and earnings growth targets that allowed the Individual Defendants to obtain their

significant incentive based compensation. Indeed, the food safety incidents at the core of this

case, and the resultant Class Period decline in sales at Yum!’s China KFCs, have significantly

impaired the possibility that the Individual Defendants will obtain similar incentive based

compensation in 2013 as they had in the past.

167. In addition, the revelation of the food safety concerns has increased the

likelihood that minimum three-year earnings growth targets ending on December 28, 2013 and

beyond, will not be met and therefore unvested portions of incentive stock compensation

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received from 2011 and 2012, will now be totally lost. Even if the minimum targets are met,

the food safety scandal has also increased the likelihood that the actual three-year earnings

growth levels ending on December 2012 (and beyond as discussed below) will be lowered,

therefore drastically reducing the unvested portions of incentive compensation received during

2011 through 2012, as well as lowering payoffs on expiring options that could have been cashed

by the Individual Defendants, again potentially costing them millions of dollars.

1. The Defendants’ Cash-Based Incentive Compensation Over 2011 and 2012

168. Yum!’s Annual Report for the Fiscal Year 2012, reflects that all of the Individual

Defendants received cash bonuses that amounted to a multiple of their base salaries for

generating earnings growth. As set forth in the chart below, Defendant Novak received a base

salary of $1.45 million, and a cash bonus of $4.58 million. Defendant Su received a base salary

of $1.1 million and a bonus of $2.04 million. Defendant Carucci received a base salary of

$900,000 but a bonus of $1.84 million.

2012 Cash Base and Bonus

Executive Base Salary Annual Bonus Paidx Team Year End x Target Bonus

Performance x Individual

Performance = for 2012

Officer 2012 Percentage Performance

Novak $ 1,450,000 × 160 % × 152 % × 130 % = $ 4,584,320

Su $ 1,100,000 × 115 % × 129 % × 125 % = $ 2,039,813

Carucci $ 900,000 × 120 % × 155 % × 115 % = $ 1,846,785

169. EPS growth and operating profit growth played key roles in providing these

executives with this incentive pay. Defendants Novak and Carucci earned their substantial

bonuses in 2012 because EPS grew at a rate of 13% against a target of 10% growth.

170. Su, on the other hand, earned substantial incentive pay by having overall sales

growth in the China divisions of 20% against a target growth rate of 15%, and by relatedly

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building 889 new restaurants (which the Company admits in its SEC filings drive overall sales

growth), well over the target of 550. However, notably, in 2012 Su was unable to reach his

target operating profit growth for the China division of 12% - instead hitting only 9%.

171. The Defendants’ compensation schedule in 2011 was similar, except that Su’s

actual compensation was significantly higher. Once again, in 2011, Individual Defendants were

given millions of dollars of incentive compensation for generating earnings growth.

2011 Cash Base and Bonus

Base Annual Bonus Performance Performance Bonus Formula Factor

Salary Target % Factor Team Award Individual

Novak $ 1,450,000 × 160 % × 145 % × 135 % = $ 4,541,400

Su $ 1,000,000 × 115 % × 180 % × 150 % = $ 3,105,000

Carucci $ 800,000 × 100 % × 145 % × 135 % = $ 1,566,000

2. Incentive Based Stock Option Compensation

172. The Individual Defendants were also eligible to receive compensation in the form

of stock options or stock appreciation rights. The principal metric used to determine whether

they received these payouts in the form of stock options and stock appreciation rights was also

EPS growth. The next chart shows possible levels of option based incentive compensation the

Individual Defendants could have earned based on Yum!’s fiscal 2012 performance. Whether

the executive will actually earn these amounts depends on the stock price performance relative to

the exercise price of the options. If the stock price remains below the exercise price of the

options by the maturity dates, these values could be lost to Individual Defendants. A potential

decline in stock prices during the life of the options caused by sales and earnings decline would

jeopardize the payouts from these options.

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Executive Option Awards Grant Day Fair Values

Officer

Novak 327,328 $ 5,625,960

Su 165,309 $ 2,467,739

Carucci 115,856 $1,727,413

173. The Individual Defendants were awarded these millions of dollars’ worth of

options also for generating earnings growth in 2012. The next chart outlines the relationship

between EPS growth and payouts to the Individual Defendants in the form of stock options or

stock appreciation rights for the year 2012. As the chart indicates, EPS growth of 13% (relative

to the benchmark of 10% growth), would trigger an increase of 50% in the Individual

Defendants’ performance share units. If EPS growth hit 16%, the Individual Defendants’

performance share units would increase by another 100% relative to the 10% benchmark. By

contrast, compensation in the form of performance share units was sensitive to even a small

decline in earnings. For example, if EPS grew by 7%—just 3% lower than the 10% target—the

Individual Defendants would earn zero performance share units.

Option Payout Rates 2012

EPS <7 % 7 % 8.50 % 10 % 11.50 % 13 % 14.50 % 16 % Growth

Payout as 0 % 50 % 75 % 100 % 125 % 150 % 175 % 200 % % of Target

174. In 2012, EPS grew at a rate of 13%. As a result, all of the Individual Defendants

earned substantial long-term incentive awards in 2012. Novak was granted an additional $7.2

million. Su was granted an additional $3.1 million. And Carucci was granted an additional

$2.17 million as shown in the next chart.

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Executive Officer 2012 Grant Value

Novak $7,195,000

Su $3,105,000

Carucci $2,169,000

175. The incentives provided in 2011 were similar, except Su’s stock incentive

compensation was dependent on Yum China’s operating profits. By achieving an EPS growth of

14%, Novak and Carucci were able to achieve significant incentive compensation. Similarly,

Su earned significant incentive compensation by achieving an operating profit growth of 15%.

Each of the Defendants therefore earned a multiple of their salaries in stock bonuses and long-

term incentive compensation in 2011 and 2012. Novak was granted over $14 million in 2012

and a total of over $20 million in 2011. Carucci was granted over $5 million in 2012 and over

$10 million in 2011. Su was granted over $16 million in 2012 and over $12 million in 2011.

Part of these awards could be lost if the stock price is below the exercise price by the options’

maturity dates.

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2009-2012 Compensation

Executive Year Salary Stock Option / Non-Equity Change in All Other Total ($) Awards S A R Incentive Pension Compensation ($)

($) Awards Plan Value and ($) ($) Compensation Nonqualified

($) Deferred Compensation

Earnings ($)

(a) (b) (c) (d) (e) (f) (g) (h) (i)

Novak 2012 1,450,000 773,022 5,625,960 4,584,320 1,345,665 389,388 14,168,355

2011 1,474,038 773,024 5,807,028 4,541,400 7,507,185 309,177 20,411,852

2010 1,400,000 740,005 5,029,877 5,066,880 2,038,361 338,783 14,613,906

2009 1,400,000 739,989 4,192,111 2,993760 3,565,977 239,455 13,131,292

Carucci 2012 877,692 265,042 1,727,413 1,846,785 687,438 55,820 5,460,190

2011 810,769 235,013 2,621,573 1,566,000 4,764,483 18,798 10,016,636

2010 715,000 225,023 1,387,559 1,589,445 361,071 58,213 4,336,311

2009 711,923 224,994 1,479,567 907,818 1,083,683 50713 4,458698

Su 2012 1,088,462 385,029 2,467,739 2,039,813 5,537,865 5,042,547 16,561,455

2011 1,007,692 324,986 1,668,280 3,105,000 4,556,233 1,842,530 12,504,721

2010 815,000 7,106,2112 1,387,559 2,628,986 1,470,360 909,904 14,318,020

2009 711,923 224,994 1,479,567 907,818 1,083,683 50,713 4,458,698

3. Long Term Incentive Based Compensation

176. In addition to cash awards and stock options (stock appreciation rights or SARs),

the Individual Defendants were also given performance share units (“PSUs”), stock awards

based on performance levels that were subject to multi-year performance benchmarks. The next

table shows executives’ stock awards in 2009:

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Stock awards in 2009

Grant Thresh Maxim Grant date

Grant date fair Executive Target fair value at Date -hold um value at maximum

target

Novak 2009 0 21,161 42,321 $739,989 $1,479,988

Carucci 2009 0 6,434 12,868 $224,994 $449,988

Su 2009 0 8,865 17,730 $310,011 $620,022

177. Whether the Individual Defendants would actually earn these awards depended

again on EPS growth from December 2008 to December 2011. For instance, to actually earn the

target award, the three-year EPS growth ending in December 2011 had to equal at least 10%.

