Case 3:06-cv D Document 33 Filed 03/05/2007 Page 1 of 93 UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS DALLAS DIVISION

Transcription

1 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 1 of 93 UNITED STATES DISTRICT COURT NORTHERN DISTRICT OF TEXAS DALLAS DIVISION ANTHONY SALVATO, On Behalf of Himself and All Others Similarly Situated, Plaintiff, Case No. 3:06-CV-1124 (SAF) (Consolidated with Case No. 3:06-CV- 1972) v. ZALE CORPORATION, RICHARD C. MARCUS, MARY L. FORTÉ, J. GLEN ADAMS, MARY E. BURTON, SUE E. GOVE, JOHN B. LOWE, JR., THOMAS C. SHULL, DAVID M. SZYMANSKI, MARK R. LENZ, GREGORY HUMENESKY, ERV POLZE, STEVE MASSANELLI, STEVE STRONG, HILARY MOLAY, PAUL LOGAN, Defendants. AMENDED AND CONSOLIDATED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE EMPLOYEE RETIREMENT INCOME SECURITY ACT (ERISA) Plaintiffs Anthony Salvato and Richard A. Connell ( Plaintiffs ), on behalf of themselves and the Zale Corporation Savings and Investment Plan (the Plan ), and a class of similarly situated participants and beneficiaries (the Participants ) of the Plan, by their attorneys, allege the following for their Amended Complaint (the Complaint ): INTRODUCTION 1. Prior to the start of the Class Period (as defined below), companies in the retail jewelry industry, such as Zale ( Zale or the Company ), enjoyed a healthy profitability with net margins reaching as high as 50% in a given financial period. However, entering the Class

2 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 2 of 93 Period, Defendants could no longer avoid recognizing that the Zales Jewelers division, which accounted for 45% of Zale s total sales, was continuing to lose market share. Defendant Forté had implemented a plan that steered the Company away from its historical platform aimed at average-income Americans. Defendant Forté attempted to push Zales Jewelers into a more up-scale market, de-emphasizing popular diamond fashion and solitaire categories in favor of more expensive gold and silver merchandise. These significant changes disrupted Zale s struggling flagship brand. Defendant Forté also tried to transition to the direct importation of diamond jewelry, while dramatically shifting the mix of products Zales Jewelers offered and canceling historically successful promotional events, which alone cost the Company $22 million. This unfocused merchandising strategy led to ordering delays and merchandise shortages during the critical 2005 holiday season. 2. While Zales Jewelers market share rapidly eroded, Zale s competitors posted excellent sales results. Undeterred by the worsening business picture at Zale, the Individual Defendants (described below) provided unrealistic and unreasonable guidance to Wall Street that the Company just could not meet, so as to try to compare more favorably with the Company s competitors. Indeed, the Company s earnings guidance was so unrealistic that, during the fourth quarter of fiscal year 2005, Zale faced an earnings miss of nearly $30 million. Further, payroll expenses which were typically an area where the Company could cut expenses to meet forecasts were already cut to bare bones for the quarter, forcing the Company to look elsewhere to meet quarterly and year-end forecasts. 3. Faced with the threat of disappointing Wall Street, and in order to maintain the price -2-

3 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 3 of 93 of Zale common stock, Defendants engaged in a scheme during the Class Period to artificially inflate revenues by improperly accounting for extended service agreements ( ESAs ) with its customers. An ESA is a service warranty sold to customers to cover jewelry sizing and breakage issues over a period of two years. 4. Specifically, Zale engaged in cookie jar accounting by improperly manipulating the amount and timing of revenue that it initially recognized upon the sale of ESAs in order to smooth its earnings. Whenever the Company was going to miss earnings targets, Defendants would increase the percentage of revenue the Company initially recognized upon the sale of ESAs, or change the timing over which it recognized revenues from ESAs. This practice violated not only Generally Accepted Accounting Principles ( GAAP ), but Zale s own publicly-stated revenue recognition policy with respect to ESAs. 5. In addition to manipulating the Company s financials through the improper accounting for ESAs, Defendants also manipulated the Company s free cash flow during the Class Period. Specifically, during 4Q04, defendants Forté, Gove and Gordon instructed the Zale buyers to contact all of the Company s vendors and change the terms of the buys to postpone receivables and payments. Thus, a letter was forwarded to these vendors explaining that vendors would not be paid until after July 31, 2005, because the Company s inventory system and the merchandising system did not match and, as a result, that Zale could not pay vendors. In reality, delaying vendor payments allowed Zale to reverse cost of goods sold and accounts payable accounts, thus removing expenses that would otherwise impact the Company s free cash flow figures that were reported to Wall Street and investors. -3-

