Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 1 of 141 1 THE HONORABLE THOMAS S. ZILLY 2 3 4 5 6 7 8 UNITED STATES DISTRICT COURT 9 WESTERN DISTRICT OF WASHINGTON 10 AT SEATTLE 11 ) 12 PIRELLI ARMSTRONG TIRE ) CORPORATION RETIREE MEDICAL ) 13 BENEFITS TRUST, Derivatively on Behalf of ) COSTCO WHOLESALE CORPORATION, ) 14 ) Plaintiff, ) 15 ) vs. ) 16 ) JAMES D. SINEGAL, et al., ) 17 ) Defendants, ) 18 ) – and – ) 19 ) COSTCO WHOLESALE CORPORATION, a ) 20 Washington corporation, ) ) 21 Nominal Defendant. ) ) 22 Lead Case No. 2:08-cv-01450-TSZ CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT DEMAND FOR JURY TRIAL 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 2 of 141 NATURE OF THE ACTION 1 2 1. This is a shareholder derivative action brought by shareholders of Costco Wholesale 3 Corporation (“Costco” or the “Company”) on behalf of the Company, seeking to remedy violations 4 of state and federal law arising out of stock option backdating. Plaintiffs’ investigation has revealed 5 that Costco secretly backdated millions of options to its top officers, directors and employees for 6 nearly a decade, reporting false financial statements and issuing false statements to shareholders. 7 The derivative claims are asserted against members of Costco’s Board of Directors (the “Board”) 8 and certain of its senior executives (collectively, “defendants”). More than a majority of the Board’s 9 members each approved and/or received hundreds of thousands of backdated options. 10 2. Backdating stock options is now recognized as a deceptive practice companies 11 throughout the securities markets have used to conceal grants of “in-the-money” options or options 12 otherwise with more intrinsic value than disclosed, without reporting the corresponding requisite 13 compensation expense. Backdating stock options illicitly confers upon option recipients options far 14 greater in value than that represented by the option date and price. For example, a company grants 15 options on June 10, when its stock price is $26.00, but records the option date as February 10, when 16 the stock price was only $20.00, and prices the option at fair market value on the purported date of 17 grant, i.e., $20.00. In this example, the recipients of the option garner a hidden riskless profit, 18 compensation expense is understated by $6.00 for each option, and the company receives $6.00 less 19 that it should have upon the option’s exercise. 20 3. Statistical analysis based on extensive review of the Company’s Securities and 21 Exchange Commission (“SEC”) filings reveals that Costco’s stock option grants to officers and 22 directors were often priced at or near the lowest closing price for the month, quarter and/or year. 23 This occurred with highly improbable frequency. Indeed, the odds that Costco dated and priced 24 discretionary option grants by chance (rather than manipulation) are well over 1 in 1,000,000. See 25 infra ¶¶66-68. It is no wonder that the Company has now admitted millions of options were 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -1- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 3 of 141 1 approved after the stated option date and unreported compensation expense totals nearly $175 2 million. 3 4. As found by U.S. Attorney’s Office (“USAO”) for the Western District of 4 Washington, the Company issued “backdated stock options” from which executives benefitted and 5 “[a]s a result, Costco failed to properly account for the stock options on its books and records, 6 including on financial statements filed with the Securities and Exchange Commission.” The USAO 7 did not bring criminal charges only because Costco implemented an “enhanced ethics and 8 compliance program” and the Company and the Company’s Chief Executive Office (“CEO”) and 9 Chief Financial Officer (“CFO”) agreed to remedial measures. The USAO did not seek or obtain 10 civil damages. 11 5. This action alleges on behalf of the Company violations of state law, including 12 breaches of fiduciary duty, abuse of control, constructive fraud, corporate waste, unjust enrichment 13 and gross mismanagement, and violations of federal law, including §§10(b) and 29(b) of the 14 Securities Exchange Act of 1934 (“Exchange Act”). Defendants caused or allowed Costco to 15 understate reported compensation expense and overstate net income and other financial statement 16 accounts, while diverting millions of dollars of corporate assets to themselves and other Costco 17 insiders, including executives and employees, by backdating option grants. Although many 18 employees of Costco benefitted in the short run from defendants’ conduct, the Company was 19 defrauded during the course of the backdating and damaged thereby. 20 6. Not only was the Company damaged by issuing overvalued options and underpriced 21 stock upon exercise of those options, and by related securities transactions, it was damaged by the 22 consequences of the backdating that have followed since the Company admitted option grants were 23 not priced at fair market value. As but one example, Costco has paid tens of millions of dollars 24 associated with tax liabilities incurred by the issuance and exercise of the backdated options. 25 7. Each of the defendants also participated in the concealment of the backdating option 26 scheme complained of herein and/or refused to take advantage of the Company’s legal rights to halt CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -2- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 4 of 141 1 and remedy the backdating. For nearly a decade, defendants caused Costco to file false and 2 misleading statements with the SEC. These filings included proxy statements and Reports on Form 3 10-K that stated options granted by Costco carried with them an exercise price based on the fair 4 market value of Costco stock (closing price) on the date of grant. By concealing the backdating, 5 defendants kept their positions on the Board and with the Company and reaped great wealth from the 6 sale of their Costco stock, much of which issued from the exercise of backdated options. 7 8. Lynn Turner, the SEC’s former Chief Accountant, described undisclosed backdating 8 as follows: “It’s like allowing people to place bets on a horse race after the horses have crossed the 9 finish line.” Arthur Levitt, former Chairman of the SEC, described backdating as stealing: “It is 10 ripping off shareholders in an unconscionable way” and “represents the ultimate in greed.” In fact, 11 defendants were aware that the practices employed by the Board allowed the stock option grants to 12 be backdated or otherwise manipulated to dates when the Company’s shares were trading at or near 13 the lowest price for that relevant period. Defendants’ backdating yielded stock option grants to the 14 Company’s executive officers and directors that were in-the-money by millions of dollars. 15 9. As stated by Harvey Pitt, former Chairman of the SEC, “backdating” plainly violates 16 both the federal securities laws and state corporate fiduciary laws: 17 18 19 What’s so terrible about backdating options grants? For one thing, it likely renders a company’s proxy materials false and misleading. Proxies typically indicate that options are granted at fair market value. But if the grant is backdated, the options value isn’t fair – at least not from the vantage point of the company and its shareholders. 20 * * * 21 22 23 Securities law violations are not the only potential problems with backdating options grants. Backdating may violate the Internal Revenue Code, and companies may not be able to deduct the options payments. On the state level, backdating could involve a breach of fiduciary duty, a waste of corporate assets and even a usurpation of a corporate opportunity. 24 * * * 25 26 More fundamentally, the financial statements of a company that has engaged in backdating may require restatement. The options may not be deductible, and the CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -3- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 5 of 141 1 expenses, as well as the various periods to which they may have been allocated, may also be incorrect. . . . 2 3 4 5 6 More to the point, what does this kind of conduct say about those who do it and those who allow it to occur (either wittingly or unwittingly)? Those who backdate options grants violate federal and state law. And those on whose watch this conduct occurs are also potentially liable: If they knew about the backdating, they’re participants in fraudulent and unlawful conduct. If they didn’t know about the backdating, the question will be: Should they have done more to discover it? 7 Harvey Pitt, The Next Big Scandal, Forbes.com, May 26, 2006. 8 10. Defendants’ gross mismanagement and malfeasance over the past decade has exposed 9 Costco and its senior executives to criminal and civil liability for issuing false and misleading 10 financial statements. Specifically, defendants concealed that the Company’s compromised internal 11 controls prevented it from issuing materially accurate financial reports and projections. Defendant 12 officers and audit committee members who approved backdated options in bad faith and with 13 deliberate recklessness disregarded their conduct in endorsing the integrity of the Company’s 14 financial statements and internal controls. Because defendants backdated or otherwise manipulated 15 stock options, stock-based compensation expense was hidden. As a result, the Company’s financial 16 results were not presented in accordance with Generally Accepted Accounting Principles (“GAAP”) 17 and materially inflated Costco’s reported earnings. 18 11. Defendants’ malfeasance and mismanagement during the relevant period has wreaked 19 millions of dollars of damages on Costco. Meanwhile, certain of the defendants and other insiders, 20 who received undisclosed in-the-money stock options and/or knew material non-public information 21 regarding Costco’s internal control problems, abused their fiduciary relationship with the Company 22 by accepting backdated options, exercising those options, and selling their personally held shares. 23 Defendants alone sold stock during the relevant period, including stock based on exercises of 24 backdated options, for total gross proceeds of over $316 million. 25 12. On October 12, 2006, the Company admitted that to “review” its stock option grants 26 it had formed a “Special Committee,” the composition of which includes a member of Costco’s CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -4- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 6 of 141 1 Board that engaged in backdating, defendant Charles T. Munger. See infra ¶¶45-47, 63-64. The 2 Company has described a report of the “Special Committee” in only vague generalities. However, it 3 is apparent from the Company’s statements that there are indications of the sort of deception that 4 accompanies backdating. The Company admits that in many instances it was “unable to identify the 5 likely grant date of the options” and that “[g]iven the lack of historical documentation, it was not 6 possible to precisely determine the amount of the adjustments that should be made” to option dates 7 and prices. Form 8-K dated Oct. 12, 2006 at Ex. 99.1. “[I]n several instances, it was impossible to 8 determine with precision the appropriate measurement date for specific grants.” Without stating any 9 details concerning the scope of the “review” or whose conduct (if any) was examined, the Company 10 has stated the “review identified no evidence of fraud.” Id. But, and this cannot be a surprise given 11 the improbable pattern of fortuitous option grants, the Company was unable to conclude there was 12 no backdating or other fraudulent conduct. Indeed, the USAO found options were “backdated.” 13 This action seeks recovery for Costco against defendants, for the Board, more than a majority of 14 which is composed of defendants who approved and/or received backdated options, is simply unable 15 or unwilling to do so. JURISDICTION AND VENUE 16 17 13. The claims asserted herein arise under §§10(b) and 29(b) of the Exchange Act, 15 18 U.S.C. §§78j(b) and 78cc(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. §240.10b-5, and 19 under Washington law for breach of fiduciary duty, abuse of control, constructive fraud, corporate 20 waste, unjust enrichment and gross mismanagement. In connection with the acts, conduct and other 21 wrongs complained of herein, defendants, directly or indirectly, used the means and instrumentalities 22 of interstate commerce, the United States mail and the facilities of a national securities market. 23 14. This Court has subject matter jurisdiction pursuant to §27 of the Exchange Act, 15 24 U.S.C. §78aa, as well as 28 U.S.C. §1331. This Court also has jurisdiction over this action pursuant 25 to 28 U.S.C. §1332(a)(2) in that plaintiffs and defendants are citizens of different states and the 26 matter in controversy exceeds $75,000, exclusive of interests and costs. Plaintiff Pirelli Armstrong CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -5- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 7 of 141 1 Tire Corporation Retiree Medical Benefits Trust and its trustees are citizens of the state of Tennessee 2 and none of the defendants is a citizen of that state. Plaintiff Daniel Buckfire is a citizen of the state 3 of Michigan and none of the defendants is a citizen of that state. Moreover, this Court also has 4 supplemental jurisdiction over the state law claims asserted herein pursuant to 28 U.S.C. §1367. 5 15. This action is not a collusive one to confer jurisdiction on a court of the United States 6 which it would not otherwise have. 7 16. Venue is proper in this District pursuant to §27 of the Exchange Act, 15 U.S.C. 8 §78aa, as well as 28 U.S.C. §1391(b). Many of the acts charged herein, including the preparation 9 and dissemination of materially false and misleading information, occurred in substantial part in this 10 District. Costco is located in and conducts business in this District. Further, many of the individual 11 defendants are citizens of Washington and reside in this District. PARTIES 12 13 17. Plaintiff Pirelli Armstrong Tire Corporation Retiree Medical Benefits Trust (“Pirelli”) 14 holds and has held Costco common stock since at least as early as February 28, 2003. Each of the 15 trustees of Pirelli is a citizen of the state of Tennessee. 16 18. Plaintiff Daniel Buckfire holds and has held Costco common stock since June 12, 17 2000. Daniel Buckfire is a citizen of the state of Michigan. 18 19. Nominal party Costco is a Washington corporation with its principal executive offices 19 located at 999 Lake Drive, Issaquah, Washington. 20 20. Defendant James D. Sinegal (“Sinegal”) co-founded the Company and has been 21 President and a director since the Company’s inception. Sinegal acted as Chief Operating Officer 22 (“COO”) from 1983 to 1993 and since 1993 has been CEO of the Company. Sinegal approved and 23 accepted hundreds of thousands of backdated options, in contravention of the express authorization 24 of the Company’s shareholders and Costco’s stock option plans. He knew the adverse non-public 25 information about the business of the Company, as well as its finances, markets, and present and 26 future business prospects, via access to internal corporate documents, conversations and connections CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -6- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 8 of 141 1 with other corporate officers and employees, attendance at management and/or Board meetings and 2 committees thereof, and via reports and other information provided to him in connection therewith. 3 Through this and his approval and acceptance of hundreds of thousands of backdated options, 4 Sinegal knew that the Company’s directors and officers were backdating stock option grants. 5 21. Based on his admissions of responsibility in connection with so-called “imprecisions” 6 in option grants, Sinegal was one member of a two-member “executive committee” vested with 7 authority to grant options to rank-and-file employees (not officers and executives) of Costco. See 8 infra p.23 & n.7. In nearly each year during at least 1995-2004, Sinegal approved thousands of 9 backdated options as a member of that committee. 10 22. Sinegal participated in the preparation of management representation letters to 11 Costco’s auditors that falsely omitted (i) breaches of the Company’s internal controls, namely the 12 backdating of stock options; (ii) material inflation of the Company’s reported financial results due to 13 the false underreporting of compensation expense; and (iii) the resulting irregularities of the 14 Company’s deceptive stock option granting practices and false financial reporting that would require 15 a restatement of the Company’s financial statements and/or the withdrawal or modification of audit 16 opinions certifying the Company’s financial reports. 17 23. Although he disregarded that he and other of the Company’s directors and officers 18 were backdating and/or accepting backdated stock option grants, Sinegal participated in the 19 preparation of, and approved, false and misleading statements, including press releases and SEC 20 filings including proxy statements, and he signed the Company’s false and misleading Reports on 21 Form 10-Q, Reports on Form 10-K, Forms 3, 4 and 5, and Certifications pursuant to the Sarbanes22 Oxley Act of 2002 (“Sarbanes-Oxley”) attached to Costco’s Reports on Forms 10-K and 10-Q. 23 Sinegal has forewent a bonus, paid the Company $200,000, and stated “I take full responsibility for 24 the fact that the administration of our stock option program did not live up to the high standards we 25 follow in other aspects of our business” but he and the Company are loathe to admit his role in the 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -7- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 9 of 141 1 backdating, other than to state he had “responsibilities for the imprecisions” in stock option grants. 2 Form 8-K dated Oct. 12, 2006 at Ex. 99.1. 3 24. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 4 were falsely inflated by understatement of compensation expense and that the Company’s internal 5 controls were materially impaired, Sinegal sold over 2.3 million shares of Costco stock during 1998 6 to 2006. Sinegal is a citizen of the state of Washington. 