178. By not disclosing the information about the adverse Liuhe tests and the state of

Yum!’s food safety practices during 2011, the Individual Defendants surpassed their EPS targets

and earned their stock awards granted in 2009. The Company more particularly explained how

the program worked as follows:

In March 2009, the Committee modified our long term incentive compensation for our CEO, Chief Financial Officer and our division presidents by adding a Performance Share Plan and discontinuing the executives' participation in the matching restricted stock unit program under the Executive Income Deferral Plan. The Performance Share Plan will distribute a number of shares of Company common stock based on the 3 year compound annual growth rate (“CAGR”) of the Company's EPS adjusted to exclude special items believed to be distortive of consolidated results on a year over year basis. The target grant value was set based on a value equal to 33% of the NEO’s annual bonus target. This amount was designed to equal the value of the discontinued Company match on deferral of their annual cash incentive into Company common stock. The performance period covers 2009- 2011 fiscal years and will be leveraged up or down based on the 3- year CAGR EPS performance against a target of 10%. The payout leverage is 0 - 200% of the target grant value. Dividend equivalents will accrue during the performance cycle but will be distributed in shares only in the same proportion and at the same time as the original performance shares are earned. If no performance shares are earned, no dividend equivalents will be

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paid. The Performance Share Units ("PSUs") are eligible for deferral under the Executive Income Deferral Plan. The target, threshold and maximum potential value of these awards are described at page 46.

179. The next table shows executives’ stock awards in 2010:


Grant Thresh Maxim Grant date Grant date fair value Executive Target fair value at

Date -hold um at maximum target

Novak 2/5/2010 0 22,438 44,876 $740,005 $1,480,010

Carucci 2/5/2010 0 6,823 13,646 $225,023 $450,046

Su 2/5/2010 0 9,400 18,800 $310,012 $620,024


again on EPS growth from December 2009 to December 29, 2012. For instance, if EPS growth

did not meet the threshold level of an annually compounded rate of 7% during this period, then

all of these awards would be lost. By concealing the information about the adverse Liuhe tests

and the state of Yum!’s food safety practices during 2012 (except when the risk materialized and

the information was disclosed at the end of 2012), the Individual Defendants surpassed their EPS

targets and earned their stock awards granted in 2010. The Company’s proxy more fully

described the program in the quote below:

grants of PSUs [are] subject to performance-based vesting conditions under the Long Term Incentive Plan in 2010. The PSUs vest on February 5, 2013, subject to the Company's achievement of specified earnings per share ("EPS") growth during the performance period ending on December 29, 2012. The performance target for all the PSU awards granted to the NEOs in 2010 is compounded annual EPS growth of 10%, determined by comparing EPS as measured at the end of the performance period to base EPS (2009 EPS). Both base EPS and EPS for the performance period are adjusted to exclude certain items as described on page 43 of this proxy statement. If the 10% growth target is achieved, 100% of the PSUs will pay out in shares of

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Company stock. If less than 7% compounded EPS growth is achieved, there will be no payout. If EPS growth is at or above 16%, PSUs pay out at the maximum, which is 200% of target. If EPS growth is at or above the 7% threshold but below the 16% maximum, the awards will pay out in proportion to the level of EPS growth achieved between the threshold and the target and between the target and the maximum, as applicable.

181. In addition, Individual Defendants got similar stock awards in fiscal 2011 and

2012 subject to multi-year performance targets ending in December 2013 and December 2014,

respectively. Stock awards in 2011 are given below:


Grant Thresh Maxim Grant date

Grant date fair Executive Target fair value at Date -hold um value at maximum

target

Novak 2011 0 13,100 26,200 $773,024 $1,546,048

Carucci 2011 0 3,983 7,965 $235,013 $470,026

Su 2011 0 5,507 11,015 $324,986 $649,972



did not meet the threshold level of annually compounded rate of 7% during this period, then all

of these awards would be lost. The Company laid-out the details in its proxy as follows:

The grant date fair value of the PSUs ... is the target payout based on the probable outcome of the performance condition, determined as of the grant date. The maximum potential values of the PSUs would be 200% of target. For 2011, Mr. Novak's PSU maximum value at grant date fair value would be $1,546,048; Mr. Carucci's PSU maximum value would be $470,026; Mr. Su's PSU maximum value would be $649,972; Mr. Allan's PSU maximum value would be $640,012; and Mr. Pant's PSU maximum value would be $339,972. In 2010, Mr. Su was the only NEO to receive an RSU grant. Mr. Su's RSU grant vests after five years and Mr. Su may not sell the shares until 12 months following retirement from the Company. The expense of Mr. Su's award is recognized over the vesting period.

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183. Individual Defendants got similar stock awards in fiscal 2012 again subject to

multi-year performance targets ending in December 2014.


Grant Thresh Maxim Grant date Grant date fair Executive Target fair value at

Date -hold um value at maximum target

Novak 2011 0 11,996 23,992 $773,022 $1,546,044

Carucci 2011 0 4,113 8,226 $265,042 $530,084

Su 2011 0 5,975 11,950 $385,029 $770,058



did not meet the threshold level of annually compounded rate of 7% during this period, then all

of these awards would be lost. Specifically, Yum! Brands explains that:

grants of PSUs subject to performance-based vesting conditions under the Long Term Incentive Plan in 2012... vest on December 27, 2014, subject to the Company’s achievement of specified earnings per share (“EPS”) growth during the performance period ending on December 27, 2014. The performance target for all the PSU awards granted to the Named Executive Officers in 2012 is compounded annual EPS growth of 10%, determined by comparing EPS as measured at the end of the performance period to base EPS (2011 EPS). Both base EPS and EPS for the performance period are adjusted to exclude certain items as described on page 40 of this proxy statement. If the 10% growth target is achieved, 100% of the PSUs will pay out in shares of Company stock. If less than 7% compounded EPS growth is achieved, there will be no payout. If EPS growth is at or above 16%, PSUs pay out at the maximum, which is 200% of target. If EPS growth is at or above the 7% threshold but below the 16% maximum, the awards will pay out in proportion to the level of EPS growth achieved between the threshold and the target and between the target and the maximum, as applicable.

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185. Disclosure to the market of the material inside information known to the

Individual Defendants regarding Yum!’s food safety problems, including the adverse SIFDC

tests, would have critically impaired the Individual Defendants’ ability to attain and retain their

2011 and 2012 long term incentive payment benchmarks, cost them millions on their vested

options, and additional millions in cash-based incentives, as well as partial or complete loss of

stock awards. Indeed, when Yum!’s food safety problems in China did ultimately become

public, Yum!’s sales and earnings both took a substantial hit, even though the disclosures took

place during only over the last month and a half of 2012.

186. Yum!’s financial report for the quarterly period ending March 23, 2013,

expressly links the metastasizing of the disclosures of Yum!’s food safety problems in China

into a massive lowering of the Company’s expected 2013 EPS growth:

The ongoing earnings growth rates referenced above represent our average annual targets for the next several years. Consistent with these ongoing earnings growth rates, in December 2012 we indicated our expectation of at least 10% EPS growth for 2013. We have subsequently lowered our 2013 full year expectations. See the China Poultry Supply Situation and Avian Flu section within the Significant Known Events, Trends or Uncertainties Impacting or Expected to Impact Comparisons of Reported or Future Results section of this MD&A for further discussion.