4 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 4 of As a result of these practices which were unknown to investors (including Plan Participants), Defendants issued a series of materially false and misleading statements and omissions during the Class Period concerning: (i) Zale s quarterly and year-end financial results; (ii) Zale s policy for recognizing revenue from ESAs; and (iii) free cash flow figures. 7. Defendants were only able to carry on their scheme for so long, as they finally attracted the attention of the United States Securities and Exchange Commission ( SEC ). In particular, on April 10, 2006, the Company issued a press release announcing that the SEC had initiated a nonpublic investigation into various accounting and other matters related to the Company, including, among other things, the Company s accounting for ESAs and the timing of certain vendor payments. This partial disclosure caused the price of Zale common stock to plummet $2.64, or 9.5%. Zale stock closed at $27.80 on April 7, 2006, and $25.16 on April 10, 2006, on unusually heavy trading volume of 1,599,700 shares. 8. Disclosure of the SEC investigation into Zale s accounting practices was just the tip of the iceberg. The true state of Zale s financial condition was further revealed on May 5, 2006, when the Company announced, after the close of market, that defendant Lenz had been placed on administrative leave as a result of his failure to timely disclose to Zale s auditors that vendor payments scheduled to be made during the last two weeks of 4Q05 had been delayed into the first week of 1Q06. This news also negatively impacted Zale s financial results, causing the price of Zale common stock to fall another $1.73, or 7.03%, the following week, from a closing price of $24.62 on May 5, 2006, to a close of $22.89 on May 12,

5 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 5 of As detailed herein, certain defendants engaged in this scheme in order to sell $15.8 million of inflated Zale stock and to obtain significant bonuses which were tied to the false financial results the Company was reporting all at the Plan s expense. NATURE OF THE ACTION AND SUMMARY OF CLAIMS 10. Plaintiffs, participants in the Plan, bring this action against Zale and others for Planwide relief on behalf of the Plan, and on behalf of a class of Participants in the Plan for whose individual accounts the Plan held an interest in the common stock of Zale from February 18, 2005 to May 5, 2006 (the Class Period ). Plaintiffs bring this action on behalf of the Plan and the Participants pursuant to 502(a)(2) and (3) of the Employee Retirement Income Security Act ( ERISA ), 29 U.S.C. 1132(a)(2)and (3). 11. As more fully set forth below, Defendants breached their fiduciary duties owed to the Plan and the Participants, including those fiduciary duties set forth in ERISA 404, 29 U.S.C. 1104, and Department of Labor Regulations, 29 C.F.R As a result of these wrongful acts, pursuant to ERISA 409(a), 29 U.S.C. 1109(a), Defendants are liable to make good to the Plan the losses resulting from each such breach of fiduciary duty. Plaintiffs also seek equitable relief. 12. Plaintiffs allege that it was imprudent for the Plan to invest in Zale common stock because the common stock was too risky for a retirement plan investment in that the price of common stock was artificially inflated. Plaintiffs also allege that Defendants breached their fiduciary duties by negligently failing to disclose material information necessary for Participants to make informed decisions concerning the Plan s assets and benefits and investing in Zale common stock. JURISDICTION AND VENUE 13. Plaintiffs claims arise under ERISA Section 502(e)(1), 29 U.S.C. 1132(e)(1). -5-

6 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 6 of This Court has jurisdiction over this action pursuant to ERISA Section 502(e)(l), 29 U.S.C. 1132(e)(l). 15. Venue is proper in this district pursuant to ERISA Section 502(e)(2), 29 U.S.C. 1132(e)(2), because this is the district where some or all of the breaches took place, where one or more Defendants reside or may be found, and/or where the acts and transactions alleged herein. 16. In connection with the acts alleged in this Complaint, 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. THE PARTIES Plaintiffs 17. Plaintiff Anthony Salvato is a resident of the State of Texas. At various times, Plaintiff s individual account in the Plan included Zale common stock as an investment option under the Plan. 18. Plaintiff Richard A. Connell is a resident of the State of Pennsylvania. At various times, Plaintiff s individual account in the Plan included Zale common stock as an investment option under the Plan. Defendants 19. Defendant Zale Corporation ( Zale ) is a Delaware corporation, headquartered at 901 Walnut Hill Lane, Irving, Texas. Zale operates retail jewelry stores and has employees in all 50 states under the Zales, Gordon s, and Bailey Banks & Biddle names. The Company s stores are -6-

7 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 7 of 93 located primarily in shopping malls in the United States and Puerto Rico. Zale s offers moderately priced jewelry, Gordon s offers merchandise at somewhat higher prices, and Bailey Banks & Biddle offers upscale jewelry. During the Class Period, Zale s common stock traded on the New York Stock Exchange (the NYSE ) under the symbol ZLC. 20. Zale is the Plan Sponsor and Administrator and is a named fiduciary of the Plan in that it exercises discretionary authority acting through its Board of Directors (the Board ) and officers, including Defendants herein with respect to management and administration of the Plan and/or management and disposition of Plan assets. 21. Defendant Richard C. Marcus ( Marcus ) has served as Chairman of the Board of Directors of the Company since August 1, 2004 and has also served as a Director of the Company since July 21, Because of defendant Marcus s position, he knew the adverse non-public information about the business of Zale, as well as its finances, markets and present and future business prospects, via access to internal corporate documents, conversations and connections with other corporate officers and employees, attendance at Board meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, defendant Marcus participated in the issuance of false and/or misleading statements, including the preparation of the false and/or misleading press releases and SEC filings. Upon information and belief, defendant Marcus was a fiduciary of the Plan within the meaning of ERISA in that he exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. 22. Defendant Mary L. Forté ( Forté ) served as President, Chief Executive Officer and a Director of the Company. Defendant Forté also served as Executive Vice President and Chief -7-