7 25. Defendant Richard A. Galanti (“Galanti”), has been Executive Vice President and 8 CFO of Costco since October 1993, and has been a director since 1995. Previously, Galanti acted as 9 Vice President, Finance, starting in March 1984, was promoted to Senior Vice President and 10 Treasurer of the Company in January 1985, and acted as Treasurer until becoming CFO in 1993. He 11 approved and accepted hundreds of thousands of backdated options in contravention of the express 12 authorization of the Company’s shareholders and Costco’s stock option plans. Galanti knew the 13 adverse non-public information about the business of the Company, as well as its finances, markets, 14 and present and future business prospects, via access to internal corporate documents, conversations 15 and connections with other corporate officers and employees, attendance at management and/or 16 Board meetings and committees thereof, and via reports and other information provided to him in 17 connection therewith. Through this and his approval and acceptance of hundreds of thousands of 18 backdated options, Galanti knew that the Company’s directors and officers were backdating stock 19 option grants. 20 26. Based on his admissions of responsibility in connection with so-called “imprecisions” 21 in option grants, Galanti was one member of a two-member “executive committee” vested with 22 authority to grant options to rank-and-file employees (not officers and executives) of Costco. See 23 infra p.23 & n.7. In nearly each year during at least 1995-2004, Galanti approved thousands of 24 backdated options as a member of that committee. 25 27. Galanti participated in the preparation of management representation letters to 26 Costco’s auditors that falsely omitted (i) breaches of the Company’s internal controls, namely the CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -8- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 10 of 141 1 backdating of stock options; (ii) material inflation of the Company’s reported financial results due to 2 the false underreporting of compensation expense; and (iii) the resulting irregularities of the 3 Company’s deceptive stock option granting practices and false financial reporting that would require 4 a restatement of the Company’s financial statements and/or the withdrawal or modification of audit 5 opinions certifying the Company’s financial reports. 6 28. Although he disregarded that he and other of the Company’s directors and officers 7 were backdating and/or accepting backdated stock option grants, Galanti participated in the 8 preparation of, and approved, false and misleading statements, including press releases and SEC 9 filings including proxy statements, and he signed the Company’s false and misleading Reports on 10 Form 10-Q, Reports on Form 10-K, Reports on Forms 3, 4 and 5, and Sarbanes-Oxley Certifications 11 attached to Costco’s Reports on Forms 10-K and 10-Q. According to the Company, “[b]ecause of 12 [his] responsibilities for the imprecisions” in certain option grants, Galanti agreed to forego a bonus 13 to be awarded by the Company. 14 29. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 15 were falsely inflated by understatement of compensation expense and that the Company’s internal 16 controls were materially impaired, Galanti sold over 970,000 shares of Costco stock during 1997 to 17 2006. Galanti is a citizen of the state of Washington. 18 30. Defendant Jeffrey H. Brotman (“Brotman”), co-founded the Company in 1983, was 19 Vice-Chairman of the Board from October 1993 until December 1994, and since December 1994 has 20 been Chairman of the Board. Brotman accepted hundreds of thousands of backdated options in 21 contravention of the express authorization of the Company’s shareholders and Costco’s stock option 22 plans. Brotman knew the adverse non-public information about the business of the Company, as 23 well as its finances, markets, and present and future business prospects, via access to internal 24 corporate documents, conversations and connections with other corporate officers and employees, 25 attendance at management and/or Board meetings and committees thereof, and via reports and other 26 information provided to him in connection therewith. Through this and his acceptance of hundreds CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) -9- Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 11 of 141 1 of thousands of backdated options, Brotman knew that the Company’s directors and officers were 2 backdating stock option grants. 3 31. Although he disregarded that he and other of the Company’s directors and officers 4 were backdating and/or accepting backdated stock option grants, Brotman participated in the 5 preparation of, and approved, false and misleading statements, including press releases and SEC 6 filings including proxy statements and Sarbanes-Oxley Certifications, and he signed the Company’s 7 false and misleading Reports on Form 10-K and Forms 3, 4 and 5. 8 32. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 9 were falsely inflated by understatement of compensation expense and that the Company’s internal 10 controls were materially impaired, Brotman and his family trust sold over 3.3 million shares of 11 Costco stock during 1997 to 2006. Brotman is a citizen of the state of Washington. 12 33. Defendant Hamilton E. James (“James”) has been a director of Costco since August 13 1988. James was a member of the Compensation Committee from 1994 to 2008 and has been a 14 member of the Audit Committee since 2002. James granted hundreds of thousands of backdated 15 options to Costco’s executives and officers, in contravention of the express authorization of the 16 Company’s shareholders and Costco’s stock option plans. James knew the adverse non-public 17 information about the business of the Company, as well as its finances, markets, and present and 18 future business prospects, via access to internal corporate documents, conversations and connections 19 with other corporate officers and employees, attendance at management and/or Board meetings and 20 committees thereof, and via reports and other information provided to him in connection therewith. 21 Through this and his approval of hundreds of thousands of backdated options, James knew that the 22 Company’s directors and officers were backdating stock option grants. 23 34. James participated in (and did work in connection with) at least two meetings of the 24 Compensation Committee in each of fiscal 1995-2002, and one Compensation Committee meeting in 25 each of fiscal 2003-2004, and executed at least one Unanimous Written Consent, during which he 26 engaged in backdating options. James also did work and/or communicated with the Company’s CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 10 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 12 of 141 1 external auditors in connection with six meetings of the Audit Committee in fiscal 2002, seven 2 meetings of the Audit Committee in fiscal 2003, nine meetings of the Audit Committee in fiscal 3 2004-2005, seven meetings of the Audit Committee in fiscal 2006 and numerous meetings thereafter, 4 during which he withheld from the Company’s auditors (i) breaches of the Company’s internal 5 controls, namely the backdating of stock options; (ii) material inflation of the Company’s reported 6 financial results due to the false underreporting of compensation expense; and (iii) the resulting 7 irregularities of the Company’s deceptive stock option granting practices and false financial 8 reporting that would require a restatement of the Company’s financial statements and/or the 9 withdrawal or modification of audit opinions certifying the Company’s financial reports. 10 35. Although he disregarded that Costco’s directors and officers were backdating stock 11 option grants, James participated in the preparation of, and approved, false and misleading 12 statements, including press releases and SEC filings, and he signed the Company’s false and 13 misleading Reports on Form 10-K, Forms 3, 4 and 5, and proxy statements. 14 36. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 15 were falsely inflated by understatement of compensation expense and that the Company’s internal 16 controls were materially impaired, James sold over 290,000 shares of Costco stock during 1999 to 17 2005. James is a citizen of the state of New York. 18 37. Defendant John W. Meisenbach (“Meisenbach”) has been a director of Costco since 19 1983. Meisenbach was a member of both the Audit and Compensation Committees from 1994 to 20 2002. Meisenbach granted hundreds of thousands of backdated options to Costco executives and 21 officers, in contravention of the express authorization of the Company’s shareholders and Costco’s 22 stock option plans. Meisenbach knew the adverse non-public information about the business of the 23 Company, as well as its finances, markets, and present and future business prospects, via access to 24 internal corporate documents, conversations and connections with other corporate officers and 25 employees, attendance at management and/or Board meetings and committees thereof, and via 26 reports and other information provided to him in connection therewith. Through this and his CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 11 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 13 of 141 1 approval of hundreds of thousands of backdated options, Meisenbach knew that the Company’s 2 directors and officers were backdating stock option grants. 3 38. Meisenbach participated in (and did work in connection with) at least 2 meetings of 4 the Compensation Committee in each of fiscal 1995-2002, and executed at least one Unanimous 5 Written Consent, during which he engaged in backdating options. Meisenbach also did work and/or 6 communicated with the Company’s external auditors in connection with one meeting of the Audit 7 Committee in fiscal 1995, two Audit Committee meetings in each of fiscal 1996-1997 and 2001, four 8 meetings of the Audit Committee in each of fiscal 1998-2000, and six meetings of the Audit 9 Committee in fiscal 2002, during which he withheld from the Company’s auditors (i) breaches of the 10 Company’s internal controls, namely the backdating of stock options; (ii) material inflation of the 11 Company’s reported financial results due to the false underreporting of compensation expense; and 12 (iii) the resulting irregularities of the Company’s deceptive stock option granting practices and false 13 financial reporting that would require a restatement of the Company’s financial statements and/or the 14 withdrawal or modification of audit opinions certifying the Company’s financial reports. 15 39. Although he disregarded that Costco’s directors and officers were backdating stock 16 option grants, Meisenbach participated in the preparation of, and approved, false and misleading 17 statements, including press releases and SEC filings, and he signed the Company’s false and 18 misleading Reports on Form 10-K, Forms 3, 4 and 5, and proxy statements. 19 40. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 20 were falsely inflated by understatement of compensation expense and that the Company’s internal 21 controls were materially impaired, Meisenbach sold over 520,000 shares of Costco stock during 22 1997 to 2006. Meisenbach is a citizen of the state of Washington. 23 41. Defendant Jill S. Ruckelshaus (“Ruckelshaus”) has been a director of Costco since 24 February 1996. Ruckelshaus was a member of the Compensation Committee from 1997 to 2003 and 25 a member of the Audit Committee from 2001 to 2006. Ruckelshaus granted hundreds of thousands 26 of backdated options to Costco’s executives and officers, in contravention of the express CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 12 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 14 of 141 1 authorization of the Company’s shareholders and Costco’s stock option plans. Ruckelshaus knew 2 the adverse non-public information about the business of the Company, as well as its finances, 3 markets, and present and future business prospects, via access to internal corporate documents, 4 conversations and connections with other corporate officers and employees, attendance at 5 management and/or Board meetings and committees thereof, and via reports and other information 6 provided to him in connection therewith. Through this and her approval of hundreds of thousands of 7 backdated options, Ruckelshaus knew that the Company’s directors and officers were backdating 8 stock option grants. 9 42. Ruckelshaus participated in (and did work in connection with) at least two meetings 10 of the Compensation Committee in each of fiscal 1997-2002, and one Compensation Committee 11 meeting in fiscal 2003, during which she engaged in backdating options. Ruckelshaus also did work 12 and/or communicated with the Company’s external auditors in connection with two meetings of the 13 Audit Committee in fiscal 2001, six meetings of the Audit Committee in fiscal 2002, seven meetings 14 of the Audit Committee in fiscal 2003, nine meetings of the Audit Committee in fiscal 2004-2005, 15 and seven meetings of the Audit Committee in fiscal 2006, during which she withheld from the 16 Company’s auditors (i) breaches of the Company’s internal controls, namely the backdating of stock 17 options; (ii) material inflation of the Company’s reported financial results due to the false 18 underreporting of compensation expense; and (iii) the resulting irregularities of the Company’s 19 deceptive stock option granting practices and false financial reporting that would require a 20 restatement of the Company’s financial statements and/or the withdrawal or modification of audit 21 opinions certifying the Company’s financial reports. 22 43. Although she disregarded that Costco’s directors and officers were backdating stock 23 option grants, Ruckelshaus participated in the preparation of, and approved, false and misleading 24 statements, including press releases and SEC filings, and she signed the Company’s false and 25 misleading Reports on Form 10-K, Forms 3, 4 and 5, and proxy statements. 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 13 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 15 of 141 1 44. Notwithstanding her knowledge of the backdating, that Costco’s reported earnings 2 were falsely inflated by understatement of compensation expense and that the Company’s internal 3 controls were materially impaired, Ruckelshaus sold 32,000 shares of Costco stock during 2004 to 4 2006. Ruckelshaus is a citizen of the state of Washington. 5 45. Defendant Charles T. Munger (“Munger”) has been a director of Costco since 6 January 1997. Munger has been a member of the Compensation Committee since 2002 and has been 7 a member of the Audit Committee since 2001. Munger granted hundreds of thousands of backdated 8 options to Costco’s executives and officers, in contravention of the express authorization of the 9 Company’s shareholders and Costco’s stock option plans. Munger knew the adverse non-public 10 information about the business of the Company, as well as its finances, markets, and present and 11 future business prospects, via access to internal corporate documents, conversations and connections 12 with other corporate officers and employees, attendance at management and/or Board meetings and 13 committees thereof, and via reports and other information provided to him in connection therewith. 14 Through this and his approval of hundreds of thousands of backdated options, Munger knew that the 15 Company’s directors and officers were backdating stock option grants. 16 46. Munger participated in (and did work in connection with) at least two meetings of the 17 Compensation Committee in fiscal 2002, and one Compensation Committee meeting in each of 18 fiscal 2003-2004, during which he engaged in backdating options. Munger also did work and/or 19 communicated with the Company’s external auditors in connection with six meetings of the Audit 20 Committee in fiscal 2002, seven meetings of the Audit Committee in fiscal 2003, nine meetings of 21 the Audit Committee in fiscal 2004-2005, seven meetings of the Audit Committee in fiscal 2006 and 22 numerous meetings thereafter, during which he withheld from the Company’s auditors (i) breaches 23 of the Company’s internal controls, namely the backdating of stock options; (ii) material inflation of 24 the Company’s reported financial results due to the false underreporting of compensation expense; 25 and (iii) the resulting irregularities of the Company’s deceptive stock option granting practices and 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 14 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 16 of 141 1 false financial reporting that would require a restatement of the Company’s financial statements 2 and/or the withdrawal or modification of audit opinions certifying the Company’s financial reports. 3 47. Although he disregarded that Costco’s directors and officers were backdating stock 4 option grants, Munger participated in the preparation of, and approved, false and misleading 5 statements, including press releases and SEC filings, and he signed the Company’s false and 6 misleading Reports on Form 10-K and proxy statements. Munger is a citizen of the state of 7 Minnesota. 8 48. Defendant Benjamin S. Carson, Sr. (“Carson”) has been a director of Costco since 9 May 1999. Carson has been a member of the Compensation Committee since 2002. Carson granted 10 hundreds of thousands of backdated options to Costco’s executives and officers, in contravention of 11 the express authorization of the Company’s shareholders and Costco’s stock option plans. Carson 12 knew the adverse non-public information about the business of the Company, as well as its finances, 13 markets, and present and future business prospects, via access to internal corporate documents, 14 conversations and connections with other corporate officers and employees, attendance at 15 management and/or Board meetings and committees thereof, and via reports and other information 16 provided to him in connection therewith. Through this and his approval of hundreds of thousands of 17 backdated options, Carson knew that the Company’s directors and officers were backdating stock 18 option grants. 19 49. Carson participated in (and did work in connection with) at least two meetings of the 20 Compensation Committee in fiscal 2002, and one Compensation Committee meeting in each of 21 fiscal 2003-2004, during which he engaged in backdating options. Carson also did work and/or 22 communicated with the Company’s external auditors in connection with six meetings of the Audit 23 Committee in fiscal 2002, seven meetings of the Audit Committee in fiscal 2003, nine meetings of 24 the Audit Committee in fiscal 2004-2005, seven meetings of the Audit Committee in fiscal 2006 and 25 numerous meetings thereafter, during which he withheld from the Company’s auditors (i) breaches 26 of the Company’s internal controls, namely the backdating of stock options; (ii) material inflation of CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 15 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 17 of 141 1 the Company’s reported financial results due to the false underreporting of compensation expense; 2 and (iii) the resulting irregularities of the Company’s deceptive stock option granting practices and 3 false financial reporting that would require a restatement of the Company’s financial statements 4 and/or the withdrawal or modification of audit opinions certifying the Company’s financial reports. 