187. A section extensively discussing the food safety problems in China comes just

after, followed closely by the statement that:

China Division sales and profits were significantly impacted by adverse publicity from the poultry supply situation that occurred in late December 2012.

188. As a result of the lowered EPS growth projections and the continuing effects of

the food safety scandal at the heart of this Complaint on the Company’s earnings and

profitability – largely stemming from the enormous loss of sales at China KFCs – it appears

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likely that the corrective information detailed herein will have a significant and detrimental

effect on their personal compensation.

VII. DEFENDANTS’ MATERIAL MISSTATEMENTS AND OMISSIONS

189. Lead Plaintiff incorporates by reference each of the allegations set forth above.

190. Each of the Individual Defendants, as directors and/or the most senior officers of

Yum! during the Class Period, are liable as direct participants in all of the wrongs complained of

herein. Through their positions of control and authority, these defendants were in a position to

and did control all of the Company’s materially false statements as well as statements that were

rendered materially misleading because they omitted material information. In addition, all of

these false and misleading statements constitute “group published information,” which each of

the Individual Defendants were responsible for creating.

191. Defendants’ duty to disclose omitted information was created by the issuance of

their misstatements regarding Yum!’s adherence to global food safety and quality standards,

which were rendered misleading by omitted information known to Defendants. The duty to

disclose that omitted information thus arose on the day of the misleading statement with respect

to all omitted information then known by Defendants that rendered that statement misleading.

A. The Year-End 2011 Earnings Announcement

192. As set forth in Section IV.B, above, by February 6, 2012, the first day of the

Class Period, Defendants had actual knowledge that the SIFDC concluded on eight separate

occasions between 2010 and 2011 that Yum! not only purchased – but continued to purchase –

tainted chicken from Liuhe, as well as several similar incidents involving other local suppliers.

193. On February 6, 2012, Yum! issued a press release, subsequently filed with the

SEC on Form 8-K, announcing financial results for the quarter and year ended December 31,

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2011 (the “2011 Earnings Announcement”). Yum! signed the 2011 Earnings Announcement as

a registrant through a duly authorized officer and Defendant Novak was quoted therein.

194. The 2011 Earnings Announcement identified several risk factors, including that:

Our forward-looking statements are subject to risks and uncertainties , which may cause actual results to differ materially from those projected. Factors that can cause our actual results to differ materially include, but are not limited to: food borne-illness or food safety issues[.]

195. This risk disclosure was materially misleading when made because it omitted that

the identified “risks and uncertainties” related to “food safety issues” was a present-day fact, and

was no longer abstract or speculative. Such omitted information, which renders the above

statements materially misleading, includes the following:

• By February 6, 2012, the SIFDC had already alerted Defendants that eight separate tests performed between 2010 and 2011 – including those dated November 9, 2010 and December 20, 2010 – showed that chicken purchased by Yum! from Liuhe contained prohibited chemicals , including Chloramphenicol and Furaltodone Metabolite;

• The chemicals Chloramphenicol and Furaltodone Metabolite have been demonstrated to cause dangerous side effects in humans. Side effects associated with Chloramphenicol include bone marrow toxicity, fatal aplastic anaemia and increased risk of childhood leukemia. Side effects associated with Furaltodone Metabolite include bone marrow toxicity and systemic toxicity . The FDA classifies Nitrofurans such as Furaltodone Metaboliteare as mutagens / carcinogens, which have been banned from use since 1991;

• Liuhe group supplied approximately 40-50 tons of chicken a month to Yum! China, as confirmed in the CCTV exposé;

• Defendants failed to alert government public health regulators and stop sourcing chicken from Liuhe after receiving the adverse chemical residue test results, as Defendant Su admitted in a May 25, 2013 television newsmagazine interview; and

• Yum! had also learned in 2010 that another of its suppliers, Yingtai Group, had provided tainted chicken to Yum!, but, as with Liuhe, failed to disclose the contaminated poultry to

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investors or regulators, and thereafter continued to source chicken from Yingtai Group.

196. The above-described omitted information was material to investors for at least the

following reasons:

• as Defendants expressly acknowledged in Yum!’s so-called “risk factors,” food safety issues “may cause actual results to differ materially from those projected”; and

• as Defendants knew from the Sudan Red Dye scandal, as well as other recent food scares, it was foreseeable that that upon disclosure of the omitted information, Yum!’s global sales, profitability and reputation would be adversely affected over a prolonged period of time.

197. Accordingly, for all of these reasons, Defendants had a duty to disclose this

information in order to make their affirmative representations not misleading.

B. The 2011 Form 10-K

198. On February 21, 2012, Yum! filed with the SEC its Annual Report for the Fiscal

Year 2011 on Form 10-K (the “2011 Form 10-K”). Defendants Novak, Carucci and Su, in their

capacities as senior executives of the Company, each signed the 2011 Form 10-K, as well as on

behalf of registrant Defendant Yum!

199. Under a heading titled “Risk Factors,” the 2011 Form 10-K stated:

[F]ood safety issues have occurred in the past, and could occur in the future. Any report or publicity linking us or one of our Concept restaurants, including restaurants operated by our franchisees, to instances of food-borne illness or other food safety issues, including food tampering or contamination, could adversely affect our Concepts’ brands and reputations as well as our revenues and profits. If a customer of our Concepts or franchisees becomes ill from food-borne illnesses, we and our franchisees may temporarily close some restaurants, which would decrease our revenues. In addition, instances of food-borne illness, food tampering or food contamination solely involving our suppliers or distributors or solely at restaurants of competitors could adversely affect our sales as a result of negative publicity about the foodservice industry generally. Such

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instances of food-borne illness, food tampering and food contamination may not be within our control.

200. The above-emphasized statements were materially misleading when made, and

omitted material adverse information that Defendants had a duty to disclose, for all of the

reasons discussed above in ¶¶ 195 - 196. In addition, the statement that “instances of food-

borne illness, food tampering and food contamination solely involving our suppliers ... may not

be within our control ” was materially misleading when made because it omitted that Defendants

knew of at least eight repeated, specific examples of “food tampering and food contamination”

by Liuhe, and understood the broad financial impact on Yum!’s sales that these reports would

have, but nevertheless did not stop sourcing chicken from that supplier or warn regulators and

the market, although it was well within their “control” to do so.

201. In addition, under a heading titled “Suppliers,” the 2011 Form 10-K stated:

The Company purchases food, paper, equipment and other restaurant supplies from numerous independent suppliers throughout the world. These suppliers are required to meet and maintain compliance with the Company’s standards and specifications.

202. The above-emphasized statement was materially misleading when made, and


reasons discussed above in ¶¶ 195 - 196. The statement is also materially misleading because it

omits that, despite representing that suppliers were required by Yum! to “maintain compliance

with the Company’s standards and specifications,” Yum! knew of repeated instances in which at

least two specific suppliers (Liuhe and Yingtai) sold chemically contaminated chicken to Yum!

In addition, the statement was materially misleading when made because it omitted that

Defendants knew that Yum! China quality and safety standards were woefully insufficient to

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cope with the known problem of local farmers administering dangerous chemicals to chickens

supplied to Yum!

203. In addition, the 2011 Form 10-K stated:

The Company is committed to conducting its business in an ethical, legal and socially responsible manner. All restaurants, regardless of their ownership structure or location, must adhere to strict food quality and safety standards. The guidelines are translated to local market requirements and regulations where appropriate and without compromising the standards.

204. The above-emphasized statement was materially misleading when made, and


reasons discussed above in ¶¶ 195 - 196.

205. In addition, the statement was materially misleading when made because it

omitted that Defendants knew that Yum! China quality and safety standards were woefully

insufficient to cope with the known problem of local farmers administering dangerous

chemicals, including hormones, to chickens supplied to Yum.

206. Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Defendants Novak

and Carucci each falsely certified that, based on their knowledge, “this report does not contain

any untrue statement of a material fact or omit to state a material fact necessary to make the

statements made, in light of the circumstances under which such statements were made, not

misleading with respect to the period covered by this report[.]”

C. March 8, 2012 Bank of America Merrill Lynch Consumer & Retail Conference

207. On March 8, 2012, approximately one month into the Class Period, Defendant

Carucci participated in a Bank of America Merrill Lynch Consumer & Retail Conference.

During the investor conference, an audience member asked Carucci point-blank about Yum!’s

ability to control “food quality issues” in China. Although Carucci acknowledged that there is

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“probably more risk” in China, he falsely tried to allay any potential concerns by asserting that

Yum! “spent a lot of time and energy getting that right and having the right suppliers”:

Unidentified Audience Member

In China, political risk seems to rear its ugly head once in a while. You're probably maybe what they would call too big to mess with, but I'm not sure. What kind of challenges do you have potentially? And related to that, what do you do about controlling food quality and making sure there isn't any problem there?

Rick Carucci - Yum! Brands, Inc. - CFO

In terms of food supply, that's something that we spend a lot of time and energy on. And we've had some issues in the distan[t] past on that. . . . And we obviously work a lot with our suppliers . So I think the amount of time and attention we’ve put in China is probably higher than anywhere in the world. But realistically, we know there's probably more risk there than there is in places like Western Europe and the US in terms of just the way the food chain works. But we've spent a lot of time and energy getting that right and having the right suppliers.

208. Carucci’s above-emphasized statements were materially false when made, and


reasons discussed above in ¶¶ 195, 196 and 205. In addition, the statement was materially

misleading when made because it omitted that Defendants knew that Yum! China quality and

safety standards were woefully insufficient to cope with the known problem of local farmers

administering dangerous chemicals to chickens supplied to Yum.

D. The 2012 Proxy Statement and Code of Conduct

209. On April 6, 2012, Yum! filed with the SEC its 2012 Notice and Proxy Statement

on Schedule 14(a) (the “2012 Proxy Statement”). Defendant Novak signed the cover letter

inviting shareholders to attend Yum!’s annual shareholder meeting. The notice of Yum!’s

annual meeting was issued “By order of the Board of Directors,” including Defendants Novak

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(Chairman of the Board) and Su (Vice Chairman of the Board). The Board also solicited the

2012 Proxy Statement for use at Yum!’s annual shareholder meeting.

210. Under a heading titled “What are the Company’s Governance Policies and Ethical

Guidelines?” the 2012 Proxy Statement stated:

Code of Ethics. YUM’s Worldwide Code of Conduct was adopted to emphasize the Company’s commitment to the highest standards of business conduct. The Code of Conduct also sets forth information and procedures for employees to report ethical or accounting concerns, misconduct or violations of the Code in a confidential manner. The Code of Conduct applies to the Board of Directors [including, i.e., Novak and Su] and all employees of the Company, including the principal executive officer [Novak], the principal financial officer [Carucci] and the principal accounting officer. Our directors and the senior-most employees in the Company are required to regularly complete a conflicts of interest questionnaire and certify in writing that they have read and understand the Code of Conduct. The Code of Conduct is available on the Company’s Web site at www.yum.com/investors/governance/conduct.asp .

211. As stated above investors were invited to consult Yum!’s then-operative Code of

Conduct, dated March 5, 2012, at the above internet address. In relevant part, Yum!’s Code of

Conduct stated the following:

FOOD SAFETY

Food safety is a primary responsibility of Yum!, and nothing, including cost, is allowed to interfere with this responsibility .

To ensure that our customers receive safe, wholesome food, and “food you crave,” Yum!:

• Maintains strict specifications for raw products including specifications which meet or exceed government requirements.

• Adheres to a strict food safety testing program.

Follows rigid food handling and preparation procedures in the restaurants.

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• Trains management and crews in proper food-handling procedures and personal hygiene practices.

• Continually monitors and improves its procedures and practices to ensure food safety.

The responsibility for food safety is shared by everyone in our system:

• As an employee you are expected to immediately report any problem with food safety to your supervisor or the next level of management.

• Any product suspected to be unsafe must immediately be pulled from distribution until safety can be assured.

• If, at any time, your own health or that of anyone serving the restaurant might negatively impact food safety, you should immediately notify your supervisor and determine the proper course of action.

212. The above-emphasized statements in the 2012 Proxy Statement and Code of

Conduct were materially misleading, and omitted material adverse information that Defendants

had a duty to disclose, when made. Specifically, the statements in the Code of Conduct that

Yum! “[m]aintains strict specifications for raw products,” “[a]dheres to a strict food safety

testing program,” “[c]ontinually monitors and improves its procedures and practices to ensure

food safety,” and “[a]ny product suspected to be unsafe must immediately be pulled from

distribution until safety can be assured” omitted the materially adverse information discussed in

¶¶ 195, 196 and 205. including that: (i) contrary to Yum!’s purportedly “strict specifications for

raw products,” from 2010 to 2011 Yum! admittedly received at least eight specific reports from

the SIFDC that raw chicken supplied to Yum! by Liuhe contained numerous prohibited

chemicals, yet continued to purchase chicken from Liuhe; (ii) contrary to Yum!’s purportedly

“strict food safety testing program,” Yum! admittedly did not audit any of the thousands of

farmers that supplied chicken to its poultry suppliers, and also assigned a total quality

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assessment value of just 10% to chemical residue tests such as those that Liuhe failed; (iii) Yum!

did not “continually... improve[] its procedures and practices to ensure food safety,” because it

knew that its suppliers sourced chicken from 4,700 small farmers, 1,000 of which the Company

deemed “high-risk” ; and (iv) Yum! admittedly did not “pull [contaminated poultry] from

distribution until safety can be assured” because, as admitted by Defendant Su, “once any

problems are found, the chicken has unfortunately already entered the system” so “we’re just too

late.”

213. In addition, the representations in the 2012 Proxy Statement that (i) the Code of

Conduct “applie[d]” to “Directors and all employees [including Defendants],” and (ii) that

“directors and the senior-most employees [including Defendants]” had “regularly... certif[ied] in

writing” that they “understand the Code of Conduct,” were materially misleading when made

because they omitted that Defendants possessed contemporaneous knowledge of facts, including

the facts discussed in ¶¶ 195, 196 and 205. that directly contravened all of the above-emphasized

food safety provisions of Yum!’s Code of Conduct.

E. The 1Q12 Earnings Announcement

214. On April 18, 2012, Yum! issued a press release, subsequently filed with the SEC

on Form 8-K, announcing financial results for the quarter ended March 24, 2012 (the “1Q12

Earnings Announcement”). Defendant Yum! signed the 1Q12 Earnings Announcement as

registrant through a duly authorized officer and Defendant Novak was quoted therein.

215. The 1Q12 Earnings Announcement repeated verbatim the materially misleading

information contained in the preceding Class Period Earnings Announcements. This statement

was materially misleading when made, and omitted material adverse information that

Defendants had a duty to disclose, for all of the reasons discussed above in ¶¶ 195, 196 and 205.

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F. The 1Q12 10-Q

216. On April 25, 2012, Yum! filed with the SEC the Company’s Form 10-Q for the

quarter ended March 24, 2012 (the “1Q12 10-Q”).

217. The 1Q12 10-Q stated the following regarding Risk Factors:

We face a variety of risks that are inherent in our business and our industry, including operational, legal, regulatory and product risks. Such risks could cause our actual results to differ materially from our forward-looking statements, expectations and historical trends ... there have been no material changes from the risk factors disclosed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011.

218. This statement was materially misleading when made, and omitted material

adverse information that Defendants had a duty to disclose, for all of the reasons discussed

above in ¶¶ 195, 196 and 205.

219. Defendant Yum! signed the 1Q12 10-Q as registrant through a duly authorized

officer. Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Defendants Novak and

Carucci each certified that, based on their knowledge, “this report does not contain any untrue

statement of a material fact or omit to state a material fact necessary to make the statements

made, in light of the circumstances under which such statements were made, not misleading with

respect to the period covered by this report[.]”