8 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 8 of 93 Merchandise Officer from February 2001 to July From January 1998 to February 2001, she served as Executive Vice President and Chief Administrative Officer. Defendant Forté joined the Company in July 1994 as the President of the Company s Gordon s Jewelers brand, and served in that position until January On January 31, 2006, defendant Forté resigned as President and Chief Executive Officer and as a director of the Company. Because of defendant Forté s position, she knew the adverse non-public information about the business of Zale, as well as its finances, markets and present and future business prospects, via access to internal corporate documents, conversations and connections with other corporate officers and employees, attendance at Board meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, defendant Forté participated in the issuance of false and/or misleading statements, including the preparation of the false and/or misleading press releases and SEC filings. Upon information and belief, defendant Forté was a fiduciary of the Plan within the meaning of ERISA in that she exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. Defendant Forté also signed other SEC filings that are specifically incorporated into the Plan documents, including the Company's Forms 10-K, 10-Q and 8-K. During the Class Period, Forté sold $6.3 million worth of Zale stock at artificially inflated prices. 23. Defendant J. Glen Adams ( Adams ) has served as a Director of the Company since July 21, Because of defendant Adams position, he knew the adverse non-public information about the business of Zale, as well as its finances, markets and present and future business prospects, via access to internal corporate documents, conversations and connections with other corporate officers and employees, attendance at Board meetings and committees thereof and via reports and -8-

9 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 9 of 93 other information provided to him in connection therewith. During the Class Period, defendant Adams participated in the issuance of false and/or misleading statements, including the preparation of the false and/or misleading press releases and SEC filings. Upon information and belief, defendant Adams was a fiduciary of the Plan within the meaning of ERISA in that he exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. 24. Defendant Mary E. Burton ( Burton ) has served as a Director of the Company since August 1, In connection with defendant Forté s resignation, defendant Burton has been appointed to serve as interim Chief Executive Officer, effective February 1, Because of defendant Burton s position, she knew the adverse non-public information about the business of Zale, as well as its finances, markets and present and future business prospects, via access to internal corporate documents, conversations and connections with other corporate officers and employees, attendance at management meetings and via reports and other information provided to him in connection therewith. During the Class Period, defendant Burton participated in the issuance of false and/or misleading statements, including the preparation of the false and/or misleading press releases and SEC filings. Upon information and belief, defendant Burton was a fiduciary of the Plan within the meaning of ERISA in that she exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. Defendant Burton also signed other SEC filings that are specifically incorporated into the Plan documents, including the Company s Forms 8-K. 25. Defendant Sue E. Gove ( Gove ) served as a Director of the Company. Defendant Gove also served as Chief Operating Officer. Defendant Gove remained in the position of Chief -9-

10 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 10 of 93 Financial Officer until February On March 23, 2006, defendant Gove resigned as Executive Vice President and Chief Operating Officer and as a director of Zale Corporation. Because of defendant Gove s positions, she knew the adverse non-public information about the business of Zale, as well as its finances, markets and present and future business prospects, via access to internal corporate documents, conversations and connections with other corporate officers and employees, attendance at Board meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, defendant Gove participated in the issuance of false and/or misleading statements, including the preparation of the false and/or misleading press releases and SEC filings. Upon information and belief, defendant Gove was a fiduciary of the Plan within the meaning of ERISA in that she exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. During the Class Period, Gove sold $8.7 million worth of Zale stock at artificially inflated prices. 26. Defendant John B. Lowe, Jr. ( Lowe ) has served as a Director of the Company since March 5, Because of defendant Lowe s Board position, he knew the adverse non-public information about the business of Zale, as well as its finances, markets and present and future business prospects, via access to internal corporate documents, conversations and connections with other corporate officers and employees, attendance at Board meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, defendant Lowe participated in the issuance of false and/or misleading statements, including the preparation of the false and/or misleading press releases and SEC filings. Upon information and belief, defendant Lowe was a fiduciary of the Plan within the meaning of ERISA in that he exercised -10-

11 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 11 of 93 discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. 27. Defendant Thomas C. Shull ( Shull ) has served as a Director of the Company since August 26, Because of defendant Shull s Board position, he knew the adverse non-public information about the business of Zale, as well as its finances, markets and present and future business prospects, via access to internal corporate documents, conversations and connections with other corporate officers and employees, attendance at Board meetings and committees thereof and via reports and other information provided to him in connection therewith. During the Class Period, defendant Shull participated in the issuance of false and/or misleading statements, including the preparation of the false and/or misleading press releases and SEC filings. Upon information and belief, defendant Shull was a fiduciary of the Plan within the meaning of ERISA in that he exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. 28. Defendant David M. Szymanski ( Szymanski ) has served as a Director of the Company since January 15, Upon information and belief, defendant Symanski was a fiduciary of the Plan within the meaning of ERISA in that he exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. 29. Defendant Mark R. Lenz ( Lenz ) was the Group Senior Vice President, Chief Financial Officer of the Company, and the Chairman of the Plan Committee. Upon information and belief, defendant Lenz was a fiduciary of the Plan within the meaning of ERISA in that he exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or -11-