5 50. Although he disregarded that Costco’s directors and officers were backdating stock 6 option grants, Carson participated in the preparation of, and approved, false and misleading 7 statements, including press releases and SEC filings, and he signed the Company’s false and 8 misleading Reports on Form 10-K and proxy statements. 9 51. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 10 were falsely inflated by understatement of compensation expense and that the Company’s internal 11 controls were materially impaired, Carson sold 12,000 shares of Costco stock during 2006. Carson 12 is a citizen of the state of Maryland. 13 52. Defendant Richard D. DiCerchio (“DiCerchio”) has been a director of the Company 14 since 1986. DiCerchio has also been Senior Executive Vice President of Costco since 1997 and 15 COO of Global Operations, Distribution and Construction since 2004. He accepted hundreds of 16 thousands of backdated options in contravention of the express authorization of the Company’s 17 shareholders and Costco’s stock option plans. DiCerchio knew the adverse non-public information 18 about the business of the Company, as well as its finances, markets, and present and future business 19 prospects, via access to internal corporate documents, conversations and connections with other 20 corporate officers and employees, attendance at management and/or Board meetings and committees 21 thereof, and via reports and other information provided to him in connection therewith. Through this 22 and his acceptance of hundreds of thousands of backdated options, DiCerchio knew that the 23 Company’s directors and officers were backdating stock option grants. 24 53. Although he disregarded that the Company’s directors and officers were backdating 25 and/or accepting backdated stock option grants, DiCerchio participated in the preparation of, and 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 16 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 18 of 141 1 approved, false and misleading statements, including press releases and SEC filings, and he signed 2 the Company’s false and misleading Reports on Form 10-K and Forms 3, 4 and 5. 3 54. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 4 were falsely inflated by understatement of compensation expense and that the Company’s internal 5 controls were materially impaired, DiCerchio sold over 1.2 million shares of Costco stock during 6 1997 to 2005. DiCerchio is a citizen of the state of Washington. 7 55. Defendant David S. Petterson (“Petterson”) has been Senior Vice President, 8 Corporate Controller and Chief Accounting Officer of Costco since 1995. Petterson accepted 9 hundreds of thousands of backdated options in contravention of the express authorization of the 10 Company’s shareholders and Costco’s stock option plans. Petterson knew the adverse non-public 11 information about the business of the Company, as well as its finances, markets, and present and 12 future business prospects, via access to internal corporate documents, conversations and connections 13 with other corporate officers and employees, attendance at management and/or Board meetings and 14 committees thereof, and via reports and other information provided to him in connection therewith. 15 Through this, his acceptance of hundreds of thousands of backdated options, and his oversight of the 16 recordation of stock option grants, Petterson knew that the Company’s directors and officers were 17 backdating stock option grants. 18 56. Petterson signed and/or participated in the preparation of management representation 19 letters to the Company’s auditors that falsely omitted (i) intentional breaches of the Company’s 20 internal controls, namely the backdating of stock options; (ii) material inflation of the Company’s 21 reported financial results due to the false underreporting of compensation expense; and (iii) the 22 resulting irregularities of the Company’s deceptive stock option granting practices and false financial 23 reporting that would require a restatement of the Company’s financial statements and/or the 24 withdrawal or modification of audit opinions certifying the Company’s financial reports. 25 57. Although he disregarded that directors and officers were backdating stock option 26 grants, Petterson participated in the preparation of, and approved, false and misleading statements, CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 17 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 19 of 141 1 including the Company’s Reports on Forms 10-Q and 10-K, Forms 3, 4 and 5, and false and 2 misleading Sarbanes-Oxley Certifications attached to Costco’s Reports on Forms 10-K and 10-Q, 3 and he signed the Company’s Reports on Form 10-K. 4 58. Notwithstanding his knowledge of the backdating, that Costco’s reported earnings 5 were falsely inflated by understatement of compensation expense and that the Company’s internal 6 controls were materially impaired, Petterson sold over 400,000 shares of Costco stock during 1997 7 to 2006. Petterson is a citizen of the state of Washington. BACKDATING ALLEGATIONS 8 9 Costco’s Stock Option Plans Authorized by the Shareholders 59. 10 At all relevant times Costco granted incentive stock options (or otherwise purported 11 “fair market value” options) pursuant to its 1993 Combined Stock Grant and Stock Option Plan 12 (“1993 Stock Option Plan”) and 2002 Stock Incentive Plan (“2002 Stock Option Plan”) (collectively, 13 the “stock option plans”). A fundamental requirement of Costco’s stock option plans is, and in all 14 relevant instances was, that the exercise price of incentive stock options be calculated relative to the 15 fair market value (the closing price) of the Company’s common stock on the date of the grant of the 16 option. 17 60. In all relevant instances with respect to incentive stock options (“ISOs”) granted to 18 those owning less than 10% of the Company, Costco’s stock option plans required that the option 19 exercise price shall not be less than 100% of the fair market value of the shares covered thereby on 20 the option grant date. See 1993 Stock Option Plan (as approved by shareholders October 1993 and 21 as amended January 1997, January 1998 and January 1999), §5 (“EXERCISE PRICE OF OPTIONS. 22 The price to be paid for shares of Common Stock covered by each option shall be not less than 100% 23 . . . of the fair market value of such shares of Common Stock . . . on the date the option is granted.”); 24 2002 Stock Option Plan, §6.1 (“Price. No Option may have an Option Price less than 100% of the 25 Fair Market Value of the Shares on the Grant Date.”); 2002 Stock Option Plan, §7(f) (“The Option 26 Price of an Incentive Stock Option shall never be less than the Fair Market Value of the Shares at the CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 18 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 20 of 141 1 Grant Date.”). The Company in all relevant instances was required to (and purportedly) defined fair 2 market value as the closing sales price for the Company’s common stock on the grant date. See, e.g., 3 2002 Stock Option Plan, §16.2(a) (“closing sales price for the Shares as quoted on that stock 4 exchange”). 5 61. The minimum vesting period and expiration date of incentive stock options granted 6 under the Plans was one and ten years, respectively, after the date of grant of the option. See 1993 7 Stock Option Plan (as approved by shareholders October 1993 and as amended January 1997, 8 January 1998 and January 1999), §7(a) (“no option shall be exercisable until one year from the Date 9 Of Option Grant, nor after the expiration of ten years from the Date Of Option Grant”); 2002 Stock 10 Option Plan, §6.2 (“Term. No Option shall be exercisable after its Expiration Date. No Option may 11 have an Expiration Date that is more than ten years after its Grant Date.”); 2002 Stock Option Plan, 12 §6.3 (“no Option shall be exercisable until one year from the Grant Date”). 13 62. The aforementioned fundamental requirements directly contradict dating or approving 14 a stock option as if it were granted on a date prior to its actual grant date, pricing a stock option as if 15 it were dated prior to the date of the grant, or accepting (as if granted on such a date) an option so 16 dated or priced. Dating or approving a stock option as if it were granted on a date prior to its actual 17 grant date and thereby underreporting compensation expense and tax liability, also violates state and 18 federal securities laws as well as the Internal Revenue Code. Nonetheless, the Compensation 19 Committees over the years repeatedly approved stock options which on their face were backdated 20 and retroactively priced. The Compensation Committee backdated incentive stock options and 21 priced those options (purportedly at fair market value) as if they were dated prior to the date of the 22 actual grant. The Compensation Committee also backdated nonqualified options (whether they were 23 reported as nonqualified or not) for the purpose of underreporting compensation expense and insider 24 tax liability, among other things. 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 19 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 21 of 141 1 Alleged Backdated Stock Option Grants at Costco 2 Purported Option Grant Date (Expiration Date) 05/26/1995 (05/26/2005) 3 4 5 6 Price (splitadjusted price)1 $13.31 ($6.66) 7 8 9 10 11 12 10/26/1995 (10/26/2005) 13 14 15 16 $16.50 ($8.25) Some Directors & Officers Who Received Grants2 Sinegal Number of Options Received3 Options Exercised, Stock Sold4 Defendants Who Engaged in Backdating Purported Stock Option Grants5 100,000 √ Sinegal, Galanti, James and Meisenbach Brotman DiCerchio Maron Zook Galanti Portera Lazarus Jelinek Loge Moulton Petterson DiCerchio 100,000 32,000 24,000 24,000 16,000 24,000 20,000 21,000 28,000 12,000 18,000 42,000 √ √ √ √ √ √ √ √ √ √ √ √ Maron Zook Galanti Portera Lazarus Jelinek 36,000 42,000 60,000 36,000 36,000 49,000 √ √ √ √ √ √ Sinegal, Galanti, James and Meisenbach 17 18 19 20 21 22 23 24 25 26 1 Certain defendants caused the Company to engage in a two-for-one stock split on January 14, 2000. Splitadjusted prices are stated in parenthesis. If options were exercised, the split-adjusted price is indicated as of the exercise date. Otherwise, the price in parenthesis is fully split-adjusted. 2 Executives whose names are not previously defined are: Edward Maron (“Maron”), Dennis Zook (“Zook”), Joseph Portera (“Portera”), Franz Lazarus (“Lazarus”), Walter Jelinek (“Jelinek”), David Loge (“Loge”), Paul Moulton (“Moulton”), Thomas Walker (“Walker”) and Douglas Schutt (“Schutt”). 3 Number of options received is split-adjusted. If options were exercised, the split-adjusted quantity is indicated as of the exercise date. Otherwise, the quantity is fully split-adjusted. 4 “√” indicates the recipient exercised/converted all or a substantial portion of the options received and thereafter sold, transferred or exchanged the stock issued from the option exercise. See infra ¶224 (insider trading table). 5 Sinegal’s and Galanti’s involvement included backdating options to rank-and-file employees. All other Board members indicated granted backdated options to the officers and directors identified in the third column of the table herein. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 20 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 22 of 141 1 2 3 Purported Option Grant Date (Expiration Date) Price (splitadjusted price)1 4 5 04/10/1996 (04/10/2006) $17.50 ($8.75) 6 7 8 9 10 11 12 04/02/1997 (04/02/2007) $26.88 ($13.44) 13 14 15 16 17 18 19 02/09/1999 (02/09/2009) $73.81 ($36.91) 20 21 22 23 24 25 26 03/13/2000 (03/13/2010) $43.00 Some Directors & Officers Who Received Grants2 Loge Moulton Walker DiCerchio Number of Options Received3 54,000 12,000 30,000 85,000 √ √ √ √ Maron Zook Galanti Portera Lazarus Jelinek Loge Moulton Walker Petterson Sinegal 90,000 60,000 100,000 70,000 70,000 71,278 70,000 30,000 50,000 35,000 200,000 √ √ √ √ √ √ √ √ √ √ √ Brotman DiCerchio Maron Zook Galanti Portera Lazarus Jelinek Loge Moulton Petterson Walker DiCerchio 200,000 130,000 90,000 40,000 100,000 90,000 80,000 70,000 80,000 40,000 40,000 50,000 120,000 √ √ √ √ √ √ √ √ √ √ √ √ Zook Galanti Portera Lazarus Jelinek Loge Moulton Walker Petterson DiCerchio 100,000 100,000 100,000 100,000 100,000 100,000 80,000 80,000 60,000 90,000 √ √ √ √ √ √ √ √ √ √ Zook Galanti Portera 75,000 75,000 75,000 √ √ √ CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 21 - Options Exercised, Stock Sold4 Defendants Who Engaged in Backdating Purported Stock Option Grants5 Sinegal, Galanti, James and Meisenbach Sinegal, Galanti, James, Meisenbach and Ruckelshaus Sinegal, Galanti, James, Meisenbach and Ruckelshaus Sinegal, Galanti, James, Meisenbach and Ruckelshaus Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 23 of 141 Purported Option Grant Date (Expiration Date) 1 2 3 Price (splitadjusted price)1 Number of Options Received3 75,000 60,000 30,000 90,000 √ √ √ $34.28 Some Directors & Officers Who Received Grants2 Moulton Walker Petterson DiCerchio 75,000 75,000 75,000 75,000 60,000 37,500 160,000 90,000 √ √ √ √ √ √ √ $38.79 Zook Galanti Portera Moulton Walker Petterson Schutt DiCerchio 75,000 75,000 75,000 24,000 37,500 40,000 150,000 √ $30.41 Zook Galanti Portera Walker Petterson Schutt Brotman $37.35 DiCerchio Galanti Lazarus Moulton Portera Petterson Zook Brotman 90,000 75,000 75,000 75,000 75,000 37,500 75,000 150,000 DiCerchio Sinegal Galanti Lazarus Moulton Portera Petterson Zook Walker 90,000 150,000 75,000 75,000 30,000 60,000 30,000 75,000 75,000 4 5 04/24/2001 (04/24/2011) 6 7 8 9 04/02/2002 (04/02/2012) 10 11 12 13 04/01/2003 (04/01/2013) 14 15 16 17 18 04/01/20046 (03/31/2014) 19 20 21 22 23 24 Options Exercised, Stock Sold4 Defendants Who Engaged in Backdating Purported Stock Option Grants5 Sinegal, Galanti, James, Meisenbach and Ruckelshaus Sinegal, Galanti, James, Meisenbach and Ruckelshaus √ √ √ √ Sinegal, Galanti, James, Ruckelshaus, Carson and Munger √ √ √ √ Sinegal, Galanti, James, Carson and Munger √ √ √ √ √ 25 26 6 Vested beginning April 1, 2005. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 22 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 24 of 141 Purported Option Grant Date (Expiration Date) 1 2 3 4 5 63. Price (splitadjusted price)1 Some Directors & Officers Who Received Grants2 Jelinek Schutt Number of Options Received3 Options Exercised, Stock Sold4 Defendants Who Engaged in Backdating Purported Stock Option Grants5 75,000 75,000 The Compensation Committee was delegated ultimate responsibility for 6 administration of the Company’s 1993 Stock Option Plan and 2002 Stock Option Plan and under the 7 1993 Stock Option Plan was the sole authority for granting stock options to officers and executives 8 of the Company subject to reporting requirements of Section 16 of the Exchange Act. See 1993 9 Stock Option Plan §3(a) (“the ‘Independent Committee’ shall make any and all decisions to grant 10 Common Stock or to award option sunder the Plan to officers of the Company who are subject to the 11 reporting requirements under Section 16”).7 The 2002 Stock Option Plan also required that “only 12 the Board or the Committee may approve grants of Options to Executives,” and the Board delegated 13 its discretion to the Compensation Committee. See 2002 Stock Option Plan, §4.1; see also 2002 14 Proxy at 12. Specifically, from at least 1995 until the filing of this action, from 1995 until October 15 15, 2002, and from 1997 until 2004, James, Meisenbach and Ruckelshaus, respectively, had the 16 responsibility and authority to grant options to the Company’s officers and executives. From at least 17 October 15, 2002 until the filing of this action, Carson and Munger also had the responsibility and 18 authority to grant options to the Company’s officers and executives. 19 20 21 22 23 24 25 26 7 On January 21, 1998, the 1993 Stock Option Plan was amended to provide that “any and all decisions regarding the grant of Common Stock or options under the Plan to officers . . . shall be made wither by the entire Board or by a committee . . . consisting solely of two or more ‘non-employee directors’ . . . .” 1993 Stock Option Plan (as amended January 1998 and January 1999), §3(a). At all relevant times Costco’s proxy statements stated that it was the Compensation Committee that “approv[ed] grants and awards under . . . the option plan” to officers and executives. See 1998 Proxy at 10; 1999 Proxy at 8; 2000 Proxy at 8; 2001 Proxy at 9. Furthermore, subject to the Compensation Committee’s authority, the CEO was allowed to “recommend[]” employees to be granted options. Under the 1993 Stock Option Plan, an unnamed “Executive Committee” was vested authority to award options to rank-and-file employees (i.e., not reporting persons under Section 16 of the Exchange Act). See 1993 Stock Option Plan (as approved by shareholders October 1993 and as amended January 1997, January 1998 and January 1999), §3(a). Based on their admissions of responsibility in connection with the granting of options, it appears that Sinegal and Galanti were members of that committee. See supra ¶¶23, 28. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 23 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 25 of 141 1 64. The Compensation Committee’s authority and responsibility at all relevant times has 2 been to, as a committee, grant stock options and determine the recipients and terms of options, 3 including the time of grant, nature of option (incentive or not) number of shares subject to the option 4 and the terms and conditions of exercise, among other things. See 1993 Stock Option Plan (as 5 approved by shareholders October 1993 and as amended January 1997, January 1998 and January 6 1999), §3(c); 2002 Stock Option Plan, §4.2. 7 65. Abusing their authority and committing bad faith and ultra vires acts, defendants 8 Sinegal, Galanti, James, Meisenbach, Ruckelshaus, Carson and Munger violated Costco’s stock 9 option plans, in that they: (i) backdated and mispriced stock options; and (ii) in collusion with one 10 another, other defendants, or current or former employees of the Company, determined and granted 11 option awards dated with dates prior to the dates the awards were properly authorized, employees 12 were entitled to receive the options, or the option or price was known. Each of the defendants 13 abused their authority in causing the backdating and mispricing to occur, and/or accepting such 14 options without disclosure of the true facts. 