G. The 2Q12 Earnings Announcement

220. On July 18, 2012, Yum! issued a press release, subsequently filed with the SEC

on Form 8-K, announcing financial results for the quarter ended June 16, 2012 (the “2Q12

Earnings Announcement”). Defendant Yum! signed the 2Q12 Earnings Announcement as

registrant through a duly authorized officer and Defendant Novak was quoted therein.


information contained in the 1Q12 Earnings Announcement. This statement was materially

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misleading when made, and omitted material adverse information that Defendants had a duty to

disclose, for all of the reasons discussed above in ¶¶ 195, 196 and 205.

H. The 2Q12 10-Q

222. On July 24, 2012, Yum! filed with the SEC the Company’s Form 10-Q for the

quarter ended June 16, 2012 (the “2Q12 10-Q”). The 2Q12 10-Q repeated verbatim the

materially misleading information contained in the 1Q12 10-Q. This statement was materially




officer. Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Defendants Novak and

Carucci each certified that, based on their knowledge, “this report does not contain any untrue

statement of a material fact or omit to state a material fact necessary to make the statements

made, in light of the circumstances under which such statements were made, not misleading with

respect to the period covered by this report[.]”

I. The 3Q12 Earnings Announcement

224. On October 9, 2012, Yum! issued a press release, subsequently filed with the

SEC on Form 8-K, announcing financial results for the quarter ended September 8, 2012 (the

“3Q12 Earnings Announcement”). Defendant Yum! signed the 3Q12 Earnings Announcement

as registrant through a duly authorized officer and Defendant Novak was quoted therein.


information contained in the preceding Class Period Earnings Announcements. This statement



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J. The 3Q12 10-Q

226. On October 16, 2012, Yum! filed with the SEC the Company’s Form 10-Q for

the quarter ended September 8, 2012 (the “3Q12 10-Q”). The 3Q12 10-Q repeated verbatim the

materially misleading information contained in the 1Q12 10-Q and 2Q12 10-Q. This statement




officer. Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, Defendant Novak certified

that, based on their knowledge, “this report does not contain any untrue statement of a material

fact or omit to state a material fact necessary to make the statements made, in light of the

circumstances under which such statements were made, not misleading with respect to the period

covered by this report[.]”

K. The November 23, 2012 Bloomberg News Article and KFC China Statement

228. On November 23, 2012, Bloomberg News published a story concerning reports in

the Chinese media that one of Yum! China’s chicken suppliers, Shanxi, had administered

hormone stimulants to the chicken that it supplied to Yum! in order to accelerate the poultry’s

growth. Bloomberg also reported that Shanxi had kept the chickens in unhygienic conditions,

“packing 5,000 chickens in a coop, an environment which easily bred disease.”

229. Bloomberg News further reported that Yum! had responded to the Chinese media

reports in an statement posted on KFC China’s official internet page. Bloomberg News

paraphrased portions of Yum!’s statement, including that: “Co. said it watches food safety very

closely, expects all its chicken meat suppliers to follow strict food safety rules, and conducts

random checks on the products.”

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230. The below translation of Yum!’s statement, which accords with Bloomberg’s

article, read in pertinent part:

KFC always attaches importance to food safety, requesting all chicken suppliers to adopt complete food safety management measures. It also makes spot checks on their products. Shanxi Suhai Group is a relatively small regional supplier within KFC’s chicken supply system, supplying only about 1% of the chickens for KFC, and it has maintained a normal food safety record in the past. KFC will carry out investigations according to the media reports, enhance inspections and mete out punishments according to the results of the investigations. 55

231. The above-referenced statement, as reported by Bloomberg News , was materially



THE TRUTH BEGINS TO BE REVEALED

L. Partial Disclosure: the November 29, 2012 Press Release

232. Less than a week after the November 23 Report, on November 29, 2012, the

financial implications of Yum!’s failure to adhere to its purported global food safety and quality

standards, and the known risks that Defendants had fraudulently concealed throughout the Class

Period, began to materialize. On that day, after trading hours, Yum! issued a press release (the

“November 29 2012 Press Release”) that updated projected fourth quarter same-store sales for

Yum! China to negative 4%, a surprising reduction from prior predictions of flat or single-digit

same-store sales.

233. In the November 29, 2012 Press Release, Defendant Novak attributed the lowered

guidance regarding Yum! China same store sales to “ softer sales in China. ”

234. This statement was materially misleading because it omitted that the drop was

substantially attributable to rumors of poultry contamination by one of Yum! China’s suppliers

55 Exhibit P.

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(Shanxi), as reported by Bloomberg News on November 23, 2012, and subsequently discussed

by Forbes, as well as by analysts at Morgan Stanley. S ee infra. at ¶¶94 through 105.

235. In the November 29, 2012 Press Release, Novak also made the lulling statement

that, “We are extremely confident Yum! China remains the best growth story in the restaurant

industry.” Analysts responded to Novak’s “softer sales in China” explanation with trepidation.

In a November 29, 2012 report titled “YUM could see Street reset on ’13 outlook, China

uncertainty,” analysts at Jefferies & Co., Inc. observed:

Preliminary 4Q [same store sales] of 4% in YRI and 3% in the US are better than expected, but China [same store sales] guidance for -4% implies that comps have been down ~6-7% in recent weeks .... this reflects a sharp deceleration vs. about +2% at 5 weeks into the quarter.

236. Analysts at Morgan Stanley & Co. LLC also displayed concern at the reduction to

Yum! China same-store sales. A November 29, 2012 Morgan Stanley report titled “November

Surprise – China Weakens, Worst Since 09” noted as to Yum’s 11/29/2012 Press Release that,

“[a]ll was in line but for one important negative twist: 4Q China comps will likely be down 4%

... this versus our +2% estimate.”

237. Analysts’ skepticism was born out by the market’s response to Yum!’s news—on

the trading day that followed the issuance of the November 29, 2012 Press Release, Yum!’s

share price plunged over 10%, closing at $67.08 per share, representing the largest one-day hit to

Yum’s share price in ten years.

238. Furthermore, the selloff caused by Yum!’s surprise negative outlook on Yum!

China’s same-store sales constituted an initial materialization of the risk engendered by

Defendants’ actions. On December 6, 2012, Forbes published an article titled “Too-Fast Food:

Behind the Scene of YUM! Brand China Slump.” The article, which was co-authored by the

Head of Equity Research at a China-based research firm specializing in data procession and

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analysis, concluded that a slowdown in China’s economy was not likely to be the “entire story”

behind Yum’s guidance reduction. Instead, Forbes pointed to the swirling poultry

contamination rumors, as reported by Bloomberg on November 23, 2012:

So the “China slowdown” catchall, while somewhat valid, is unlikely to tell the entire story behind KFC China’s dimming prospects. With no other notable factors on the horizon, the toxic 45-day chicken hullaballoo emerges as a possible culprit.

239. The Forbes article added that the toxic chicken rumors would be particularly

jarring to KFC’s Chinese customers because (unlike in the U.S.), “[i]n China, KFC is premium

fast food – a dining experience that symbolizes the purity and heartiness of American life.”

M. False and Misleading Statement: December 7, 2012 KFC China Statement

240. On the following day, December 7, 2012, Yum! China posted a statement on

KFC China’s official web page, responding to the persistent Chinese media reports regarding

KFC chicken fed with growth hormones (the “12/07/2012 KFC China Statement”). In pertinent

part, the statement read:

Recently, there have been a lot of discussions about the growth of imported breeds of white-feather chickens in a period of 45 days. A few media outlets pointed out some safety risks in China’s white-feather breeding industry at present. Consistent with our commitment of responsibility to consumers, KFC hereby reaffirms as follows: ....