12 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 12 of 93 (ii) the management and disposition of the Plan s assets. On May 5, 2006, defendant Lenz was placed on administrative leave. Defendant Lenz also signed other SEC filings that are specifically incorporated into the Plan documents, including the Company s Forms 10-K, 10-Q and 8-K. During the Class Period, Lenz sold $755,000 worth of Zale stock at artificially inflated prices. 30. Defendant Cynthia T. Gordon ( Gordon ) was at all relevant time the Senior Vice President and Controller of the Company. During the Class Period, Gordon was the principal accounting officer of Zale and sold $55,620 worth of Zale stock at artificially inflated prices. Upon information and belief, defendant Gordon was a fiduciary of the Plan within the meaning of ERISA in that she exercised discretionary authority with respect to: (i) the management and administration of the Plan; and/or (ii) the management and disposition of the Plan s assets. Defendant Gordon signed the Form 11-Ks. 31. Defendants Gregory Humenesky ( Humenesky ), Erv Polze ( Polze ), Steve Massanelli ( Massanelli ), Steve Strong ( Strong ), Hilary Molay ( Molay ), and Paul Logan ( Logan ) are the members of the Plan Committee, all of whom were fiduciaries with respect to Plan assets. These Plan Committee Defendants exercised discretionary authority and discretionary control with respect to the management of the Plan, they possessed discretionary authority or discretionary responsibility in the administration of the Plans, and they exercised authority or control with respect to the management of the Plan s assets. According to the Plan documents, the Plan is administered by the Plan Committee. 32. Defendants Marcus, Forté, Adams, Burton, Gove, Lowe, Shull, Szymanski, Lenz, Humenesky, Polze, Massanelli, Strong, Molay, Logan and Gordon are herein referred to as the Individual Defendants. -12-

13 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 13 of 93 CLASS ACTION ALLEGATIONS 33. Plaintiffs bring this action on his own behalf and, pursuant to Rules 23(a),(b)(l), (b)(2) and (b)(3) of the Federal Rules of Civil Procedure, on behalf of a class of all current and former participants in the Plan at any time from February 18, 2005 to May 5, Excluded from the Class are Defendants herein, officers and directors of Defendant Zale, members of the Individual Defendants immediate families, and the heirs, successors or assigns of any of the foregoing. 34. The members of the Class are so numerous that joinder of all members is impracticable. While the exact number of Class members is unknown to Plaintiffs at this time and can only be ascertained through appropriate discovery, Plaintiffs believe that there were hundreds, if not thousands, of present and former employees of Zale who held shares of Zale common stock in their individual accounts under the Plan. 35. Common questions of law and fact exist as to all members of the Class which predominate over any questions affecting solely individual members of the Class. Among the questions of law and fact common to the Class are: (a) (b) (c) (d) Whether Defendants were fiduciaries; Whether Defendants breached their fiduciary duties; Whether the Plan and the Participants were injured by such breaches; and Whether the Class is entitled to certain benefits and injunctive relief. 36. Plaintiffs claims are typical of the claims of the other members of the Class as Plaintiffs and all members of the Class sustained injury arising out of Defendants wrongful conduct in breaching their fiduciary duties and violating ERISA as complained of herein. -13-

14 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 14 of Plaintiffs will fairly and adequately represent and protect the interests of the Class. Plaintiffs have retained able counsel with experience in ERISA class action litigation. The interests of Plaintiffs are coincident with and not antagonistic to the interests of the other Class members. 38. Prosecution of separate actions by members of the Class would create a risk of inconsistent adjudications with respect to individual members of the Class which would establish incompatible standards of conduct for Defendants. In addition, adjudications with respect to individual members of the Class would, as a practical matter, be dispositive of the interests of the other members not parties to the adjudications or substantially impair or impede their ability to protect their interests. 39. A class action is superior to other available methods for the fair and efficient adjudication of the controversy since joinder of all members of the Class is impracticable. Furthermore, because the injury suffered by the individual Class members may be relatively small, the expense and burden of individual litigation makes it impracticable for the Class members individually to redress the wrongs done to them. There will be no difficulty in the management of this action as a class action. DESCRIPTION OF THE PLAN 40. The Zale Corporation Savings and Investment Plan is an employee benefit plan within the meaning of ERISA 3(3) and 3(2)(A), 29 U.S.C. 1002(3) and 1002(2)(A). 41. The Plan was established by Zale explicitly to provide retirement benefits to its employees. 42. The Form 11-K/A Annual Report filed with the SEC by the Plan on or about January 26, 2006, covering the Plan s fiscal year ended July 31, 2005, states, among other things: -14-