15 66. An objective analytical review, using court-accepted methodologies of all publicly 16 reported stock option dates in option grants to directors and officers of Costco between 1995 and 17 2005, over 20 dates, reveals that discretionary stock option grants tended to be dated and priced 18 based on dates: (i) following significant decreases in the Company’s stock price; (ii) near or on the 19 very day that Costco’s stock price closed at the lowest closing price for the month, quarter and/or 20 year; and/or (iii) preceding significant stock price increases. To illustrate, the following graph 21 depicts the cumulative increase/decrease in Costco’s stock price preceding and following all 22 publicly reported stock option dates in option grants to directors and officers of Costco between 23 1995 and 2005. 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 24 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 26 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 67. 16 17 18 19 20 21 22 23 The data points reflected in the graph above are cumulative, meaning they represent the cumulative effect or average of increases and decreases in Costco’s closing stock price nine trading days (approximately two weeks) before and after all the purported option grant dates.8 Costco’s closing stock price might have been less or more at any point in time for a particular grant. But the cumulative data points clearly and objectively demonstrate the predominance of Costco’s closing stock prices preceding and following the option dates, namely that options were dated shortly after significant decreases in Costco’s stock price and preceding very large increases in the stock’s price. In addition, it is clear that during the 18 trading-day period (and more) defendants 24 25 26 8 Costco’s limited after-the-fact admissions indicate that with respect to the option approval dates for certain options the Company was required to disclose in its proxy statement for the 2008 Annual Meeting of Shareholders, the actual approval dates were as much as nine trading days after the stated option grant date. See infra ¶78 & nn.13-14. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 25 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 27 of 141 1 overwhelmingly selected as the option date the date on which Costco’s stock closed at the lowest 2 closing price. 3 68. Indeed, approximately 50% of discretionary option grants to Costco’s directors and 4 officers were dated and priced based on Costco’s lowest closing stock price of the month. The odds 5 of that happening absent intentional manipulation are so remote (over 1 in 1,000,000) that 6 backdating is a rational if not the most rational explanation for these fortuitous option grants.9 And 7 that is not even considering a number of the reported option grants were dated as of and priced based 8 on Costco’s lowest or second lowest closing price of the quarter, which, in and of itself is even more 9 improbable than selecting a single grant date that falls on the lowest closing price of the month. 69. 10 The Merrill Lynch methodology examines the “20 day period subsequent to options 11 pricing in comparison to stock price returns for the calendar year in which the options were 12 granted.”10 According to the Merrill Lynch methodology, “companies should not be generating any 13 systematic excess return in comparison to other investors as a result of how options pricing events 14 are timed.” This 20-day analysis makes sense because, “[t]heoretically, if the timing of options 15 grants is an arm’s length process, and companies haven’t systematically taken advantage of their 16 ability to backdate options within the 20-day windows that the law provided prior to the 17 implementation of Sarbanes Oxley in 2002, there shouldn’t be any difference between the two 18 measures.” This analysis has also been referred to as “the easiest and simplest way” to measure the 19 pricing of options. New York University finance professor David Yermack and University of Iowa 20 21 22 23 24 25 26 9 This conservatively reflects the results of a binomial statistical analysis based on all reported discretionary option grants to Costco’s officers and directors during the analytical review period above (over 20 grant dates) and how many such grants were dated as of the date in which Costco’s stock price reached the lowest closing price of the month. 10 Several decisions acknowledge the usefulness of the Merrill Lynch and Center for Financial Research and Analysis (“CFRA”) analyses in determining whether a pattern of backdating exists. See, e.g., Alaska Elec. Pension Fund v. Olofson, No. 08-2344-CM, 2009 U.S. Dist. LEXIS 46564, at *17-*19 (D. Kan. June 3, 2009); Belova v. Sharp, No. CV-07-299-MO, 2008 U.S. Dist. LEXIS 19880, at *11-*12 (D. Or. Mar. 13, 2008); In re CNET Networks, Inc., 483 F. Supp. 2d 947, 957 (N.D. Cal. 2007); In re Computer Scis. Corp. Derivative Litig., No. CV 06-05288 MRP (Ex), 2007 U.S. Dist. LEXIS 25414, at *44-*45 (C.D. Cal. Mar. 27, 2007); Ryan v. Gifford, 918 A.2d 341, 354-55 (Del. Ch. 2007); Conrad v. Blank, 940 A.2d 28, 39 n.30 (Del. Ch. 2007). CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 26 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 28 of 141 1 finance professor Erik Lie said that 20-day post-grant price surges are “a reasonable yardstick to 2 detect possible backdating” and that “[u]sing a longer period, such as a year, wouldn’t be a good way 3 to spot backdating of a few days or weeks because the longer-term trading would overwhelm any 4 backdating effect.” 5 70. Using Merrill Lynch’s methodology in comparing, annualized 20-day 6 increases/decreases in Costco’s stock price following management grant dates (“management 7 annualized returns”), to public “investor” annualized returns, i.e., the fiscal annual increase/decrease 8 in Costco’s stock price (“investor annualized return”), plaintiffs analyzed all of the publicly reported 9 stock option dates to directors and officers of Costco between 1995 and 2005.11 There were over 20 10 separate grant dates. The analysis revealed that, between 1995 and 2005, the average management 11 annualized return on publicly reported grants was approximately 109%, while the average public 12 investor annualized return was approximately 17%. 13 14 15 16 17 18 19 20 21 22 23 24 25 26 11 Plaintiffs’ analysis uses Merrill Lynch’s methodology and the same terminology as Merrill Lynch (e.g., “management annualized return” and “investor annualized return”). CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 27 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 29 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 71. In other words, as shown above, there was a significant disparity between 17 management annualized returns and the public investor annualized returns – the average 18 management return being more than 600% higher than the average public investor annualized 19 return. Indeed, except for in 2005, the management annualized return was always significantly 20 positive and as much as 1493% higher than the investor annualized return, while for three years 21 public investors lost between .8% and 11.3%. 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 28 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 30 of 141 Costco Average “Management Annualized Return” Compared to “Investor Annualized Return,” by Fiscal Year, 1995 - 2005 1 2 3 Fiscal Year 4 10 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 11 Total Average 12 72. 5 6 7 8 9 Average Management “Annualized Return” 108.9% 48.4% 61.5% 227.4% 114.9% 274.0% 88.1% 35.9% 248.6% 7.2% -7.9% 109.7% “Investor Annualized Return,” Same Year 9.8% 14.0% 74.8% 23.8% 50.3% -6.7% 5.9% -11.3% -0.8% 24.3% 6.3% 17.3% And the results above reflect plaintiffs’ analysis of all the publicly reported stock 13 option dates to directors and officers of Costco from 1995 to 2005, inclusive. The disparity is even 14 greater when observing the alleged backdated option grants. Thus, the disparity of returns 15 demonstrated by the Merrill Lynch analytical methodology is demonstrably conservative when 16 compared with the disparity of returns shown when the “management return” of the individually 17 alleged backdated grants in particular is determined and compared with the public “investor 18 annualized return” in the same fiscal year. These option grants also fell on suspiciously fortuitous 19 dates, e.g., dates where Costco’s closing stock price was the lowest or near the lowest of the month 20 or quarter. 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 29 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 31 of 141 Alleged Backdated Option Grant Price Rankings 1 2 Option Date 3 05/26/1995 10/26/1995 04/10/1996 04/02/1997 02/09/1999 03/13/2000 04/24/2001 04/02/2002 04/01/2003 04/01/2004 4 5 6 7 8 9 73. Option Price Ranking by Month, Fiscal Quarter or Fiscal Year Lowest of the Month Lowest of the Month Lowest of the Month & Second-Lowest of the Quarter Lowest of the Month Lowest of the Month Lowest of the Month Second-Lowest of the Month & Quarter Lowest of the Month & Third-Lowest of the Quarter Lowest of the Month Second-Lowest of the Month In determining alleged backdated option grants, plaintiffs also screened each grant 10 according to the methodology used by the Center for Financial Research and Analysis (“CFRA”). 11 “CFRA considers a company’s options backdating risk to be significant when a company has, on 12 three or more occasions, granted options to executives at exercise prices and dates that matched 13 exactly or were close to a 40-day low in the company’s stock price.” In assessing the likelihood of 14 backdating, the CFRA report uses the following criteria: (i) where the price on the grant date is 15 within 105% of the 10- or 40-day period stock price low following date of grant; and (ii) the stock 16 price range for the 40-day period (highest stock price minus lowest stock price) is greater than 10% 17 of the lowest stock price. Every alleged backdated stock option grant tested positive under these 18 criteria. In addition, on more than three occasions (indeed, five) the Company granted options to 19 executives at dates where closing prices matched exactly or were close to a 40-day low in Costco’s 20 stock price. 21 74. Another indication of backdating may be seen in the period of time between the 22 purported grant date and the date the grant was disclosed to the SEC. Thus, plaintiffs also reviewed 23 the amount of time between the purported stock option grant date and disclosure of the grants to the 24 SEC via Forms 3, 4 or 5. Grants that are not disclosed to the SEC in a timely fashion are more likely 25 to be backdated. “If executives are backdating, a longer reporting lag implies that, on average, they 26 were backdating aggressively, seeking a lower exercise price. This in turn implies that the extent of stock price rise following the manager-designated grant date will be positively correlated with the CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 30 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 32 of 141 1 reporting lag.” M. P. Narayanan, Cindy A. Schipani & H. Nejat Seyhun, The Economic Impact of 2 Backdating of Executive Stock Options, 105 Mich. L. Rev. 1597, 1603 (2007). 3 75. With respect to a number of the alleged backdated option grants, there are no known 4 SEC Forms 4 or Thomson financial data derived from such filings, showing the changes in 5 beneficial ownership from these purported grants – the options were not evidenced until years later, 6 when SEC filings were made indicating the exercise or exchange of these options. Otherwise, 7 Forms 4 or holdings records evidencing these backdated grants (and others) were filed by defendants 8 and others weeks, or, in most instances, many months, after the purported grant date. 9 76. For the stock option grants plaintiffs allege were backdated after Sarbanes-Oxley was 10 enacted, plaintiffs reviewed the price movement in the lag time between the grant dates and the dates 11 defendants disclosed the grants to the SEC. 77. 12 Similarly, stock option grants are more likely backdated when they are discretionary 13 and granted by a sporadic method.12 Accordingly, plaintiffs also reviewed each grant to determine 14 whether or not it was granted in a sporadic fashion or on a fixed date pursuant to a non-discretionary 15 stock option plan. The alleged backdated grants were discretionary and sporadic. 16 78. Additional analyses based on Costco’s limited after-the-fact admissions regarding 17 certain option approval dates. In its proxy statement for the 2008 Annual Meeting of Shareholders, 18 Costco was required to disclose stock option awards held by named executive officers during fiscal 19 2007.13 In the table, footnotes appended to the table, and footnotes cross-referenced in footnotes 20 appended to the table, the Company obliquely admitted “stated grant dates” of certain options were 21 22 23 24 25 26 12 That a stock option grant might be issued pursuant to a non-discretionary fixed date plan only reduces, but does not eliminate, the likelihood that stock options were being backdated. For example, in a recent stock option backdating action against CNET Networks, Inc., the company was forced to re-price so-called non-discretionary fixed-date grants and admit that those grants were not actually granted on the fixed date required by the applicable stock option plan. 13 The admissions only concerned the specific option awards then held by named executive officers. The Company’s revisions to its reported net income indicate that many more option grants were backdated. But the window of time that transpired between the false option date and the purported actual grant date has not been revealed with respect to the other option grants. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 31 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 33 of 141 1 not accurate.14 Rather, as admitted by the Company, actual option approval dates were after “stated” 2 option grant dates and the option prices on those options were “lower than the market value,” i.e., 3 lower than the price of Costco’s stock on the purportedly true option grant date. According to 4 Costco, the actual approval dates of certain options was, at a minimum, two trading days, and, as 5 much as, two weeks (nine trading days) after the stated option grant date. 6 79. Therefore, plaintiffs performed additional analyses focusing on the movement of 7 Costco’s stock price in the two trading days that followed the purported option date for the option 8 grants to Costco’s officers and directors between 1995 and 2005. Increases in Costco’s stock price 9 ten trading days after purported option dates are also calculated at ¶¶85-94, infra. The results of 10 these analyses further support an inference that options were backdated. 80. 11 First, the annualized 2-day increase/decrease in Costco’s stock price following 12 purported management grant dates (“management 2-day annualized returns”) was significantly 13 positive, and much higher than the “investor annualized return” in the same year between 1995 and 14 2005. The analysis revealed that, between 1995 and 2005, the average management 2-day 15 annualized return on all publicly reported grants was approximately 520%, while the average public 16 investor annualized return was approximately 17%. In other words, overall there was a significant 17 disparity between average management 2-day annualized returns and the public investor annualized 18 returns – the average management return for the 1995-2005 period being approximately 30 times or 19 3000% higher than the average public investor annualized return. 81. 20 Indeed a distinct pattern emerges when one examines the cumulative 21 increase/decrease in Costco’s stock price in the 2-day trading period preceding and following all 22 publicly reported stock option dates in option grants to directors and officers of Costco between 23 1995 and 2005. 24 25 26 14 Because the disclosure only involved options held by named executive officers during fiscal 2007, it did not address numerous other option grants and stated (backdated) option grant dates that the Company has not been required to disclose. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 32 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 34 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 82. The cumulative data points clearly and objectively demonstrate the predominance of 18 Costco’s closing stock prices in the 2-day trading period preceding and following the option dates, 19 namely that options were dated shortly after significant decreases in Costco’s stock price and 20 preceding significant increases in the stock’s price. As with the larger windows of time reviewed in 21 the graphics following ¶¶66 and 95, overwhelmingly, defendants managed to pick the lowest closing 22 price of Costco’s stock for all option grants during the period reviewed, here four trading days. 23 83. Second, the 2-day increase/decrease in Costco’s stock price following purported 24 management grant dates (“2-day return”), as compared with all other 250-plus 2-day movements in 25 Costco’s stock price in the same fiscal year, overall, ranked unusually high. Approximately one 26 third of discretionary option grants to directors and officers of Costco between 1995 and 2005 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 33 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 35 of 141 1 ranked in the 99th percentile (i.e., were at least the third-highest ranking of over 250) of 2-day 2 returns in the same fiscal year as the option date. The probability of so frequently selecting option 3 dates in the 99th percentile of 2-day returns, without manipulation, is remote. 4 84. The following describes some of the backdated and otherwise manipulated option 5 grants and their recipients. As demonstrated by the graphs, accompanying data, and the results of 6 the Merrill Lynch and CFRA methodologies expressed herein, significant decreases in the price of 7 Costco’s stock tended to immediately precede the option dates of alleged backdated grants and 8 following those dates the price of the Company’s stock tended to significantly increase. Overall, 9 post-option-date stock price movement was positive, pre-option-date stock price movement tended 10 to be negative, and post-option-date returns tended to exceed pre-option-date returns. 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 34 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 36 of 141 1 Option Grants Backdated to May 26, 1995 2 85. These options were granted to Sinegal, Brotman, DiCerchio, Maron, Zook, Galanti, 3 Portera, Lazarus, Jelinek, Loge, Moulton and Petterson. They were dated as of, and priced based on, 4 the date on which Costco’s stock reached the lowest closing price for the month. The 2-, 10- and 205 day increases in Costco’s stock price following the option date were 6.1%, 12.7% and 15.5%, with 6 the annualized increases being 1098%, 457.2% and 279%, respectively. 