All chickens will undergo inspection by the government, suppliers and KFC before entering KFC. KFC will continue to supervise all the suppliers, strengthen the management of the suppliers continuously to ease people’s concern about food safety risks, and keep the superior and eliminate inferior suppliers to minimize the risks. 56

241. The above-emphasized statement was materially misleading when made for all of

the reasons discussed above in ¶¶ 195, 196 and 205.

56 Exhibit Q.

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242. In addition, the statement that, “All chickens will undergo inspection by the

government, suppliers and KFC before entering KFC” was materially false when made because

KFC’s chickens were not inspected by the government, KFC’s suppliers or even KFC itself

before they reached restaurants. Defendant Su attested to this in a televised interview broadcast

on May 25, 2013.

243. Further, the statement that “KFC will continue to supervise all the suppliers” was

materially misleading when made because it omitted that KFC China did not supervise its

suppliers either by testing chicken at the supplier before it entered the Yum! logistics system, or

by ascertaining that KFC China’s suppliers did not source chicken from high-risk farmers—both

of which failures Defendant Su revealed in a televised interview broadcast on May 25, 2013.

244. Finally, the statement that “KFC will continue to ... keep the superior and

eliminate inferior suppliers to minimize the risks” was materially misleading when made

because it omitted that (i) for two years, Yum! failed to eliminate Liuhe Group, even as Liuhe

Group failed 42% of chemical residue tests; (ii) “for many years,” Yum! failed to eliminate

1,000 known high-risk farmers from its supply chain; and (iii) Yum! failed to eliminate Yingtai

Group, despite awareness that Yingtai Group had supplied Yum! with tainted chicken in 2010.

N. False And Misleading Statement: December 18, 2012 KFC China Statement

245. On December 18, 2012, China’s state-owned television station, Chinese Central

Television (“CCTV”), broadcast an investigative exposé based on a year of undercover reporting

regarding the flaws in Yum! China’s food safety supply chain (the “CCTV Exposé”). The

CCTV Exposé, which was discussed in an article published by Bloomberg News after the market

opened, directly called into question the integrity of Yum! China’s food safety protocols.

246. In pertinent part, the CCTV Exposé revealed that:

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• poultry farmers in China’s Shandong Province had fed at least 18 kinds of unapproved antibiotics to chickens supplied to KFC, Yum’s marquee brand in China;

• the antibiotics were administered to keep the birds alive, due to the unsanitary and overcrowded conditions of their pens;

• CCTV interviewed a worker at Yum’s Shanghai-based logistics center, which received chickens from suppliers. The worker admitted that the center did not conduct any checks before sending the chicken to KFCs and Pizza Huts; and

• the records describing the conditions under which the chickens were raised had been fabricated.

247. In response, on December 18, 2012, Yum! posted a statement responding to the

CCTV report on KFC China’s official website (the “12/18/2012 KFC China Statement”). In

pertinent part, the 12/18/2012 KFC China Statement said:

KFC requires all the suppliers to conduct drug residue inspections of their chicken products supplied to KFC.

KFC makes spot checks on drug residues in all the chickens purchased. 57

248. The above-emphasized statements were materially misleading when made, and


reasons discussed above in ¶¶ 195, 196 and 205.

249. In addition, the statement “KFC requires all the suppliers to conduct drug residue

inspections of their chicken products supplied to KFC” was materially misleading when made

because it omitted that KFC did not require its suppliers to test chickens at the supplier end, as

confirmed by Defendant Su in a May 25, 2013 television interview.

57 Exhibit I.

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O. Partial Disclosure: the December 19, 2012 Bloomberg News Article

250. December 19, 2012 brought further revelations regarding Yum!’s food safety

debacle. On that day, before the market opened, Bloomberg News reported that Shanghai food

safety officials raided, rasacked, then shuttered several farms and plants that had supplied

chicken to KFC, allegedly for excessive use of antibiotics and growth hormones.

251. Yum’s share price declined 2.7%, to close at $67.16 on this news.

P. Partial Disclosure: the December 20, 2012 Bloomberg News Article

252. On December 20, 2012, before the market opened, Bloomberg News reported that

the Shanghai FDA found substandard samples of chicken in checks of products made between

2010-2011 of Yum! Brands supplier Liuhe group.

253. Also on December 20, 2012, analysts at Morgan Stanley issued a report that drew

the line from the mid-December poultry contamination revelations to the reports of hormone-fed

chicken that had surfaced in late November. The Morgan Stanley analysts suggested that those

reports contributed to KFC China’s same-store sales shortfall—which in turn led to the

November 30, 2012 stock selloff:

Recent news reports surrounding some of YUM’s chicken suppliers in China likely contributed to recent deceleration in [same store sales], in our view.

What's new: Certain chicken suppliers of YUM’s KFCs in China are being investigated on suspicions that they are excessively feeding chickens antibiotics. This follows national new reports in late November that suggested suppliers had sped up the growing cycle for chickens to ~40 days. From our understanding, both of these are standard industry practices, but it is not clear whether these particular suppliers are doing something excessive or beyond the norm. The current issue appears to be more widespread than a single company or brand – one of the suppliers that has been shut down sold chickens to both YUM and MCD, while the other does not appear to have ties to either.

254. On the day’s news, Yum’s share price fell a further 1%, to close at $66.49.

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Q. Partial Disclosure: December 21, 2012 Form 8-K and Bloomberg Article

255. On December 21, 2012, prior to market close, Yum! issued a press release, which

it subsequently filed with the SEC as an exhibit to Form 8-K. The press release read:

In response to recent publicity, the Company is providing the following statement: We’re cooperating fully with the Chinese government's review of two poultry suppliers who provided chicken with unapproved levels of antibiotics to KFC. These suppliers represent an extremely small percentage of product to KFC. As such, we do not anticipate a shortage of product supply. Recent publicity has resulted in moderate sales impact the past few days. We take food safety very seriously and the China team is diligently working to resolve this issue.

256. On the news of the “moderate sales impact” caused by the “Chinese

government’s review” of “unapproved levels of antibiotics” Yum! ‘s share price collapsed

another 4%, to close at $63.88.

R. Partial Disclosure: the January 7, 2013 Press Release and Bloomberg Article

257. On January 7, 2013, after market close, Yum! issued a press release, which it

subsequently filed with the SEC as an exhibit to Form 8-K (the “1/07/13 Press Release”).

258. In the 1/07/13 Press Release, the Company once again reduced guidance for

Yum! China’s fourth quarter same-store sales. Yum! specifically blamed the continued slide on

“adverse publicity associated with a government review of China poultry supply – and the

corresponding significant impact on KFC China sales during the last two weeks of December.”

259. The next day, January 8, 2013, on this news, Yum!’s share price dropped another

4.3%, to close at $65.04.

260. That day, Bloomberg News published an article describing Yum!’s press release

and discussing KFC’s continuing negative perception by Chinese consumers. In pertinent part,

the article quoted Shaun Rein, managing director of China Market Research in Shanghai,

regarding the response of KFC’s Chinese customers:

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The trust in KFC was so high that now the anger is high. People tend to trust Western brands, they think these brands have better quality control over the supply chain and they are not going to cut corners.

S. Partial Disclosure: The January 25, 2013 Bloomberg News Article

261. On January 25, 2013, Bloomberg News published an article before the market

opened. The article revealed that the official investigation by the Shanghai Food Safety

Commission had found excessive animal drugs residue in certain chicken samples obtained from

Yum! and as a result, had ordered the Company to rectify the problems and institute

strengthened supervisory processes.

262. On this news, Yum’s stock price fell a further 2.7%, to close at $64.63.

THE TRUTH IS FULLY REVEALED

263. The truth was fully revealed to investors on February 4, 2013. On that day, after

the market closed, Yum! announced its full year results for Fiscal 2012 in a Company press

release filed with the SEC on Form 8-K (the “2012 Earnings Release”), and revealed that

Defendants “no longer expect to achieve EPS growth in 2013.” The 2012 Earnings Release

quoted Defendant Novak as conceding that:

[A]s a result of adverse publicity from the poultry supply situation in mid-December, China KFC sales experienced a sharp decline. Due to continued negative same-store sales and our assumption that it will take time to recover consumer confidence, we no longer expect to achieve EPS growth in 2013.