15 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 15 of 93 (a) General According to Employees are eligible to participate in the Plan on the first day of the month that coincides with or following the date on which the employee has both i) completed one year of service and ii) attained age 21. One year of service is defined by the Plan as a 12-month period commencing on the date of employment or anniversary thereof during which the employee has completed 1,000 or more hours of service with Zale Corporation or any of its related affiliates (the Company or Employer). Employees covered under a collective bargaining agreement, which does not provide for participation in the Plan, and certain nonresident aliens are excluded from participation. The Plan is subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), as amended. (b) Employee Contributions Under the Plan, participants are permitted to voluntarily contribute, on a pre-tax basis, from 1% to 30% of their annual earnings to their respective Employee 401(k) Contribution Account. All participants are subject to Internal Revenue Service (IRS) limitations on these contributions. The maximum amount a participant could contribute under this limitation is $14,000 and $13,000 for each calendar year 2005 and 2004, respectively. Effective August 1, 2002, employees who are or will be at least 50 years of age by the end of a calendar year are eligible to make additional pre-tax contributions called catch-up contributions to the Plan at any time during such calendar year. The maximum amount of catch-up contributions a participant can contribute is $4,000 and $3,000 for the calendar years 2005 and 2004, respectively. (c) Employer Contributions The Plan provides that the Company make matching contributions (Employer 401(k) Matching Contributions) to each eligible participant who voluntarily contributes to the Plan. To be eligible for an Employer 401(k) Matching Contribution, the Plan requires that a participant be employed on the last day of the Plan year (July 31) in order to receive an allocation of matching contributions, unless the participant has died, retired on or after Normal Retirement Date (i.e., the later of age 65, or the fifth anniversary of the date the participant commenced participation in the -15-

16 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 16 of 93 plan), or has become disabled (as defined in the Plan) during the Plan year. Further, the Employer 401(k) Matching Contribution per participant is 50% of the first 4% of annual compensation contributed to the Plan as a salary deferral contribution. The Plan authorizes the Company to make Employer 401(k) Matching Contributions in cash or Company Common Stock. For Plan years ended July 31, 2005 and 2004, Employer 401(k) Matching Contributions were made in cash. Employer 401(k) Matching Contributions are allocated after the end of the Plan year. In addition, forfeitures may be used to help pay the Plan s administrative expenses as well as to reduce matching contributions in accordance with ERISA (see notes 1(f) and 1(h) for vesting and forfeiture details). (d) Investment Options Upon enrollment in the Plan, participants may direct contributions in whole percentage increments to the following investment options: Dreyfus Government Fund Option: Invests solely in securities issued and guaranteed by the U.S. government or its agencies or instrumentalities, and repurchase agreements collateralized by these securities. Bond Investment Option: Invests primarily in domestic fixed income securities such as corporate bonds, U.S. government securities, certificates of deposit, commercial paper, and other fixed income securities. Growth and Income Investment Option: Invests in domestic and international common stocks, other equity securities, corporate and government bonds, and short-term cash equivalents. Growth Investment Option: Invests primarily in domestic common stocks and other equity securities, with a smaller allocation to international securities. Aggressive Growth Investment Option: Invests primarily in common stocks and other equity securities of small, rapidly growing companies and also larger companies with strong growth potential. This option invests in both domestic and international securities. Global Investment Option: Invests primarily in common stocks and other equity securities of companies based both within and outside of the United States. -16-

17 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 17 of 93 Zale Corporation Common Stock: Participants may invest up to 25% of their past and future salary deferral contributions and employer matching contributions in Zale Corporation Common Stock. Employer matching contributions made in the form of Zale Corporation Common Stock are invested in such stock without regard to the 25% limit unless the participant directs otherwise in which case any subsequent participant investment of such contributions in Zale Corporation Common Stock is subject to the 25% limit. Employer matching contributions made in the form of cash are invested pursuant to the participant s direction, subject to the 25% limit on investments in Zale Corporation Common Stock. DEFENDANTS FIDUCIARY STATUS 43. At all times relevant to this Complaint, each of the Defendants was a fiduciary with respect to the Plan, and owed fiduciary duties to the Plan and the Plan s participants under ERISA in the manner and to the extent set forth in Plan s documents, through their conduct, and under ERISA. 44. Named Fiduciaries: ERISA requires every plan to provide for one or more named fiduciaries of the plan pursuant to ERISA 402(a)(1), 29 U.S.C. 1002(21)(A). The person named as the administrator in the plan instrument is automatically a named fiduciary, and in the absence of such a designation, the sponsor is the administrator. ERISA 3(16)(A), 29 U.S.C. 1002(16)(A). 45. Defendant Zale did not delegate fiduciary responsibilities for the Plan to an external provider. Instead, Defendants chose to comply with ERISA 402(a)(1), 29 U.S.C. 1102(a)(1), internalizing the fiduciary functions. ERISA 402(a)(1), 29 U.S.C. 1102(a)(1), requires that every plan provide for one or more named fiduciaries who will have authority to control and manage the operation and administration of the Plan. Pursuant to the Plan documents (including Zale Summary Plan Description, p. 36 and Zale Savings & Investment Plan, 13.2(c)), Zale was the appointed Plan -17-