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 35 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 37 of 141 1 2 3 4 5 6 7 Option Grant Backdated to October 26, 1995 86. These options were granted to DiCerchio, Maron, Zook, Galanti, Portera, Lazarus, Jelinek, Loge, Moulton and Walker. They were dated as of, and priced based on, the date on which Costco’s stock reached the lowest closing price for the month. The 2-, 10- and 20-day increases in Costco’s stock price following the option date were 4.5%, 2.3% and 0%, respectively, with the annualized increases being 810%, 82.8% and 0%, respectively. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 36 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 38 of 141 1 Option Grant Backdated to April 10, 1996 2 87. These options were granted to DiCerchio, Maron, Zook, Galanti, Portera, Lazarus, 3 Jelinek, Loge, Moulton, Walker and Petterson. They were dated as of, and priced based on, the date 4 on which Costco’s stock reached the lowest closing price for the month and second lowest closing 5 price of the fiscal quarter. The 2-, 10- and 20-day increases in Costco’s stock price following the 6 option date were 6.4%, 7.9% and 5.7%, respectively, with the annualized increases being 1152%, 7 284.4% and 102.6%, respectively. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 37 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 39 of 141 1 Option Grant Backdated to April 2, 1997 2 88. These options were granted to Sinegal, Brotman, DiCerchio, Maron, Zook, Galanti, 3 Portera, Lazarus, Jelinek, Loge, Moulton, Petterson and Walker. They were dated as of, and priced 4 based on, the date on which Costco’s stock reached the lowest closing price for the month. The 2-, 5 10- and 20-day increases in Costco’s stock price following the option date were 8.8%, 6.5% and 6 7.4%, respectively, with the annualized increases being 1584%, 234% and 133.2%, respectively. 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 38 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 40 of 141 1 Option Grant Backdated to February 2, 1999 2 89. These options were granted to DiCerchio, Zook, Galanti, Portera, Lazarus, Jelinek, 3 Loge, Moulton, Walker and Petterson. They were dated as of, and priced based on, the date on 4 which Costco’s stock reached the lowest closing price for the month. The 2-, 10- and 20-day 5 increases in Costco’s stock price following the option date were 9.9%, 12.8% and 22.8%, 6 respectively, with the annualized increases being 1782%, 460.8% and 410.4%, respectively. 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 39 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 41 of 141 1 Option Grant Backdated to March 13, 2000 2 90. These options were granted to DiCerchio, Zook, Galanti, Portera, Moulton, Walker 3 and Petterson. Costco has admitted these options were approved two trading days after the 4 purported option date. These options were dated as of, and priced based on, the date on which 5 Costco’s stock reached the lowest closing price for the month. The 2-, 10- and 20-day increases in 6 Costco’s stock price following the option date were 15.8%, 24.3% and 26.2%, respectively, with the 7 annualized increases being 2844%, 874.8% and 471.6%, respectively. In comparison, public 8 investors who held Costco stock during fiscal 2000 lost 6.7%. 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 40 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 42 of 141 1 Option Grant Backdated to April 24, 2001 2 91. These options were granted to DiCerchio, Zook, Galanti, Portera, Moulton, Walker, 3 Petterson and Schutt. Costco has admitted these options were approved nine trading days after the 4 purported option date. These options were dated as of, and priced based on, the date on which 5 Costco’s stock reached the second lowest closing price for the month and fiscal quarter. The 2-, 106 and 20-day increases in Costco’s stock price following the option date were 1.5%, 1.4% and 10.5%, 7 respectively, with the annualized increases being 270%, 50.4% and 189%, respectively. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 41 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 43 of 141 1 Option Grant Backdated to April 2, 2002 2 92. These options were granted to DiCerchio, Zook, Galanti, Portera, Walker, Petterson 3 and Schutt. Costco has admitted these options were approved three trading days after the purported 4 option date.15 These options were dated as of, and priced based on, the date on which Costco’s stock 5 reached the lowest closing price for the month and third lowest closing price for the fiscal quarter. 6 The 2-, 10- and 20-day increases in Costco’s stock price following the option date were 1.8%, 10.9% 7 and 3.6%, respectively, with the annualized increases being 324%, 392.4% and 64.8%, respectively. 8 In comparison, public investors who held Costco’s stock during 2002 lost over 11%. 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 15 These options were based on discretionary (i.e., not scheduled) option grants, and the earliest disclosure of these options was September 30, 2002. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 42 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 44 of 141 1 Option Grant Backdated to April 1, 2003 2 93. These options were granted to Brotman, DiCerchio, Galanti, Lazarus, Moulton, 3 Portera, Petterson and Zook. Costco has admitted these options were approved nine trading days 4 after the purported option date.16 These options were dated as of, and priced based on, the date on 5 which Costco’s stock reached the lowest closing price for the month. The 2-, 10- and 20-day 6 increases in Costco’s stock price following the option date were 3.5%, 14% and 13.8%, respectively, 7 with the annualized increases being 630%, 504% and 248.4%, respectively. In comparison, public 8 investors who held Costco’s stock during 2003 lost .8%. 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 16 These options were based on discretionary (i.e., not scheduled) option grants, and the earliest disclosure of them was September 24, 2003. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 43 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 45 of 141 1 2 3 4 5 6 7 Option Grant Backdated to April 1, 2004 94. These options were granted to Brotman, DiCerchio, Sinegal, Galanti, Lazarus, Moulton, Portera, Petterson, Zook, Walker, Jelinek and Schutt.17 They were dated as of, and priced based on, the date on which Costco’s stock closed at the second lowest closing price for the month. The 2-, 10- and 20-day increases in Costco’s stock price following the option date were 2%, 2% and .4%, respectively, with the annualized increases being 360%, 72% and 7.2%, respectively. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 17 These options, with vesting periods beginning April 1, 2005, were based on discretionary (i.e., not scheduled) option grants and were not disclosed until April 14, 2004. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 44 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 46 of 141 1 95. A composite of the increase/decrease in Costco’s stock price in the 20 trading days 2 preceding and following all of the aforementioned alleged backdated option dates clearly 3 demonstrates defendants overwhelmingly approved and accepted options (i) dated at the lowest 4 closing price of Costco’s stock, (ii) precisely following significant decreases in Costco’s closing 5 stock prices, and (iii) immediately in advance of significant increases in Costco’s closing stock 6 prices. Backdating is a reasonable, if not the most reasonable and rational, explanation for such 7 improbable timing of option date selection. 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 96. The issuance and acceptance of options identified above violated Costco’s stock option plans as set forth at ¶¶59-62. Indeed, the options identified above were not dated with the date when they were granted. As alleged herein, these ultra vires acts also contradicted the CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 45 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 47 of 141 1 Company’s statements in SEC filings and other reports to Costco’s shareholders and violated federal 2 and state securities laws. The secret practice of backdating stock option grants to themselves and 3 their colleagues was in breach of defendants’ fiduciary duties, including their duties of good faith, 4 honesty and loyalty, owed to Costco and its shareholders. 5 97. The backdating, among other things, enabled defendants to (i) hide the fact that the 6 Company was paying higher compensation to executives and employees by awarding them more 7 valuable options on the grant date than represented; (ii) avoid recording the hidden compensation as 8 compensation expense; and (iii) thus conceal the Company’s true net income, shareholders’ equity 9 and tax obligations. Keeping the scheme secret also hid the injury to the Company which occurred 10 when executives and employees exercised the options and made capital contributions to Costco that 11 were less than they should have paid, had the options not been granted in-the-money or deeper in12 the-money than represented. 13 98. Defendants also reaped more than the personal financial benefits of “in-the-money” 14 stock options they secretly overvalued by millions of dollars. Upon exercise of the stock options and 15 sale of stock issued thereby, defendants not only obtained more cash than they otherwise would have 16 by virtue of the artificially deflated exercise price, they also benefitted because Costco’s stock traded 17 at prices propelled in part by the false financial statements defendants had caused the Company to 18 issue. Indeed, Costco’s stock price significantly increased in response to the Company’s reported 19 financial statements that overstated income, net income, and earnings per share (“EPS”) as a result of 20 the backdating. And Costco’s directors in particular profited handsomely from the backdating. 21 Those on the Board who received and approved backdated options, alone, cashed in options and 22 garnered proceeds from stock sales of over $300 million. Damages to the Company related to these 23 stock sales, although not equal to the amount of proceeds from the sales, nonetheless, are in the 24 millions of dollars. 25 99. It should be no wonder that, upon closing its two-year investigation into the 26 Company’s historical stock option granting practices, the U.S. Attorney’s Office for the Western CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 46 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 48 of 141 1 District of Washington (“USAO”) found “backdated stock options,” that executives “benefitted from 2 the backdated stock options,” and that “[a]s a result, Costco failed to properly account for the stock 3 options on its books and records, including on financial statements filed with the Securities and 4 Exchange Commission.” In justifying its decision not to pursue a criminal case, however, the USAO 5 cited not lack of culpability of defendants, but rather “actions taken” upon discovery of the 6 backdating, including the Company’s “full[] cooperat[ion]” with the federal investigation and that 7 Sinegal and Galanti “voluntarily chose to forego bonuses and stock option related benefits totaling in 8 excess of $1.2 million.” But the amount of the “bonuses” and additional compensation Sinegal and 9 Galanti forewent are small in comparison to the harm Costco suffered by defendants’ conduct. 10 100. The Company has reduced retained earnings by $116 million as a result of over $173 11 million unrecorded compensation expense. Costco has also paid out cash in the tens of millions of 12 dollars to employees and recorded tens of millions of dollars in administrative expense, due to 13 adverse U.S. and Canadian tax consequences from the recognition of employees receiving “in-the14 money” options. COSTCO’S FALSE AND MISLEADING PROXY STATEMENTS 15 16 101. One of the primary methods in which defendants concealed their breaches of 17 fiduciary duty arising out of the backdating was by making false statements and omitting material 18 facts in the Company’s proxy statements. In its proxy statements the Company (and numerous 19 defendants) repeatedly communicated to Costco’s shareholders that (i) stock option grants would be 20 determined pursuant to authorization of the shareholders and in accordance with Costco’s stock 21 option plans, (ii) the Company had been granting and would continue to grant incentive stock 22 options dated and priced based on fair market value on the date of the grant of the option, in 23 accordance with Costco’s stock option plans, (iii) stock options were being granted prudently and 24 consistent with the Company’s compensation policies to compensate management through future 25 growth in the Company’s market value (i.e., not by granting backdated “in-the-money” stock 26 options), so that option holders would benefit only when, and to the extent, the Company’s stock CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 47 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 49 of 141 1 price increased after the grant, and (iv) the Audit Committee had fulfilled its duties to help ensure 2 the adequacy of the Company’s internal controls, in recommending the inclusion of the Company’s 3 financial statements in its periodic SEC filings. The proxy statements also referenced options prices, 4 market prices on purported grant dates and grant dates (identifiable by expiration date or otherwise) 5 in stating the equity holdings of, and options grants to, officers and directors, but omitted that the 6 grants were backdated and therefore stock option compensation was artificially inflated and 7 underreported. 8 102. The statements in Costco’s proxy statements (many of which are identified below) 9 were materially false and misleading and omitted material information about the Company’s 10 improper stock option practices, as detailed herein. In truth, and as those who signed and approved 11 the Company’s proxy statements in bad faith knew or were negligent or deliberately reckless in not 12 knowing, stock options at Costco were (i) backdated in violation of the Company’s stock option 13 plans and state and federal laws, (ii) otherwise determined and granted in contravention of the vested 14 authority provided by shareholders and the stock option plans, and (iii) dated with dates prior to the 15 dates the awards were properly authorized, employees were entitled to receive the options, or the 16 option or price was known. Furthermore, those defendants who sat on the Audit Committee were in 17 fact circumventing the Company’s internal controls and withholding from Costco’s external auditors 18 their knowledge of backdating. 19 103. As former SEC Chairman Harvey L. Pitt stated: “What’s so terrible about backdating 20 options grants? For one thing, it likely renders a company’s proxy materials false and misleading. 21 Proxies typically indicate that options are granted at fair market value. But if the grant is backdated, 22 the options value isn’t fair – at least not from the vantage point of the company and its 23 shareholders.”18 24 25 26 18 Harvey Pitt, The Next Big Scandal, Forbes.com. May 26, 2006. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 48 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 50 of 141 1 104. By issuing false and misleading statements in Costco’s proxy statements, the 2 defendants identified below were able to: (i) increase the numbers of authorized shares of common 3 stock of Costco from which defendants could gain shares by exercise of their backdated stock 4 options; (ii) gain the ability to grant to themselves and others backdated stock options; and (iii) 5 obtain elected directorships enabling them to perpetuate the scheme. Were the truth disclosed, the 6 Company’s shareholders would not have reasonably followed defendants’ recommendations 7 concerning the proposals submitted for their approval in the Company’s proxy statements identified 8 below. 9 105. Costco relied upon the facts stated in the Company’s false and misleading proxy 10 statements to seek the shareholders’ vote for approval of the proposals identified herein. Thus, both 11 the Company and its shareholders relied on the following materially false proxy statements. 12 Proxy Statement Filed in Connection with the 1996 Annual Meeting 13 106. On or about December 12, 1995, Costco filed with the SEC its definitive proxy 14 statement for the 1996 annual meeting of shareholders (“1996 Proxy Statement” or “1996 Proxy”). 15 The 1996 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach and 16 James. The 1996 Proxy included a “Report of Compensation Committee” signed by Meisenbach 17 and James. 18 107. The 1996 Proxy Statement made numerous significant representations and omitted 19 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 20 option grants, how stock options were being granted, and how stock options would be granted in the 21 future. The 1996 Proxy Statement communicated that stock option grants were not being backdated 22 and would not be backdated in the future. In the Compensation Committee Report, under 23 “COMPENSATION PHILOSOPHY,” the 1996 Proxy stated stock options “align total compensation 24 for senior management with corporate performance,” were “performance-based components” and 25 were among compensation “intended to reinforce management’s commitment to enhancement of 26 profitability and stockholder value.” 1996 Proxy at 8. When identifying stock option grants, CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 49 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 51 of 141 1 including the backdated May 26, 1995 options, the 1996 Proxy stated the “exercise price for these 2 stock options equals the fair market value of the Common Stock on the date of grant.” Id. at 7. The 3 1996 Proxy made similar statements related to the granting of options and suggesting options were 4 accurately dated to be the grant date. The 1996 Proxy also materially understated the “potential 5 realizable value” of options held by Sinegal, Brotman, DiCerchio, Galanti and Portera, and 6 materially understated the “value of unexercised in-the-money options” they held, insofar as these 7 defendants and Portera held backdated options. See supra ¶62 (table identifying alleged backdated 8 options accepted by defendants and other insiders). 9 Proxy Statement Filed in Connection with the 1997 Annual Meeting 108. 10 On or about December 12, 1996, Costco filed with the SEC its definitive proxy 11 statement for the 1997 annual meeting of shareholders (“1997 Proxy Statement” or “1997 Proxy”). 12 The 1997 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach and 13 James. The 1997 Proxy included a “Report of Compensation Committee” signed by Meisenbach 14 and James. 109. 15 The 1997 Proxy Statement made numerous significant representations and omitted 16 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 17 option grants, how stock options were being granted, and how stock options would be granted in the 18 future. 