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Flooring America Inc. shareholders must maneuver around Chapter 11 if they want to pursue their securities fraud case against the company’s executives. Gambrell & Stolz’s Gregory G. Schultz, who represents plaintiff Rudman Partners in the action, asked the bankruptcy court March 13 for relief from the automatic stay of all legal claims against the company, so his clients can pursue discovery in their fraud case. In Re: Flooring America, U.S. Bankr. No. 00-68370 (N.D. Ga. March 13, 2002). The motion is the latest move in a reorganization that has methodically liquidated hundreds of millions in assets over the past 18 months. And the plaintiffs hope relief grants their underlying civil case new life. There’s a lot of money at stake. When the Kennesaw, Ga.-based Maxim Group and its related companies filed for protection June 15, 2000, the company listed total assets of $342.5 million and total debts of $252.2 million. Maxim, which renamed itself Flooring America Inc. in January 2000, once operated a floor covering franchising and retail network. Before filing for protection Maxim owned more than 250 stores, some under names such as CarpetMax and CarpetPlus, as well as 15 subsidiaries. Since filing, the company and the trustee have closed or sold off most of the Maxim estate. ACQUISITION TRIGGERED PROBLEMS The same event led to Flooring America’s legal problems and its financial trouble: Maxim’s August 1998 purchase of 266 stores in 26 states from Shaw Industries Inc. The purchase was too big for Maxim to handle, and the company’s inadequate accounting procedure led to bankruptcy court and to accusations of fraud. But sorting out Maxim assets in bankruptcy court has held up shareholders’ fraud claims elsewhere in federal court. Though industry analysts initially trumpeted the buy as a triumph of “synergy,” Maxim never managed to incorporate the Shaw stores effectively into its network, and the company began to hemorrhage money. The problem, claims class lead plaintiff Rudman Partners, is that Maxim misrepresented the performance of the stores. While the company crowed about record revenue per quarter and the smooth integration of the new Shaw stores into the Maxim network, they were in trouble immediately. Maxim paid Shaw 3.15 million shares of common stock (valued at about $55 million at the time), an $11.5 million promissory note, and $25 million in cash for the stores. In July 1999, Maxim announced it would revise its financial statements from fiscal year 1999. The revised numbers showed $20 million less in revenue than the company had reported. The report also stated much higher losses than it had in previous reports: a $19.6 million net loss, compared to the $3 million loss it had reported earlier. And the loss per share jumped from 17 cents to $1.10. The plaintiffs claim that reporting those wrong numbers constitutes fraud because the defendants knew the numbers were false. However, Smith, Gambrell & Russell’s John G. Despriet, representing Maxim in the securities case, said that Maxim’s officers reported the numbers and the conditions they thought were true at the time. When they discovered that that information was wrong, they changed it, as they were required to do. Despriet said the defense has renewed its motion for judgment on the pleadings. “The gist of the defense is that there was a restatement, but there’s no showing of fraud,” he said. STOCK PLUMMETS Maxim stock, which had been trading as high as $24 15/16 in January 1999, four months after the Shaw purchase, fell into the basement. It traded at $6 9/16, dropping two points from July 12-14. By the end of the year, investors were suing. During the class period, between June 2, 1998, and July 13, 1999, Maxim had more than 18 million shares of stock outstanding, which traded on a volume of more than 115,000 shares daily. The stock closed at a fraction of 1 cent Tuesday. Investors like Rudman, claimed Stephen G. Hall of Gambrell & Stolz, Rudman’s class action lawyer, relied on statements that company officers made in press releases and Securities and Exchange Commission filings. Those statements reported record revenue and described how beautifully the Shaw stores were performing under Maxim’s management. But those statements were “false and misleading,” Hall wrote in his complaint. “Each of the defendants either knew, or recklessly disregarded, that the statements … were false or misleading, that such statements would and did adversely affect the integrity of the market for Maxim’s shares and inflate artificially the price of Maxim’s shares; and that such statements would deceive investors into purchasing Maxim securities at an inflated price,” Hall wrote. The complaint alleged that Maxim fraudulently overstated its 1999 financial results by counting revenue it didn’t receive, by hiding losses stemming from weather-related store closures in 1999 and that as a result the company’s stock was inflated artificially during the class period. Rudman owned several million dollars’ worth of shares in Maxim during the class period, only to see the stock’s value drain with the revised financial statements. The court recognized a class for the purpose of the securities fraud issue, and recognized Rudman as lead plaintiff, bringing suit on behalf of any entity that owned Maxim stock during the class period. In re: The Maxim Group Securities