18 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 18 of 93 Administrator at all relevant times. Zale, in turn, appointed a Plan Committee to oversee the administrative functions of the Plan: The Plan Committee is appointed by Zale to act on its behalf as the Plan Administrator. The Committee has overall responsibility for the Plan, including discretionary and final authority to determine eligibility for benefits, actual coverage, payment or benefits, administering the loan program and final authority to construe all terms under this Plan. They also have the authority to disburse money from the Trust fund for costs incurred in the administration of the Plan and the Trust fund. The Committee will perform the duties and may exercise the powers and discretion given to it in this Plan and its decisions and actions may be relied upon by all persons affected thereby. The Trustee and the Recordkeeper may rely without question upon any notices, directions, or other documents received from the Committee. 46. In order to effectuate the purposes of the Plan, the Plan Committee, as the Plan Administrator, was endowed with substantial powers, including but not limited to the following: (a) To appoint the Daily Administrator; *** (e) (f) (h) (i) To construe the Plan and to make equitable adjustments for any mistakes or errors made in the administration of the Plan; To receive from the Employer and the Employees such information as is necessary for the proper administration of the Plan; *** To determine and resolve in its sole and absolute discretion all questions relating to the administration of the Plan and Trust Fund.... To select the Investment Funds under the Plan; -18-

19 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 19 of 93 (j) To direct the Trustee as to the investment of any Participant s Individual Account and the crediting and distribution of the Trust Fund... *** (m) To appoint, in its discretion, in accordance with the provisions of the Trust Agreement, one or more Investment Managers (as defined under section 4(38) of ERISA) to manage, including the power to acquire or dispose of, all or any portion of the assets of the Plan and Trust Fund; *** (o) To amend the Plan pursuant to Section *** The Plan also expressly provides that: The foregoing list of express powers is not intended to be either comprehensive or conclusive, and the Administrator will, in addition, have such powers as it may reasonably determine to be necessary or appropriate in the performance of its powers and duties under the Plan. See, Zale Corp., Savings & Investment Plan, 13.4 (Emphasis added). 47. Defendant Zale and the Plan Committee were thus the Named Fiduciaries of the Plan pursuant to ERISA 402(a)(2), 29 U.S.C. 1029(a)(2), and the Plan documents. The Plan Committee, on behalf of Zale, exercised broad responsibility for the management and administration of the Plan, and, among its other duties, was responsible for oversight of Plan investment options, policies, and the performance of the Plan investments, as well as the review of investment managers. 48. In its capacity to select and monitor investment options for the Plan, the Plan Committee had the discretion and authority to suspend, eliminate, or reduce any Plan investment, including investments in the Zale Stock Fund: The [Plan] Committee shall be responsible for determining the appropriateness under the fiduciary responsibility and other -19-

20 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 20 of 93 applicable provisions of ERISA of acquiring and holding Qualifying Employer Securities [defined as the Zale Common Stock]. See, Zale Defined Contribution Plan Trust Agreement with Mellon Bank, 5.5(b). The Named Fiduciary shall continually monitor the suitability of the Trust acquiring and holding Sponsor Stock [defined as the Zale Common Stock], under the fiduciary duty rules of section 404(a)(1) of ERISA (as modified by section 404(a)(2) of ERISA). See, Zale Trust Agreement with Fidelity Management Trust Company, 5(e)(ii). The Plan Committee regularly exercised its authority to suspend, eliminate, reduce, or restructure Plan investments. The Plan Committee also reported to the Board of Directors regarding these duties and responsibilities and Plan events pertaining to the same. 49. De Facto Fiduciaries: ERISA treats as fiduciaries not only persons explicitly named as fiduciaries under ERISA 402(a)(1), but also any other persons who in fact perform fiduciary functions. Thus, a person is a fiduciary to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management of disposition of its assets, (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of such plan. ERISA 3(21)(A)(i), 29 U.S.C. 1002(21)(A)(i). 50. During the Class Period, the Zale Board of Directors was directly involved with the administration of the Plan and the investment of its assets. The Board of Directors exercised authority to select, monitor, retain, and remove the members of the Plan Committee and, accordingly, exercised authority and oversight over the Plan Committee, which reported to the Board regarding the Plan Committee s fiduciary duties and responsibilities to the Plan and with respect to its actions -20-