264. The market finally and fully understood that the financial implications of Yum!’s

tainted chicken problems were not going to disappear anytime soon. After the publication of the

earnings release, Robert W. Baird & Co. issued an analyst report in which it lowered its rating

for Yum! from outperform to neutral and stated:

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We are stepping to the sidelines on YUM amid the highly uncertain near-term outlook for China ... While optimistic that YUM is taking appropriate actions to stem the same-store traffic declines, we hesitate to assume that these initiatives will lead to a quick recovery.

265. Analysts at Barclays Capital Inc. also sounded a cautionary note. While

conceding that Yum! had “performed well through past adversity,” Barclays warned that “this

time around [Yum’s] diversified portfolio is more heavily dominated by China , and weakness in

the segment began even prior to the high-profile December supplier issue[.]”

266. On the news, investors continued to abandon ship—on February 5, 2013, the last

day of the Class Period, YUM’s stock price fell 3%, to close at $62.08 per share.

267. In sum, Defendants’ false statements and omissions caused Yum!’s securities to

trade at artificially-inflated prices during the Class Period. As a result of the foregoing

revelations about the truth regarding the inadequacy of Yum!’s food safety protocols and

concealment of known food safety violations, Yum!’s stock price fell nearly 17%, from $74.47

per share on November 29, 2012, to $62.08 per share on February 5, 2013, after the truth was

fully revealed.

VIII. LOSS CAUSATION

268. Defendants’ wrongful conduct directly caused the economic losses suffered by

Lead Plaintiff and the Class. During the Class Period, the prices of Yum! securities were

artificially inflated as a result of Defendants’ misstatements and omissions, as set forth herein.

As alleged in ¶¶97-135 and 232-267 when the foreseeable risks that Defendants fraudulently

concealed began to materialize, and when Defendants’ material misstatements were corrected by

the partial and full revelations of the truth, the artificial inflation was removed from the market

price of Yum! securities, causing investors to incur substantial losses.

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269. Specifically, the foreseeable risks described herein materialized, and Defendants’

material misstatements were corrected by, the loss-causing information that was disseminated

on: (i) November 29, 2012; (ii) December 19, 2012; (iii) December 20, 2012; (iv) December 21,

2012; (v) January 7, 2013; (vi) January 25, 2013; and (vii) February 4, 2013, for the reasons that

are more fully detailed in ¶¶97-135 and 232-267.

270. As explained above, the loss-causing information that was disseminated on each

of the corrective disclosure dates between November 29, 2012 and January 25, 2013 did not

fully remove the inflation from Yum!’s securities prices because the foreseeable risks that began

to materialize on those dates, and the partial corrections of Defendants’ material misstatements,

had not fully materialized and/or corrected Defendants’ misstatements until Defendants’

disclosure of Yum!’s fiscal 2012 results and 2013 EPS guidance on February 4, 2013.

IX. CLASS ACTION ALLEGATIONS

271. Lead Plaintiff brings this action as a class action pursuant to Rule 23 of the

Federal Rules of Civil Procedure (“Rule 23”) on behalf of the Class. Excluded from the Class

are: (i) Defendants; (ii) members of the immediate family of any Defendant; (iii) any person who

was an officer or director of Yum! during the Class Period; (iv) any firm, trust, corporation,

officer, or other entity in which any Defendant has or had a controlling interest; (v) Defendants’

directors’ and officers’ liability insurance carriers, and any affiliates or subsidiaries thereof; (vi)

the Company’s employee retirement and benefit plan(s); and (vi) the legal representatives,

agents, affiliates, heirs, successors-in-interest, or assigns of any such excluded party.

272. The members of the Class are so numerous that joinder of all members is

impracticable. The disposition of their claims in a class action will provide substantial benefits

to the parties and the Court. As of April 23, 2013, Yum! had more than 449 million shares of

common stock outstanding, owned by thousands of investors.

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273. There is a well-defined community of interest in the questions of law and fact

involved in this case. Questions of law and fact common to the members of the Class that

predominate over questions that may affect individual Class members include:

(a) whether Defendants violated the Exchange Act;

(b) whether Defendants misrepresented material facts;

(c) whether Defendants’ statements omitted material facts necessary in order

to make the statements made, in light of the circumstances under which they were made, not

misleading;

(d) whether Defendants knew or recklessly disregarded that their statements

were false and misleading;

(e) whether the price of Yum! securities was artificially inflated; and

(f) the extent of damage sustained by Class members and the appropriate

measure of damages.

274. Lead Plaintiff’s claims are typical of those of the Class because Lead Plaintiff and

the Class sustained damages from Defendants’ wrongful conduct.

275. Lead Plaintiff will adequately protect the interests of the Class and has retained

counsel who are experienced in class action securities litigation. Lead Plaintiff has no interests

that conflict with those of the Class.

276. A class action is superior to other available methods for the fair and efficient

adjudication of this controversy.

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X. PRESUMPTION OF RELIANCE UNDER THE AFFILIATED UTE DOCTRINE AND/OR, IN THE ALTERNATIVE, THE FRAUD ON THE MARKET DOCTRINE

277. Lead Plaintiff is entitled to a presumption of reliance under Affiliated Ute Citizens

of Utah v. United States , 406 U.S. 128 (1972), because the claims asserted herein are predicated

in part upon omissions of material fact that Defendants had a duty to disclose.

278. In the alternative, Lead Plaintiff is entitled to a presumption of reliance on

Defendants’ misstatements and omissions under the fraud-on-the-market doctrine because, at all

relevant times, the market for Yum! securities was open, efficient, and well-developed for the

following reasons, among others:

(a) The market for Yum! securities was, at all relevant times, an efficient

market that promptly digested current information with respect to the Company from reliable,

publicly-available sources and reflected such information in the price of Yum! securities;

(b) Yum!’s publicly traded securities met the requirements for listing and

were listed and actively traded on the NYSE, a highly efficient and automated market;

(c) As a regulated issuer, Yum! filed periodic public reports with the SEC;

(d) Yum! regularly communicated with public investors by means of

established market communication mechanisms, including through regular dissemination of

press releases on the major news wire services and through other wide-ranging public

disclosures, such as communications with the financial press, securities analysts and other

similar reporting services;

(e) Yum! securities were covered by numerous securities analysts employed

by major brokerage firms who wrote reports that were distributed to the sales force and certain

customers of their respective firms; and

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(f) The price of Yum! securities reacted promptly to the dissemination of new

information regarding the Company, as set forth above. Yum! securities were actively traded

during the Class Period with substantial trading and average weekly turnover and high

institutional investor participation.

XI. CAUSES OF ACTION

COUNT I

For Violation of § 10(b) of the Exchange Act and Rule 10b-5 Against Yum!

279. Lead Plaintiff incorporates by reference and realleges each and every allegation

contained above as if fully set forth herein.

280. During the Class Period, officers, management, and agents of Yum! carried out a

plan, scheme and course of conduct which was intended to and, throughout the Class Period,

did: (i) deceive the investing public regarding Yum!’s business, operations, management and the

intrinsic value of Yum!’s securities; (ii) enable Yum! to artificially inflate the price of its

securities; and (iii) cause Lead Plaintiff and other members of the Class to purchase Yum!

securities at artificially inflated prices. In furtherance of this unlawful scheme, plan and course

of conduct, Yum! took the actions set forth herein.

281. Officers, management, and agents of Yum! directly and indirectly, by the use of

means and instrumentalities of interstate commerce, the mails, and/or the facilities of a national

securities exchange: (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 made 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 Yum!’s securities in violation of Section

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10(b) of the Exchange Act and SEC Rule 10b-5. Yum! is sued as a primary participant in the

wrongful and illegal conduct charged herein.