Litigation, No. 1:99-CV-1280-CAP. (N.D. Ga. April 10, 2000). DISCOVERY SNAGGED The bankruptcy court stayed all claims against Maxim for the duration of the case. But the plaintiffs want to continue their case against Maxim’s officers: President and Chief Executive Officer A.J. Nasser, Chief Financial Officer Gary Brugliera, and company director Richard A. Kaplan. An attempt at resolving the dispute through mediation failed in September 2001, and the plaintiffs now want to begin discovery. To do that, however, they need financial documents about revenue and store performance from Maxim documents now held by the bankruptcy trustee. Schultz’s motion notes that there is conflicting authority as to whether the bankruptcy court’s stay automatically suspends all discovery against a debtor, even though the claims against the debtor are not being pursued at the moment. However, maintaining the stay would prejudice the plaintiffs’ case against the corporate officers, who are not under Chapter 11 protection, Schultz wrote. “The heart of the Securities Class Action is that these Individual defendants overstated positive financial results and understated losses causing an improperly inflated price for Maxim stock. It will be very difficult for Movant and the class it represents to pursue their claims against the Individual defendants without access to Maxim’s financial records.” There is a hearing set on the issue for April 9. Schultz said that he doesn’t anticipate much trouble for his clients in lifting the stay for their purposes. “I don’t expect it to be a problem,” he said. “We don’t think our request is burdensome to the estate at all.” Smith Gambrell’s Barbara J. Ellis-Monro, representing Flooring America in the bankruptcy matter, did not return a phone call on this story. Lifting the stay would revive the plaintiff’s momentum in the civil action — momentum the plaintiffs have lost over the past year. District Judge Orinda Evans of the Northern District of Georgia tossed out a similar complaint brought against Flooring America Sept. 28, 2001. Maxim reported record revenue in its 10-Q filings with the SEC for all four quarters of fiscal 1999. The numbers for the third quarter reflected a 160 percent increase in revenue from the same period the year before. VENDOR FUNDS AT ISSUE However, the complaint charged, Maxim was wrongly counting vendor funds as revenue. This is money suppliers pay the company to get shelf space at Maxim’s stores. However, the company only can report that as revenue if the stores meet certain sales levels — which the stores were not reaching. “As defendants would later admit, the Shaw stores were big money losers, and Maxim lacked the internal controls to monitor their progress (or lack thereof),” Hall wrote. The company’s condition would decline from there, as reports of inflated earnings and inadequate accounting controls began spreading in the market. In a March 17, 1999, conference call with analysts, Maxim announced that a blizzard in the Midwest had forced several stores to close for three or four days in January, affecting the company’s revenue. However, it announced that the Shaw stores had become profitable, after losing $9 million in the same quarter the previous year. “Unfortunately, the worst was yet to come,” Hall wrote. In April 1999, the company reported record revenue for the previous fiscal year: $684 million — more than twice the $365.1 million it posted the year before. But on April 13, Merrill Lynch analysts Celeste Elia and Pamela Singleton issued a report noting that Maxim was not doing especially well at integrating the Shaw stores into the retail network. “According to the report, in a conference call with analysts, defendant Nasser likened the Maxim purchase of the Shaw stores to ‘Schwinn buying General Motors,’ ” Hall wrote. The stock price dropped to $8 a share after the announcement. A month earlier, it had traded at $14. Then in May Maxim announced it would have to reissue financial statements for the second, third and fourth quarters of the fiscal year ending Jan. 31, 1999. “Unfortunately for investors, Maxim’s condition was even worse than had been revealed in the May 19 announcement,” Hall wrote. Two months later, Maxim announced it would have to reissue reports for the entire fiscal year, not just for the three quarters it had claimed in May. Fortunately for company officers Nasser and Kaplan, they sold hundreds of thousands of shares before the stock bottomed. During the six weeks between the last week of March 1999 and the first week of May, Nasser sold 325,284 shares of Maxim stock, reducing his holdings by 60 percent or so. Over the course of the class period, Kaplan sold 545,000 shares of stock — 72 percent of his holdings — and received about $4.5 million from the sale, Hall wrote. The defense said these sales were forced sales in response to margin calls. But that doesn’t protect the officers from claims that they knew they were artificially inflating the price of Maxim stock, Hall wrote. The company was using stock to execute purchases of other companies, so it made sense to keep the price as high as the company could. “To the extent that these sales were made to cover margin calls, defendant Nasser was particularly motivated to keep the stock price of Maxim artificially high to avoid margin calls during the class period,” he wrote.

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