21 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 21 of 93 pertaining to the same. Additionally (as reflected by Amendments to the Zale Savings & Investment Plan 1-6; Unanimous Written Consent of the Board of Directors of Zale; and Resolutions to be adopted by the Zale Savings & Investment Plan Committee, and perhaps other documents), the Zale Board of Directors exercised its authority to amend the Plan in regards to various significant administrative provisions, including but not limited to, changing the terms and amounts of mandatory lump sum cash-out distributions, expanding the indemnity provisions of the Plan, and updating the claims procedures.. The Zale Board of Directors was thus a de facto fiduciary of the Plan as defined by ERISA Section 3(21)(A), 29 U.S.C. 1002(21)(A), because it exercised discretionary authority or control respecting management, disposition of assets and had discretionary authority or responsibility in the administration of the Plan. 51. Since Zale acted by and through its directors, officers, and employees, the actions of these individuals, including the Plan Committee, the Board, and others are properly imputed and attributed to Zale. Therefore, the participation in and knowledge of Zale s inappropriate and potentially unlawful practices by defendants as alleged herein is imputed and attributed to Zale, the Plan Committee, and the Board of Directors. 52. Each Defendant is liable for the breaches of fiduciary duty of the other Defendants under ERISA Section 405, 29 U.S.C DEFENDANTS FIDUCIARY DUTIES UNDER ERISA 53. The Statutory Requirements: ERISA imposes strict fiduciary duties upon plan fiduciaries. ERISA 404(a), 29 U.S.C. 1104(a), states, in relevant part, that: [A] fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries and... for the exclusive purpose of providing benefit to participants and their -21-

22 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 22 of 93 beneficiaries; and defraying reasonable expenses of administering the plan; with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims; by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this title and Title IV. 54. The Duty of Loyalty: ERISA imposes on a plan fiduciary the duty of loyalty that is, the duty to discharge his [or her] duties with respect to a plan solely in the interest of the participants and beneficiaries and... for the exclusive purpose of... providing benefits to participants and their beneficiaries The duty of loyalty entails a duty to avoid conflicts of interest and to resolve them promptly when they occur. A fiduciary must always administer a plan with an eye single to the interests of the participants and beneficiaries, regardless of the interests of the fiduciaries themselves or the plan sponsor. 56. The Duty of Prudence: Section 404(a)(1)(B) also imposes on a plan fiduciary the duty of prudence that is, the duty to discharge his [or her] duties with respect to a plan solely in the interest of the participants and beneficiaries and... with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man, acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims The Duty to Inform:: The duties of loyalty and prudence include the duty to disclose and inform. These duties entail: (i) a duty not to misinform; (ii) an affirmative duty to inform when -22-

23 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 23 of 93 the fiduciary knows or should know that silence might be harmful; and (iii) a duty to convey complete and accurate information material to the circumstances of participants and beneficiaries. These duties to disclose and inform recognize the disparity that may exist, and in this case did exist, between the training and knowledge of the fiduciaries, on the one hand, and the Participants, on the other. 58. Pursuant to the duty to inform, fiduciaries of the Plan were required under ERISA to furnish certain information to Participants. For example, ERISA 101, 29 U.S.C. 1021, requires that fiduciaries furnish a summary plan description ( SPD ) to Participants. ERISA 102, 29 U.S.C. 1022, provides that the SPD must apprise Participants of their rights under the plan. The SPD and all information contained or incorporated therein constitutes a representation in a fiduciary capacity upon which Participants were entitled to rely in determining the identity and responsibilities of fiduciaries under the Plan and in making decisions concerning their benefits and investment and management of assets allocated to their accounts: 29 C.F.R (b). The format of the summary plan description must not have the effect of misleading, misinforming or failing to inform participants and beneficiaries. Any description of exceptions, limitations, reductions, and other restrictions of plan benefits shall not be minimized, rendered obscure or otherwise made to appear unimportant. Such exceptions, limitations, reductions, or restrictions of plan benefits shall be described or summarized in a manner not less prominent than the style, captions, printing type, and prominence used to describe or summarize plan benefits. The advantages and disadvantages of the plan shall be presented without either exaggerating the benefits or minimizing the limitations. The description or summary of restrictive plan provisions need not be disclosed in the summary plan description in close conjunction with the description or summary of benefits, provided that adjacent to the benefit description the page on which the restrictions are described is noted. -23-

24 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 24 of The Duty to Investigate and Monitor Investment Alternatives: With respect to a retirement plan such as the Plan, the duties of loyalty and prudence also entail a duty to conduct an independent investigation into, and continually to monitor, the merits of the investment alternatives in the Plan, including employer securities, to ensure that each investment is a suitable option for the Plan. 60. The Duty to Monitor Appointed Fiduciaries: Fiduciaries who have the responsibility for appointing other fiduciaries have the further duty to monitor the fiduciaries thus appointed. The duty to monitor entails both giving information to and reviewing the actions of the appointed fiduciaries. In a retirement plan such as the Plan, the monitoring fiduciaries must therefore ensure that the appointed fiduciaries: (a) possess the needed credentials and experience, or use qualified advisors and service providers to fulfill their duties; (b) are knowledgeable about the operations of the Plan, the goals of the Plan, and the behavior of the Plan s participants; (c) (d) are provided with adequate financial resources to do their jobs; have adequate information to do their jobs of overseeing the Plan investments with respect to all investment options, including company stock; (e) (f) have access to outside, impartial advisors when needed; maintain adequate records of the information on which they base their decisions and analysis with respect to Plan investment options; and (g) report regularly to the monitoring fiduciaries. -24-