19 (a) The 1997 Proxy Statement communicated that stock option grants were not 20 being backdated and would not be backdated in the future. In the Compensation Committee Report, 21 under “COMPENSATION PHILOSOPHY,” the 1997 Proxy stated stock options “align total 22 compensation for senior management with corporate performance,” were “performance-based 23 components” and were among compensation “intended to reinforce management’s commitment to 24 enhancement of profitability and stockholder value.” 1997 Proxy at 8. When identifying stock 25 option grants, including the backdated October 26, 1995 and April 10, 1996 options, the 1997 Proxy 26 stated the “exercise price for these stock options equals the fair market value of the Common Stock CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 50 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 52 of 141 1 on the date of grant.” 1997 Proxy at 7. The 1997 Proxy made similar statements related to the 2 granting of options and suggesting options were accurately dated to be the grant date. 3 (b) The 1997 Proxy also materially understated the “potential realizable value” of 4 options held by Sinegal, Brotman, DiCerchio, Galanti and Lazarus, and materially understated the 5 “value of unexercised in-the-money options” they held, insofar as these defendants and Lazarus held 6 backdated options. See supra ¶62 (table identifying alleged backdated options accepted by 7 defendants and other insiders). 8 (c) In recommending approval of an amendment to the 1993 Stock Option Plan to 9 double the maximum number of shares available for issuance under option grants, from 10,000,000 10 shares, to 20,000,000 shares, the 1997 Proxy stated (among other things) that more shares were 11 needed to effect the aforementioned purposes of the plan, and that the exercise price of stock options 12 under the 1993 Stock Option Plan “may not be less than 100% of the fair market value of 13 PriceCostco common stock on the date of grant of the option.” 1997 Proxy at 12. Supporting these 14 representations, the proposed 1993 Stock Option Plan was expressly referenced. The referenced 15 plan further served to represent that stock option exercise prices under the plan would be the fair 16 market value of the Company’s common stock on the date of grant. This was stated in sum and 17 substance throughout the plan’s provisions concerning stock option grant exercise prices. 18 110. The 1997 Proxy Statement representations were made in connection with and 19 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. 20 (a) The first proposal concerned “ELECTION OF DIRECTORS” – including 21 certain of the same directors who were backdating and/or receiving backdated stock options and 22 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 23 recommended that Costco’s shareholders “VOTE ‘FOR’” the election of each of the nominees. 24 1997 Proxy at Proxy Card. 25 (b) The second proposal was “INCREASE IN SHARES AVAILABLE FOR 26 ISSUANCE UNDER STOCK OPTION PLAN,” to double the number of shares of common stock CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 51 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 53 of 141 1 authorized for issuance under stock options from 10,000,000 shares, to 20,000,000 shares. Each 2 defendant then a director explicitly recommended Costco’s shareholders approve the amendment. 3 “THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR ADOPTION OF THIS 4 PROPOSAL.” 1997 Proxy at 12. 5 Proxy Statement Filed in Connection with the 1998 Annual Meeting 6 111. On or about December 18, 1997, Costco filed with the SEC its definitive proxy 7 statement for the 1998 annual meeting of shareholders (“1998 Proxy Statement” or “1998 Proxy”). 8 The 1998 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, James 9 and Ruckelshaus. The 1998 Proxy included a “Report of Compensation Committee” signed by 10 Meisenbach, Ruckelshaus and James. 112. 11 The 1998 Proxy Statement made numerous significant representations and omitted 12 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 13 option grants, how stock options were being granted, and how stock options would be granted in the 14 future. 15 (a) The 1998 Proxy Statement communicated that stock option grants were not 16 being backdated and would not be backdated in the future. In the Compensation Committee Report, 17 under “COMPENSATION PHILOSOPHY,” the 1998 Proxy stated stock options “align total 18 compensation for senior management with corporate performance,” were “performance based 19 components,” and were among compensation “intended to reinforce management’s commitment to 20 enhancement of profitability and stockholder value.” 1998 Proxy at 9. When identifying stock 21 option grants, including the backdated April 2, 1997 options, the 1998 Proxy stated the “exercise 22 price for these stock options equals the fair market value of the Common Stock on the date of grant.” 23 1998 Proxy at 8. The 1998 Proxy made similar statements related to the granting of options and 24 suggesting options were accurately dated to be the grant date. 25 (b) The 1998 Proxy also materially understated the “potential realizable value” of 26 options held by Sinegal, Brotman, DiCerchio, Galanti and Lazarus, and materially understated the CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 52 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 54 of 141 1 “value of unexercised in-the-money options” they held, insofar as these defendants and Lazarus held 2 backdated options. See supra ¶62 (table identifying alleged backdated options accepted by 3 defendants and other insiders). 4 (c) In recommending approval of amendments to the 1993 Stock Option Plan to 5 (among other things) “make clear” the definition of “‘employees’ who are eligible to receive stock 6 and/or options,” and to authorize the full Board to grant options to executives and officers, the 1998 7 Proxy stated that the exercise price of stock options under the 1993 Stock Option Plan “may not be 8 less than 100% of the fair market of PriceCostco common stock on the date of grant of the option.” 9 1998 Proxy at 12. Supporting these representations, the proposed 1993 Stock Option Plan was 10 expressly referenced. The referenced plan further served to represent that stock option exercise 11 prices under the plan would be the fair market value of the Company’s common stock on the date of 12 grant. This was stated in sum and substance throughout the plan’s provisions concerning stock 13 option grant exercise prices. 14 113. The 1998 Proxy Statement representations were made in connection with and 15 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. 16 (a) The first proposal concerned “ELECTION OF DIRECTORS” – including 17 certain of the same directors who were backdating and/or receiving backdated stock options and 18 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 19 recommended that Costco’s shareholders “VOTE ‘FOR’” the election of each of the nominees. 20 1997 Proxy at Proxy Card. 21 (b) The second proposal was “AMENDMENTS TO THE COMPANY’S STOCK 22 OPTION PLAN,” to (among other things) “make clear” the definition of “‘employees’ who are 23 eligible to receive stock and/or options,” and to authorize the full Board to grant options to 24 executives and officers. Each defendant then a director explicitly recommended Costco’s 25 shareholders approve the amendment: “THE BOARD OF DIRECTORS RECOMMENDS A VOTE 26 FOR ADOPTION OF THIS PROPOSAL.” 1998 Proxy at 14. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 53 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 55 of 141 1 Proxy Statement Filed in Connection with the 1999 Annual Meeting 2 114. On or about December 15, 1998, Costco filed with the SEC its definitive proxy 3 statement for the 1999 annual meeting of shareholders (“1999 Proxy Statement” or “1999 Proxy”). 4 The 1999 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, James 5 and Ruckelshaus. The 1999 Proxy included a “Report of Compensation Committee” signed by 6 Meisenbach, Ruckelshaus and James. 7 115. The 1999 Proxy Statement made numerous significant representations concerning 8 Costco’s stock option plans, for instance, relating to the purpose of stock option grants, how stock 9 options were being granted, and how stock options would be granted in the future. 10 (a) The 1999 Proxy Statement communicated that stock option grants were not 11 being backdated and would not be backdated in the future. In the Compensation Committee Report, 12 under “Compensation Philosophy,” the 1999 Proxy stated stock options “align total compensation 13 for senior management with corporate performance,” were “performance based components,” and 14 were among compensation “intended to reinforce management’s commitment to enhancement of 15 profitability and stockholder value.” 1999 Proxy at 8. When identifying stock option grants, the 16 1999 Proxy stated the “exercise price for these stock options equals the fair market value of the 17 Common Stock on the date of grant.” 1999 Proxy at 7. The 1999 Proxy made similar statements 18 related to the granting of options and suggesting options were accurately dated to be the grant date. 19 (b) The 1999 Proxy also materially understated the “potential realizable value” of 20 options held by Sinegal, Brotman, DiCerchio, Galanti and Lazarus, and materially understated the 21 “value of unexercised in-the-money options” they held, insofar as these defendants and Lazarus held 22 backdated options. See supra ¶62 (table identifying alleged backdated options accepted by 23 defendants and other insiders). 24 (c) In recommending approval of an amendment to the 1993 Stock Option Plan to 25 increase the maximum number of shares available for issuance under option grants, from 20,000,000 26 shares to 30,000,000 shares, the 1999 Proxy stated (among other things) that more shares were CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 54 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 56 of 141 1 needed to effect the aforementioned purposes of the plan, and that the exercise price of stock options 2 under the 1993 Stock Option Plan “may not be less than 100% of the fair market of PriceCostco 3 common stock on the date of grant of the option.” 1999 Proxy at 11. Supporting these 4 representations, the proposed 1993 Stock Option Plan was expressly referenced. The referenced 5 plan further served to represent that stock option exercise prices under the plan would be the fair 6 market value of the Company’s common stock on the date of grant. This was stated in sum and 7 substance throughout the plan’s provisions concerning stock option grant exercise prices. 8 116. The 1999 Proxy Statement representations were made in connection with and 9 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. (a) 10 The first proposal concerned “ELECTION OF DIRECTORS” – including 11 certain of the same directors who were backdating and/or receiving backdated stock options and 12 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 13 recommended that Costco’s shareholders “VOTE ‘FOR’” the election of each of the nominees. 14 1999 Proxy at Proxy Card. (b) 15 The second proposal was “INCREASE IN SHARES AVAILABLE FOR 16 ISSUANCE UNDER STOCK OPTION PLAN,” to increase the number of shares of common stock 17 authorized for issuance under stock options from 20,000,000 shares to 30,000,000 shares. Each 18 defendant then a director explicitly recommended Costco’s shareholders approve the amendment: 19 “THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR ADOPTION OF THIS 20 PROPOSAL.” 1999 Proxy at 11. 21 Proxy Statement Filed in Connection with the 2000 Annual Meeting 22 117. On or about December 13, 1999, Costco filed with the SEC its definitive proxy 23 statement for the 2000 annual meeting of shareholders (“2000 Proxy Statement” or “2000 Proxy”). 24 The 2000 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, James 25 and Ruckelshaus. The 2000 Proxy included a “Report of Compensation Committee” signed by 26 Meisenbach, Ruckelshaus and James. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 55 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 57 of 141 1 118. The 2000 Proxy Statement made numerous significant representations and omitted 2 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 3 option grants, how stock options were being granted, and how stock options would be granted in the 4 future. The 2000 Proxy Statement communicated that stock option grants were not being backdated 5 and would not be backdated in the future. In the Compensation Committee Report, under 6 “Compensation Philosophy,” the 2000 Proxy stated stock options “align total compensation for 7 senior management with corporate performance,” were “performance based components” and were 8 among compensation “intended to reinforce management’s commitment to enhancement of 9 profitability and shareholder value.” 2000 Proxy at 8. When identifying stock option grants, 10 including the backdated February 9, 1999 options, the 2000 Proxy stated the “exercise price for these 11 stock options equals the fair market value of the Common Stock on the date of grant.” 2000 Proxy 12 at 7. The 2000 Proxy made similar statements related to the granting of options and suggesting 13 options were accurately dated to be the grant date. 14 119. The 2000 Proxy also materially understated the “potential realizable value” of options 15 held by Sinegal, Brotman, DiCerchio, Galanti and Portera, and materially understated the “value of 16 unexercised in-the-money options” they held, insofar as these defendants and Portera held backdated 17 options. See supra ¶62 (table identifying alleged backdated options accepted by defendants and 18 other insiders). 19 120. The 2000 Proxy Statement representations were made in connection with and 20 essential to the first proposal Costco’s Board made to the Company’s shareholders for a vote. The 21 first proposal concerned “ELECTION OF DIRECTORS” – including certain of the same directors 22 who were backdating and/or receiving backdated stock options and making misrepresentations to the 23 Company’s shareholders. 24 Proxy Statement Filed in Connection with the 2001 Annual Meeting 25 121. On or about December 18, 2000, Costco filed with the SEC its definitive proxy 26 statement for the 2001 annual meeting of shareholders (“2001 Proxy Statement” or “2001 Proxy”). CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 56 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 58 of 141 1 The 2001 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, James 2 and Ruckelshaus. The 2001 Proxy included a “Report of Compensation Committee” signed by 3 Meisenbach, Ruckelshaus and James. The 2001 Proxy also included an “Report of the Audit 4 Committee” signed by Meisenbach. 5 122. The 2001 Proxy Statement made numerous significant representations and omitted 6 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 7 option grants, how stock options were being granted, and how stock options would be granted in the 8 future. The 2001 Proxy Statement communicated that stock option grants were not being backdated 9 and would not be backdated in the future. In the Compensation Committee Report, under 10 “Compensation Philosophy,” the 2001 Proxy stated stock options “align total compensation for 11 senior management with corporate performance,” were “performance-based components” and were 12 among compensation “intended to reinforce management’s commitment to enhancement of 13 profitability and shareholder value.” 2001 Proxy at 9. When identifying stock option grants, 14 including the backdated March 13, 2000 options, the 2001 Proxy stated the “exercise price for these 15 stock options equals the fair market value of the Common Stock on the date of grant.” 2001 Proxy 16 at 8. The 2001 Proxy made similar statements related to the granting of options and suggesting 17 options were accurately dated to be the grant date. 18 123. The 2001 Proxy Statement contained a “Report of the Audit Committee” made with 19 respect to the Company’s financial statements for the fiscal year ended September 3, 2000, which 20 included Costco’s 1998-2000 financial statements and selected financial data from the Company’s 21 1995-2000 financial statements (including income statement and balance sheet data, i.e., net income, 22 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 23 herein. The Audit Committee Charter, referenced in and attached to the 2001 Proxy, demonstrated 24 the Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 25 Company’s integrity of reported financial results, soundness of internal controls, adequacy of 26 disclosures, and compliance with laws and regulations. In the report Meisenbach represented he had CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 57 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 59 of 141 1 fulfilled his duty to help ensure the adequacy of the Company’s internal controls and endorsed the 2 integrity of Costco’s financial statements and internal controls and adequacy of disclosures. In so 3 doing, he stated (among other things) that he “recommend[s] to the Board of Directors that the 4 consolidated financial statements referred to above be included in the Company’s Annual Report on 5 Form 10-K for the fiscal year ended September 3, 2000.” 2001 Proxy at 6. 6 124. The 2001 Proxy Statement representations were made in connection with and 7 essential to the first proposal Costco’s Board made to the Company’s shareholders for a vote. The 8 first proposal concerned “ELECTION OF DIRECTORS” – including certain of the same directors 9 who were backdating and/or receiving backdated stock options and making misrepresentations to the 10 Company’s shareholders. Each defendant then a director explicitly recommended that Costco’s 11 shareholders “VOTE ‘FOR’” the election of each of the nominees. 2001 Proxy at Proxy Card. 12 Proxy Statement Filed in Connection with the 2002 Annual Meeting 125. 13 On or about December 12, 2001, Costco filed with the SEC its definitive proxy 14 statement for the 2002 annual meeting of shareholders (“2002 Proxy Statement” or “2002 Proxy”). 15 The 2002 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 16 James and Ruckelshaus. The 2002 Proxy included a “Report of Compensation Committee” signed 17 by Meisenbach, Ruckelshaus and James. The 2002 Proxy also included an “Report of the Audit 18 Committee” signed by Meisenbach and Munger. 19 126. The 2002 Proxy Statement made numerous significant representations and omitted 20 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 21 option grants, how stock options were being granted, and how stock options would be granted in the 22 future. 23 (a) The 2002 Proxy Statement communicated that stock option grants were not 24 being backdated and would not be backdated in the future. In the Compensation Committee Report, 25 under “Compensation Philosophy,” the 2002 Proxy communicated stock options “align total 26 compensation for senior management with corporate performance,” were “performance-based CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 58 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 60 of 141 1 components,” and were among compensation “intended to reinforce management’s commitment to 2 enhancement of profitability and shareholder value.” 