282. Yum!, 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 the truth about Yum!’s food safety, as specified herein.

283. Officers, management, and agents of Yum! 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

Yum!’s value and performance, which included the making of untrue statements of material

facts and omitting material facts necessary in order to make the statements made about Yum!’s

operations and prospects, in the light of the circumstances under which they were made, not

misleading, as set forth more particularly herein. Officers, management, and agents of Yum! did

not have a reasonable basis for their alleged false statements and engaged in transactions,

practices, and a course of business which operated as a fraud and deceit upon the purchasers of

Yum! securities during the Class Period.

284. Yum! is liable for all materially false and misleading statements and omissions

that were made during the Class Period, as alleged in ¶¶ 189-262 above.

285. Yum! is further liable for the false and misleading statements made by Yum!’s

officers, management, and agents in press releases and during conference calls and at

conferences with investors and analysts, as alleged above, as the maker of such statements and

under the principle of respondeat superior.

286. In addition to the duties of full disclosure imposed on Yum! as a result of the

affirmative statements and reports made by its officers, management, and agents, or participation

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in the making of their affirmative statements and reports to the investing public, Yum! 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 embodied in SEC

Regulations, including truthful, complete and accurate information with respect to the

Company’s operations and financial condition so that the Company’s share price would be based

on truthful, complete and accurate information.

287. The allegations above establish a strong inference that Yum!, as an entity, acted

with corporate scienter throughout the Class Period, as its officers, management, and agents had

actual knowledge of the misrepresentations and omissions of material facts set forth herein, as

demonstrated by the Company’s receipt of at least eight separate adverse test results from the

SIFDC between 2010 and 2011, which alerted the Company that it had purchased, and continued

to purchase, significant sums of chicken containing numerous banned chemicals. Such material

misrepresentations and/or omissions were done knowingly or with recklessness, and without a

reasonable basis. By concealing these material facts from investors, Yum! maintained the

artificially inflated price of its securities throughout the Class Period.

288. In ignorance of the fact that Yum!’s securities were artificially inflated, and

relying directly or indirectly on the false and misleading statements and omissions made by

Yum!, or upon the integrity of the market in which its securities traded, and/or on the absence of

material adverse information that was known to or recklessly disregarded by Yum! but not

disclosed in public statements by Yum! during the Class Period, Lead Plaintiff and the other

members of the Class purchased or acquired Yum! securities during the Class Period at

artificially high prices and were damaged when that artificial inflation was removed from the

price of Yum! securities as the truth was revealed.

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289. At the time of said misrepresentations and omissions, Lead Plaintiff and other

members of the Class were ignorant of their falsity, and believed them to be true. Had Lead

Plaintiff, the other members of the Class, and the marketplace known of the truth concerning the

Company’s food safety, Lead Plaintiff and other members of the Class would not have

purchased or acquired their Yum! securities, or, if they had purchased or acquired such securities

during the Class Period, they would not have done so at the artificially inflated prices they paid.

290. By virtue of the foregoing, Yum! has violated Section 10(b) of the Exchange Act

and Rule 10b-5 promulgated thereunder.

291. As a direct and proximate result of Yum!’s wrongful conduct, Lead Plaintiff and

the other members of the Class suffered damages in connection with their respective purchases

and/or acquisitions of Yum! securities during the Class Period.

COUNT II For Violation of § 10(b) of the Exchange Act

and Rule 10b-5 Against the Individual Defendants

292. Lead Plaintiff incorporates paragraphs 1 through 192 by reference.

293. During the Class Period, the Individual Defendants disseminated or approved the

false statements specified above, which they knew or, as to statements of present or historical

facts, at least recklessly disregarded were misleading in that they contained misrepresentations

and failed to disclose material facts necessary in order to make the statements made, in light of

the circumstances under which they were made, not misleading.

294. The Individual Defendants violated Section 10(b) of the Exchange Act and Rule

10b-5 in that they:

(a) employed devices, schemes, and artifices to defraud;

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(b) made untrue statements of material facts or omitted to state material facts

necessary in order to make the statements made, in light of the circumstances under which they

were made, not misleading; or

(c) engaged in acts, practices, and a course of business that operated as fraud

or deceit upon Lead Plaintiff and others similarly situated in connection with their purchases of


295. Lead Plaintiff and the Class have suffered damages in that, in reliance on the

integrity of the market, they paid artificially-inflated prices for Yum! securities. Lead Plaintiff

and the Class would not have purchased Yum! securities at the prices they paid, or at all, had

they been aware that the market prices were artificially inflated by Defendants’ misleading

misstatements and omissions.

296. As a direct and proximate result of Defendants’ wrongful conduct, Lead Plaintiff

and the other members of the Class suffered damages in connection with their purchases of


COUNT III For Violation of § 20(a) of the Exchange Act

Against the Individual Defendants

297. Lead Plaintiff incorporates paragraphs 1 through 296 by reference.

298. The Individual Defendants acted as controlling persons of Yum! within the

meaning of Section 20(a) of the Exchange Act. 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 alleged false statements and omissions, each of the 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

statements which Lead Plaintiff contends were false and misleading. The Individual Defendants

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were provided with or had unlimited access to copies of the Company’s reports, press releases,

public filings and other statements that Lead Plaintiff alleges were misleading, or omitted to

state adverse material information that Defendants had a duty to disclose, 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.

299. In particular, as senior executives of Yum!, each of the Individual Defendants had

direct and supervisory involvement in the day-to-day operations of Yum! throughout the Class

Period and, therefore, is presumed to have had the power to control or influence the particular

transactions giving rise to the securities violations as alleged herein, and exercised the same.

300. As set forth above, each of the Individual Defendants violated Section 10(b) and

Rule 10b-5 based upon their fraudulent statements, acts and omissions, as alleged in this

Complaint. By virtue of their positions as controlling persons, they are thus each liable pursuant

to Section 20(a) of the Exchange Act. As a direct and proximate result of Defendants’ wrongful

conduct, Lead Plaintiff and other Class members suffered damages in connection with their

purchases of Yum! securities during the Class Period.

XII. PRAYER FOR RELIEF

WHEREFORE, Lead Plaintiff, on behalf of itself and the other members of the Class,

prays for judgment as follows:

(a) Declaring this action to be a proper class action and certifying Lead

Plaintiff as a class representative pursuant to Rule 23 of the Federal Rules of Civil Procedure;

(b) Awarding compensatory damages in favor of Lead Plaintiff and the

members of the Class 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;

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(c) Awarding Lead Plaintiff 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.

XIII. JURY TRIAL DEMANDED

Lead Plaintiff hereby demands a trial by jury of all issues so triable.

Dated: August 5, 2013

LABATON SUCHAROW LLP

/s/ Stephen W. Tountas Jonathan M. Plasse Eric J. Belfi Stephen W. Tountas Wilson Meeks 140 Broadway New York, New York 10005 Tel: (212) 907-0700 Fax: (212) 818-0477 [email protected] [email protected] [email protected] [email protected]

Lead Counsel for Lead Plaintiff and the Proposed Class

RANSDELL & ROACH PLLC

/s/ John C. Roach John C. Roach W. Keith Ransdell S. Chad Meredith 176 Pasadena Drive, Building One Lexington, Kentucky 40503 Tel: (859) 276-6262 Fax: (859) 276-4500 [email protected] [email protected] [email protected]

Liaison Counsel for Lead Plaintiff and the Proposed Class

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CERTIFICATE OF SERVICE

On August 5, 2013, I electronically filed this document with the Clerk of Court through

the ECF system, which will send a notice of electronic filing to all counsel of record.

s/ John C. Roach John C. Roach RANSDELL & ROACH PLLC 176 Pasadena Drive, Building One Lexington, Kentucky 40503 Telephone: (859) 276-6262 Facsimile: (859) 276-4500 Email: [email protected]

in re yum! brands, inc. securities litigation 13-cv-00463

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