25 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 25 of 93 The monitoring fiduciaries must then review, understand, and approve the conduct of the appointed fiduciaries. The monitoring fiduciaries must ensure that the appointed fiduciaries are performing their fiduciary obligations, including those with respect to the investment of plan assets, and take prompt and effective action to protect the plan and the plan participants. 61. The Duty Sometimes to Disregard Plan Documents: A fiduciary may not avoid his fiduciary responsibilities by relying solely on the language of the plan documents. While the basic structure of a plan may be specified, within limits, by the plan sponsor, the fiduciary may not blindly follow the plan document if to do so leads to an imprudent result or that would harm plan participants or beneficiaries, nor allow others, including those whom they direct or who are directed by the Plan, including Plan Trustees, to do so. ERISA 404(a)(1)(D), 29 U.S.C. 1104(a)(1)(D). 62. Co-Fiduciary Liability: A fiduciary is liable not only for fiduciary breaches within the sphere of his own responsibility, but also as a co-fiduciary in certain circumstances. ERISA 405(a), 29 U.S.C. 1105(a), states, in relevant part, that: In addition to any liability which he may have under any other provision of this part, a fiduciary with respect to a plan shall be liable for a breach of fiduciary responsibility of another fiduciary with respect to the same plan in the following circumstances: (1) if he participates knowingly in, or knowingly undertakes to conceal, an act or omission of such other fiduciary, knowing such act or omission is a breach; or (2) if, by his failure to comply with section 404(a)(1) in the administration of his specific responsibilities which give rise to his status as a fiduciary, he has enabled such other fiduciary to commit a breach; or (3) if he has knowledge of a breach by such other fiduciary, unless he makes reasonable efforts under the circumstances to remedy the breach. -25-

26 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 26 of Non-Fiduciary Liability: Under ERISA, non-fiduciaries who knowingly participate in a fiduciary breach may themselves be liable for a breach of fiduciary duty under ERISA 502(a)(3), 29 U.S.C. 1132(a)(3). PARTICIPANTS ARE NOT RESPONSIBLE FOR IMPRUDENT PLAN INVESTMENTS 64. The fact that Participants selected investments from options pre-selected by Defendants is no defense in this case. Fiduciaries can shift liability for imprudent investments to Participants under ERISA 404(c), 29 U.S.C. 1104(c) only if, among other things, they meet five specific requirements: (a) (b) (c) (d) (e) they disclose in advance the intent to shift liability to Participants; they designate the Plan as a 404(c) Plan and adequately communicate this to Participants; they ensure that Participants are not subject to undue influence; they provide an adequate description of the investment objectives and risk and return characteristics of each investment option; and they disclose to Participants all material information necessary for Participants to make investment decisions that they are not precluded from disclosing under other applicable law. In this regard, fiduciaries have a choice, they can disclose all material information to Participants, including information that they are not required to disclose under the securities laws, and shift liability to Participants, or they can comply with the more limited disclosure requirement under the securities laws but remain liable for imprudent investments. 29 C.F.R c-1(b)(2)(i)(B)(i) and (ii) and (c)(2)(i) and (ii). 65. Defendants failed to shift liability to Participants for imprudent investment decisions under section 404(c) because they failed to comply with the relevant regulations, therefore this defense is not available to Defendants. -26-

27 Case 3:06-cv D Document 33 Filed 03/05/2007 Page 27 of 93 2Q05 False and Misleading Statements IMPROPER STATEMENTS 66. On February 18, 2005, the Company issued a press release entitled Zale Announces Increase in Second Quarter EPS to $1.91. The press release stated in part: Zale Corporation..., North America s largest specialty retailer of fine jewelry, today announced net earnings of $99 million, or $1.91 per diluted share, for the Company s second quarter ended January 31, For the same period last year, the Company reported net earnings of $97 million, or $1.83 per diluted share. This represents an increase of 4.4% on a per share basis over the prior year. Total revenues for the second quarter ended January 31, 2005 were $972 million, compared to $949 million for the same period last year, an increase of 2.5%. Comparable store sales decreased 0.6% for the same period. Revenues for the year-to-date totaled $1.395 billion, compared to $1.366 billion for the same period last year, an increase of 2.2%. On a comparable store basis, year-to-date sales decreased 0.7%. Year-to-date net earnings totaled $88 million or $1.69 per diluted share. For the same period last year, net earnings were $88 million, or $1.63 per diluted share. This represents a 3.7% increase on a per share basis for the year-to-date over last year. 67. The February 18, 2005 press release further reported as follows (in thousands): THREE MONTHS ENDED JANUARY Total Revenues $972,332 $949,023 Operating Earnings $159,707 $156,477 Net Earnings $99,197 $97,295 Diluted Earnings Per Share $1.91 $ The same day, on February 18, 2005, Defendants hosted a conference call with analysts and investors to discuss Zale s business operations and prospects and 2Q05 financial results. The call repeated and addressed information previously made public in Zale s February 18, 2005 press release. Defendants Forté, Lenz and Gove participated on the call and had an -27-