2002 Proxy at 7-8. When identifying stock 3 option grants, including the backdated April 24, 2001 options, the 2002 Proxy stated the “exercise 4 price for these stock options equals the fair market value of the Common Stock on the date of grant.” 5 2002 Proxy at 6. The 2002 Proxy made similar statements related to the granting of options and 6 suggesting options were accurately dated to be the grant date. 7 (b) The 2002 Proxy also materially understated the “potential realizable value” of 8 options held by Sinegal, Brotman, DiCerchio, Galanti and Portera, and materially understated the 9 “value of unexercised in-the-money options” they held, insofar as these defendants and Portera held 10 backdated options. See supra ¶62 (table identifying alleged backdated options accepted by 11 defendants and other insiders). (c) 12 In recommending “APPROVAL OF THE 2002 STOCK INCENTIVE 13 PLAN,” the 2002 Proxy stated (among other things) that (i) “the exercise price of any option may 14 not be less than the fair market value of the shares subject to the option,” (ii) “no option will be 15 exercisable earlier than one year from the date of grant,” and (iii) the “term of any option granted 16 under the 2002 Plan may not exceed ten years.” 2002 Proxy at 12. Supporting these representations, 17 the proposed 2002 Stock Incentive Plan was expressly referenced and attached to the 2002 Proxy. 18 The referenced and attached plan further served to represent that stock option exercise prices under 19 the plan would be the fair market value of the Company’s common stock on the date of grant, and 20 that vesting and terms of options would be in accordance with the limits of the 2002 Stock Option 21 Plan. This was stated in sum and substance throughout the plan’s provisions. 22 127. The 2002 Proxy Statement contained a “Report of the Audit Committee” made with 23 respect to the Company’s financial statements for the fiscal year ended September 2, 2001, which 24 included Costco’s 1999-2001 financial statements and selected financial data from the Company’s 25 1996-2001 financial statements (including income statement and balance sheet data, i.e., net income, 26 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 59 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 61 of 141 1 herein. The Audit Committee Charter and references thereto in the 2002 Proxy, demonstrated the 2 Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 3 Company’s integrity of reported financial results, soundness of internal controls, adequacy of 4 disclosures, and compliance with laws and regulations. In the report Meisenbach and Munger 5 represented they had fulfilled their duties to help ensure the adequacy of the Company’s internal 6 controls and endorsed the integrity of Costco’s financial statements and internal controls and 7 adequacy of disclosures. In so doing, they stated (among other things) that “we recommend to the 8 Board of Directors that the consolidated financial statements referred to above be included in the 9 Company’s Annual Report on Form 10-K for the fiscal year ended September 2, 2001.” 2002 Proxy 10 at 10. 11 128. The 2002 Proxy Statement representations were made in connection with and 12 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. (a) 13 The first proposal concerned “ELECTION OF DIRECTORS” – including 14 certain of the same directors who were backdating and/or receiving backdated stock options and 15 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 16 recommended that Costco’s shareholders “VOTE ‘FOR’” the election of each of the nominees. 17 1999 Proxy at Proxy Card. (b) 18 The second proposal was for “APPROVAL OF THE 2002 STOCK 19 INCENTIVE PLAN.” Each defendant then a director explicitly recommended Costco’s 20 shareholders approve the amendment: “The Board of Directors unanimously recommends a vote 21 FOR the adoption of the 2002 Plan.” 2002 Proxy at 14. 22 Proxy Statement Filed in Connection with the 2003 Annual Meeting 23 129. On or about December 11, 2002, Costco filed with the SEC its definitive proxy 24 statement for the 2003 annual meeting of shareholders (“2003 Proxy Statement” or “2003 Proxy”). 25 The 2003 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 26 Carson, James and Ruckelshaus. The 2003 Proxy included a “Report of Compensation Committee” CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 60 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 62 of 141 1 signed by Munger, Carson, Ruckelshaus and James. The 2003 Proxy also included an “Report of the 2 Audit Committee” signed by James, Munger and Ruckelshaus. 3 130. The 2003 Proxy Statement made numerous significant representations and omitted 4 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 5 option grants, how stock options were being granted, and how stock options would be granted in the 6 future. The 2003 Proxy Statement communicated that stock option grants were not being backdated 7 and would not be backdated in the future. In the Compensation Committee Report, under 8 “Compensation Philosophy,” the 2003 Proxy communicated stock options “align total compensation 9 for senior management with corporate performance,” were “performance-based components” and 10 were among compensation “intended to reinforce management’s commitment to enhancement of 11 profitability and stockholder value.” 2003 Proxy at 8. When identifying stock option grants, 12 including the backdated April 2, 2002 options, the 2003 Proxy stated the “exercise price for these 13 stock options equals the fair market value of the Common Stock on the date of grant.” 2003 Proxy 14 at 7. The 2003 Proxy made similar statements related to the granting of options and suggesting 15 options were accurately dated to be the grant date. 16 131. The 2003 Proxy also materially understated the “potential realizable value” of options 17 held by Sinegal, Brotman, DiCerchio, Galanti, Portera and Lazarus, and materially understated the 18 “value of unexercised in-the-money options” they held, insofar as these defendants, Portera and 19 Lazarus held backdated options. See supra ¶62 (table identifying alleged backdated options 20 accepted by defendants and other insiders). 21 132. The 2003 Proxy Statement contained a “Report of the Audit Committee” made with 22 respect to the Company’s financial statements for the fiscal year ended September 1, 2002, which 23 included Costco’s 2000-2002 financial statements and selected financial data from the Company’s 24 1997-2002 financial statements (including income statement and balance sheet data, i.e., net income, 25 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 26 herein. The Audit Committee Charter and references thereto in the 2003 Proxy, demonstrated the CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 61 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 63 of 141 1 Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 2 Company’s integrity of reported financial results, soundness of internal controls, adequacy of 3 disclosures, and compliance with laws and regulations. In the report James, Munger and 4 Ruckelshaus represented they had fulfilled their duties to help ensure the adequacy of the 5 Company’s internal controls and endorsed the integrity of Costco’s financial statements and internal 6 controls and adequacy of disclosures. In so doing, they stated (among other things) that “we 7 recommend to the Board of Directors that the consolidated financial statements referred to above be 8 included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 1, 9 2002.” 2003 Proxy at 11. 10 133. The 2003 Proxy Statement representations were made in connection with and 11 essential to the first proposal Costco’s Board made to the Company’s shareholders for a vote. The 12 first proposal concerned “ELECTION OF DIRECTORS” – including certain of the same directors 13 who were backdating and/or receiving backdated stock options and making misrepresentations to the 14 Company’s shareholders. Each defendant then a director explicitly recommended that Costco’s 15 shareholders “VOTE ‘FOR’” the election of each of the nominees. 2003 Proxy at Proxy Card. 16 Proxy Statement Filed in Connection with the 2004 Annual Meeting 17 134. On or about December 18, 2003, Costco filed with the SEC its definitive proxy 18 statement for the 2004 annual meeting of shareholders (“2004 Proxy Statement” or “2004 Proxy”). 19 The 2004 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 20 Carson, James and Ruckelshaus. The 2004 Proxy included a “Report of Compensation Committee” 21 signed by Munger, Carson, Ruckelshaus and James. The 2004 Proxy also included an “Report of the 22 Audit Committee” signed by James, Munger and Ruckelshaus. 23 135. The 2004 Proxy Statement made numerous significant representations and omitted 24 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 25 option grants, how stock options were being granted, and how stock options would be granted in the 26 future. The 2004 Proxy Statement communicated that stock option grants were not being backdated CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 62 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 64 of 141 1 and would not be backdated in the future. In the Compensation Committee Report, under 2 “Compensation Philosophy,” the 2004 Proxy communicated stock options “align total compensation 3 for senior management with corporate performance,” were “performance-based components” and 4 were among compensation “intended to reinforce management’s commitment to enhancement of 5 profitability and shareholder value.” 2004 Proxy at 9. When identifying stock option grants, 6 including the backdated April 1, 2003 options, the 2004 Proxy stated the “exercise price for these 7 stock options equals the fair market value of the Common Stock on the date of grant.” 2004 Proxy 8 at 8. The 2004 Proxy made similar statements related to the granting of options and suggesting 9 options were accurately dated to be the grant date. 10 136. The 2004 Proxy also materially understated the “potential realizable value” of options 11 held by Sinegal, Brotman, DiCerchio, Galanti, Lazarus and Zook, and materially understated the 12 “value of unexercised in-the-money options” they held, insofar as these defendants, Lazarus and 13 Zook held backdated options. See supra ¶62 (table identifying alleged backdated options accepted 14 by defendants and other insiders). 15 137. The 2004 Proxy Statement contained a “Report of the Audit Committee” made with 16 respect to the Company’s financial statements for the fiscal year ended August 31, 2003, which 17 included Costco’s 2001-2003 financial statements and selected financial data from the Company’s 18 1998-2003 financial statements (including income statement and balance sheet data, i.e., net income, 19 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 20 herein. The Audit Committee Charter, referenced in and attached to the 2004 Proxy, demonstrated 21 the Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 22 Company’s integrity of reported financial results, soundness of internal controls, adequacy of 23 disclosures, and compliance with laws and regulations. In the report, James, Munger and 24 Ruckelshaus represented they had fulfilled their duties to help ensure the adequacy of the 25 Company’s internal controls and endorsed the integrity of Costco’s financial statements and internal 26 controls and adequacy of disclosures. In so doing, they stated (among other things) that “we CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 63 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 65 of 141 1 recommend to the Board of Directors that the consolidated financial statements referred to above be 2 included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003.” 3 2004 Proxy at 12. 4 138. The 2004 Proxy Statement representations were made in connection with and 5 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. 6 (a) The first proposal concerned “ELECTION OF DIRECTORS” – including 7 certain of the same directors who were backdating and/or receiving backdated stock options and 8 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 9 recommended that Costco’s shareholders “VOTE ‘FOR’” the election of each of the director 10 nominees. 2004 Proxy at Proxy Card. (b) 11 The second proposal was a “SHAREHOLDER PROPOSAL RELATING TO 12 ANNUAL ELECTIONS OF DIRECTORS,” to declassify the election of directors by requiring that 13 in the future all directors be elected annually rather than on a staggered basis. Each defendant then a 14 director explicitly recommended Costco’s shareholders “vote AGAINST” the proposal. 2004 Proxy 15 at 14. 16 Proxy Statement Filed in Connection with the 2005 Annual Meeting 139. 17 On or about December 20, 2004, Costco filed with the SEC its definitive proxy 18 statement for the 2005 annual meeting of shareholders (“2005 Proxy Statement” or “2005 Proxy”). 19 The 2005 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 20 Carson, James and Ruckelshaus. The 2005 Proxy included a “Report of Compensation Committee” 21 signed by Munger, Carson and James. The 2005 Proxy also included an “Report of the Audit 22 Committee” signed by James, Munger and Ruckelshaus. 23 140. The 2005 Proxy Statement made numerous significant representations and omitted 24 material facts concerning Costco’s stock option plans, for instance, relating to the purpose of stock 25 option grants, how stock options were being granted, and how stock options would be granted in the 26 future. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 64 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 66 of 141 1 (a) The 2005 Proxy Statement communicated that stock option grants were not 2 being backdated and would not be backdated in the future. In the Compensation Committee Report, 3 under “Compensation Philosophy,” the 2005 Proxy stated stock options “align total compensation 4 for senior management with corporate performance,” were “performance based components,” and 5 were among compensation “intended to reinforce management’s commitment to enhancement of 6 profitability and shareholder value.” 2005 Proxy at 9. When identifying stock option grants, 7 including the backdated April 1, 2004 options, the 2005 Proxy stated the “exercise price for these 8 stock options equals the fair market value of the Common Stock on the date of grant.” 2005 Proxy 9 at 8. The 2005 Proxy made similar statements related to the granting of options and suggesting 10 options were accurately dated to be the grant date. 11 (b) The 2005 Proxy also materially understated the “potential realizable value” of 12 options held by Sinegal, Brotman, DiCerchio, Jelinek, Lazarus and Zook, and materially understated 13 the “value of unexercised in-the-money options” they held, insofar as these defendants, Jelinek, 14 Lazarus and Zook held backdated options. See supra ¶62 (table identifying alleged backdated 15 options accepted by defendants and other insiders). 16 (c) In recommending approval of amendments to the 2002 Stock Option Plan to 17 increase the maximum number of shares available for award under the plan, from 30,000,000 shares 18 to 40,000,000 shares, the 2005 Proxy stated (among other things) that more shares were needed to 19 effect the aforementioned purposes of the plan, and that under the 2002 Stock Option Plan “[t]he 20 exercise price of any option may not be less than the fair market value of the shares subject to the 21 option on the date of grant” and the “term of any option granted under the Restated 2002 Plan may 22 not exceed ten years.” 2005 Proxy at 15. Supporting these representations, the 2002 Stock Option 23 Plan, as amended, was expressly referenced and attached to the 2005 Proxy. The referenced plan 24 further served to represent that stock option exercise prices under the plan would be the fair market 25 value of the Company’s common stock on the date of grant. This was stated in sum and substance 26 throughout the plan’s provisions concerning stock option grant exercise prices. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 65 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 67 of 141 1 141. The 2005 Proxy Statement contained a “Report of the Audit Committee” made with 2 respect to the Company’s financial statements for the fiscal year ended August 29, 2004, which 3 included Costco’s 2002-2004 financial statements and selected financial data from the Company’s 4 1999-2004 financial statements (including income statement and balance sheet data, i.e., net income, 5 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 6 herein. The Audit Committee Charter, referenced in and attached to the 2005 Proxy, demonstrated 7 the Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 8 Company’s integrity of reported financial results, soundness of internal controls, adequacy of 9 disclosures, and compliance with laws and regulations. In the report, James, Munger and 10 Ruckelshaus represented they had fulfilled their duties to help ensure the adequacy of the 11 Company’s internal controls and endorsed the integrity of Costco’s financial statements and internal 12 controls and adequacy of disclosures. In so doing, they stated (among other things) that “we 13 recommend to the Board of Directors that the consolidated financial statements referred to above be 14 included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 29, 2004.” 15 2005 Proxy at 12. 16 142. The 2005 Proxy Statement representations were made in connection with and 17 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. 18 (a) The first proposal concerned “ELECTION OF DIRECTORS” – including 19 certain of the same directors who were backdating and/or receiving backdated stock options and 20 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 21 recommended that Costco’s shareholders vote for the election of each of the nominees: “The Board 22 of Directors unanimously recommends a vote: FOR the nominees for director listed in these 23 materials and on the proxy.” 2005 Proxy at 1. 24 (b) The second proposal was “APPROVAL OF AMENDMENTS TO THE 2002 25 STOCK INCENTIVE PLAN,” to (among other things) increase the number of shares of common 26 stock authorized for issuance under the plan’s 30,000,000 shares, to 40,000,000 shares. Each CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 66 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 68 of 141 1 defendant then a director explicitly recommended Costco’s shareholders approve the amendment: 2 “The Board of Directors unanimously recommends a vote: FOR the amendment of the Company’s 3 2002 Stock Incentive Plan.” 2005 Proxy at 1. 4 Proxy Statement Filed in Connection with the 2006 Annual Meeting 5 143. On or about December 20, 2005, Costco filed with the SEC its definitive proxy 6 statement for the 2006 annual meeting of shareholders (“2006 Proxy Statement” or “2006 Proxy”). 7 The 2006 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 8 Carson, James and Ruckelshaus. The 2006 Proxy included a “Report of Compensation Committee” 9 signed by Munger, Carson and James. The 2006 Proxy also included an “Report of the Audit 10 Committee” signed by James, Munger and Ruckelshaus. 11 144. The 2006 Proxy Statement made numerous significant representations and omitted 12 material facts and omitted material facts concerning Costco’s stock option plans, for instance, 13 relating to the purpose of stock option grants, how stock options were being granted, and the 14 Company’s historical stock option granting practices. 15 (a) In the Compensation Committee Report, under “Compensation Philosophy,” 16 the 2006 Proxy stated stock options “align total compensation for senior management with corporate 17 performance and the interests of shareholders,” were “performance-based components,” and were 18 among compensation “intended to reinforce management’s commitment to enhancement of 19 profitability and shareholder value.” 2006 Proxy at 9-10. When identifying stock option grants, the 20 2006 Proxy stated the “exercise price for these stock options equals the fair market value of the 21 Common Stock on the date of grant.” 2006 Proxy at 8. The 2006 Proxy made similar statements 22 related to the granting of options and suggesting options were accurately dated to be the grant date. 23 (b) The 2006 Proxy also materially understated the “value of unexercised in-the- 24 money options” held by Sinegal, Brotman, DiCerchio, Galanti, Jelinek and Portera, insofar as these 25 defendants, Galanti, Jelinek and Portera held backdated options. See supra ¶62 (table identifying 26 alleged backdated options accepted by defendants and other insiders). CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 67 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 69 of 141 1 (c) In recommending approval of amendments to the amended and restated 2002 2 Stock Option Plan to increase the maximum number of shares available for award under the plan by 3 10,000,000 shares, the 2006 Proxy stated (among other things) that more shares were needed to 4 effect the aforementioned purposes of the plan, and that under the 2002 Stock Option Plan “[t]he 5 exercise price of any option may not be less than the fair market value of the shares subject to the 6 option on the date of grant” and the “term of any option granted under the Restated 2002 Plan may 7 not exceed ten years.” 2006 Proxy at 15. Supporting these representations, the 2002 Stock Option 8 Plan, as amended, was expressly referenced and attached to the 2006 Proxy. The referenced plan 9 further served to represent that stock option exercise prices under the plan would be the fair market 10 value of the Company’s common stock on the date of grant. This was stated in sum and substance 11 throughout the plan’s provisions concerning stock option grant exercise prices. 12 145. The 2006 Proxy Statement contained a “Report of the Audit Committee” made with 13 respect to the Company’s financial statements for the fiscal year ended August 28, 2005, which 14 included Costco’s 2003-2005 financial statements and selected financial data from the Company’s 15 2000-2005 financial statements (including income statement and balance sheet data, i.e., net income, 16 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 17 herein. References to the Audit Committee Charter in the 2006 Proxy demonstrated the Audit 18 Committee’s substantial oversight authority and responsibilities aimed at ensuring the Company’s 19 integrity of reported financial results, soundness of internal controls, adequacy of disclosures, and 20 compliance with laws and regulations. In the report, James, Munger and Ruckelshaus represented 21 they had fulfilled their duties to help ensure the adequacy of the Company’s internal controls and 22 endorsed the integrity of Costco’s financial statements and internal controls and adequacy of 23 disclosures. In so doing, they stated (among other things) that “we recommend to the Board of 24 Directors that the consolidated financial statements referred to above be included in the Company’s 25 Annual Report on Form 10-K for the fiscal year ended August 28, 2005.” 2006 Proxy at 12. 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 68 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 70 of 141 1 146. The 2006 Proxy Statement representations were made in connection with and 2 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. 3 (a) The first proposal concerned “ELECTION OF DIRECTORS” – including 4 certain of the same directors who were backdating and/or receiving backdated stock options and 5 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 6 recommended that Costco’s shareholders vote for the election of each of the nominees: “The Board 7 of Directors unanimously recommends a vote: FOR the nominees for director listed in these 8 materials and on the proxy.” 2006 Proxy at 1. 9 (b) The second proposal was “APPROVAL OF AMENDMENTS TO THE 10 AMENDED AND RESTATED 2002 STOCK INCENTIVE PLAN,” to (among other things) 11 increase the number of shares of common stock authorized for issuance by 10,000,000 shares. Each 12 defendant then a director explicitly recommended Costco’s shareholders approve the amendment: 13 “The Board of Directors unanimously recommends a vote: . . . FOR the amendments to the Restated 14 2002 Stock Incentive Plan.” 2006 Proxy at 1, 19. (c) 15 The third proposal was a “SHAREHOLDER PROPOSAL RELATING TO 16 ANNUAL ELECTIONS OF DIRECTORS,” to declassify the election of directors by requiring that 17 in the future all directors be elected annually rather than on a staggered basis. Each defendant then a 18 director explicitly recommended Costco’s shareholders “vote AGAINST” the proposal. 2006 Proxy 19 at 1, 19. 20 Proxy Statement Filed in Connection with the 2007 Annual Meeting 21 147. On or about December 20, 2006, Costco filed with the SEC its definitive proxy 22 statement for the 2007 annual meeting of shareholders (“2007 Proxy Statement” or “2007 Proxy”). 23 The 2007 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 24 Carson, James and Ruckelshaus. The 2007 Proxy included a “Report of Compensation Committee” 25 signed by Munger, Carson and James. The 2007 Proxy also included an “Report of the Audit 26 Committee” signed by James, Munger and Ruckelshaus. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 69 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 71 of 141 1 148. The 2007 Proxy Statement made numerous significant representations and omitted 2 material facts concerning Costco’s stock option plans, for instance, relating to the Company’s 3 historical stock option granting practices. In the Compensation Committee Report, under 4 “Compensation Philosophy,” the 2007 Proxy communicated stock options “align total compensation 5 for senior management with corporate performance and the interests of shareholders,” were 6 “performance-based components,” and were among compensation “intended to reinforce 7 management’s commitment to enhancement of profitability and shareholder value.” 2007 Proxy at 8 10. The Compensation Committee omitted that stock option values had been artificially and secretly 9 boosted by retrospective granting practices, e.g., backdating option grant dates to monthly and/or 10 quarterly lows in the Company’s stock price. Furthermore, in referencing the Company’s 11 “investigation” of historical stock option granting practices, the 2007 Proxy omitted that numerous 12 directors, including current and former members of the Compensation Committee, had backdated 13 stock options in contravention of the Company’s stock option plans. 14 149. The 2007 Proxy also materially understated the “value of unexercised in-the-money 15 options” (2007 Proxy at 9) held by Sinegal, Brotman, DiCerchio, Galanti, Portera and Jelinek, 16 insofar as these defendants, Portera and Jelinek held backdated options, including (but not limited to) 17 the backdated April 1, 2004 options. See supra ¶62 (table identifying alleged backdated options 18 accepted by defendants and other insiders). 19 150. The 2007 Proxy Statement contained a “Report of the Audit Committee” made with 20 respect to the Company’s financial statements for the fiscal year ended September 3, 2006, which 21 included Costco’s 2003-2006 financial statements and selected financial data from the Company’s 22 2001-2006 financial statements (including income statement and balance sheet data, i.e., net income, 23 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 24 herein. The Audit Committee Charter and references thereto in the 2007 Proxy, demonstrated the 25 Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 26 Company’s integrity of reported financial results, soundness of internal controls, adequacy of CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 70 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 72 of 141 1 disclosures, and compliance with laws and regulations. In the report James, Munger and 2 Ruckelshaus represented they had fulfilled their duties to help ensure the adequacy of the 3 Company’s internal controls and endorsed the integrity of Costco’s financial statements and internal 4 controls and adequacy of disclosures. In so doing, they stated (among other things) that “we 5 recommend to the Board of Directors that the consolidated financial statements referred to above be 6 included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 3, 7 2006.” 2007 Proxy at 13. 8 151. The 2007 Proxy Statement representations were made in connection with and 9 essential to the first proposal Costco’s Board made to the Company’s shareholders for a vote. The 10 first proposal concerned “ELECTION OF DIRECTORS” – including certain of the same directors 11 who were backdating and/or receiving backdated stock options and making misrepresentations to the 12 Company’s shareholders. Each defendant then a director explicitly recommended that Costco’s 13 shareholders vote for the election of each of the nominees: “The Board of Directors unanimously 14 recommends a vote: FOR the nominees for director listed in these materials and on the proxy.” 2007 15 Proxy at 1. 16 Proxy Statement Filed in Connection with the 2008 Annual Meeting 17 152. On or about December 18, 2007, Costco filed with the SEC its definitive proxy 18 statement for the 2008 annual meeting of shareholders (“2008 Proxy Statement” or “2008 Proxy”). 19 The 2008 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 20 Carson, James and Ruckelshaus. The 2008 Proxy included a “Report of Compensation Committee” 21 signed by Munger, Carson and James. The 2008 Proxy also included an “Report of the Audit 22 Committee” signed by James and Munger. 23 153. The 2008 Proxy Statement made numerous significant representations and omitted 24 material facts concerning Costco’s stock option plans, for instance, relating to the Company’s 25 historical stock option granting practices. The Compensation Committee’s report omitted that stock 26 option values had been artificially and secretly boosted by retrospective granting practices, e.g., CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 71 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 73 of 141 1 backdating option grant dates to monthly and/or quarterly lows in the Company’s stock price. The 2 2008 Proxy listed “Grants of Plan-Based Awards” and in so doing indicated that the approval date of 3 certain options was later than the purported option grant date, but omitted backdated options, such as 4 the April 1, 2004 options, and omitted the approval date was later than the option date due to 5 backdating. 2008 Proxy at 10. The 2008 Proxy also listed “Outstanding Equity Awards at Fiscal 6 Year End.” 2008 Proxy at 11. In so doing, the 2008 Proxy included, for example, the backdated 7 April 1, 2004 options, without disclosing those options were backdated. Instead the 2008 Proxy 8 represented “Option Grant Date[s]” that corresponded to the backdated option dates, again (as in 9 previous proxy statements) falsely indicating options were granted on those dates. Id. 10 154. The 2008 Proxy Statement contained a “Report of the Audit Committee” made with 11 respect to the Company’s financial statements for the fiscal year ended September 2, 2007, which 12 included Costco’s 2004-2007 financial statements and selected financial data from the Company’s 13 2002-2007 financial statements (including income statement and balance sheet data, i.e., net income, 14 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 15 herein. The Audit Committee Charter and references thereto in the 2008 Proxy, demonstrated the 16 Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 17 Company’s integrity of reported financial results, soundness of internal controls, adequacy of 18 disclosures, and compliance with laws and regulations. In the report James and Munger represented 19 they had fulfilled their duties to help ensure the adequacy of the Company’s internal controls and 20 endorsed the integrity of Costco’s financial statements and internal controls and adequacy of 21 disclosures. In so doing, they stated (among other things) that “we recommend to the Board of 22 Directors that the consolidated financial statements referred to above be included in the Company’s 23 Annual Report on Form 10-K for the fiscal year ended September 2, 2007.” 2008 Proxy at 18. 24 155. The 2008 Proxy Statement representations were made in connection with and 25 essential to a number of proposals Costco’s Board made to the Company’s shareholders for a vote. 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 72 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 74 of 141 1 (a) The first proposal concerned “ELECTION OF DIRECTORS” – including 2 certain of the same directors who were backdating and/or receiving backdated stock options and 3 making misrepresentations to the Company’s shareholders. Each defendant then a director explicitly 4 recommended that Costco’s shareholders vote for the election of each of the nominees: “The Board 5 of Directors unanimously recommends a vote: FOR the nominees for director listed in these 6 materials and on the proxy.” 2008 Proxy at 1. 7 (b) The second proposal was “APPROVAL OF AMENDMENTS TO THE 2002 8 STOCK INCENTIVE PLAN,” to (among other things) increase the number of shares of common 9 stock authorized for issuance by 8,000,000 shares. Each defendant then a director explicitly 10 recommended Costco’s shareholders approve the amendment: “The Board of Directors unanimously 11 recommends a vote: . . . FOR an amendment to the Second Restated 2002 Stock Incentive Plan.” 12 2008 Proxy at 1, 26. 13 Proxy Statement Filed in Connection with the 2009 Annual Meeting 14 156. On or about December 18, 2008, Costco filed with the SEC its definitive proxy 15 statement for the 2009 annual meeting of shareholders (“2009 Proxy Statement” or “2009 Proxy”). 16 The 2009 Proxy Statement was reviewed and approved by Brotman, Sinegal, Meisenbach, Munger, 17 Carson, James and Ruckelshaus. The 2009 Proxy included a “Report of Compensation Committee” 18 signed by Munger, Carson and James. The 2009 Proxy also included an “Report of the Audit 19 Committee” signed by James and Munger. 20 157. The 2009 Proxy Statement made numerous significant representations and omitted 21 material facts concerning Costco’s stock option plans, for instance, relating to the Company’s 22 historical stock option granting practices. The Compensation Committee’s report omitted that stock 23 option values had been artificially and secretly boosted by retrospective granting practices, e.g., 24 backdating option grant dates to monthly and/or quarterly lows in the Company’s stock price. The 25 2009 Proxy also listed “Outstanding Equity Awards at Fiscal Year-End.” 2009 Proxy at 11. In so 26 doing, the 2009 Proxy included, for example, the backdated April 1, 2004 options, without CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 73 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 75 of 141 1 disclosing those options were backdated. Instead the 2009 Proxy represented “Option Grant 2 Date[s]” that corresponded to the backdated option dates, again (as in previous proxy statements) 3 falsely indicating options were granted on those dates. Id. 4 158. The 2009 Proxy Statement contained a “Report of the Audit Committee” made with 5 respect to the Company’s financial statements for the fiscal year ended August 31, 2008, which 6 included Costco’s 2005-2008 financial statements and selected financial data from the Company’s 7 2003-2008 financial statements (including income statement and balance sheet data, i.e., net income, 8 net income per share and shareholders’ equity), all of which were falsified by the backdating alleged 9 herein. The Audit Committee Charter and references thereto in the 2009 Proxy, demonstrated the 10 Audit Committee’s substantial oversight authority and responsibilities aimed at ensuring the 11 Company’s integrity of reported financial results, soundness of internal controls, adequacy of 12 disclosures, and compliance with laws and regulations. In the report James and Munger represented 13 they had fulfilled their duties to help ensure the adequacy of the Company’s internal controls and 14 endorsed the integrity of Costco’s financial statements and internal controls and adequacy of 15 disclosures. In so doing, they stated (among other things) that “we recommend to the Board of 16 Directors that the consolidated financial statements referred to above be included in the Company’s 17 Annual Report on Form 10-K for the fiscal year ended August 31, 2008.” 2009 Proxy at 19. 18 False and Misleading Forms 3, 4 and 5 19 159. Costco, with the knowledge, approval and participation of each of the defendants, 20 filed with the SEC Forms 3, 4 or 5 that falsely reported the dates of Costco stock option grants to the 21 defendants and others, for each of the option grants referenced in ¶62 (table), supra. Those forms 22 incorrectly stated the grant date of the options in the transaction date column for the derivative 23 securities section of the forms. BACKDATING COSTCO’S STOCK OPTIONS FALSIFIED THE COMPANY’S FINANCIAL STATEMENTS 24 25 160. Backdating Costco’s stock options materially falsified the Company’s financial 26 statements by causing the understatement of compensation expense, the overstatement of earnings CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 74 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 76 of 141 1 and the overstatement of shareholders’ equity, among other things. For over a decade, defendants 2 caused and/or allowed the Company to understate its compensation expense by not properly 3 accounting for its stock options under GAAP and thus overstated the Company’s net earnings. 4 161. Pursuant to Accounting Principles Board Opinion (“APB”) No. 25, the applicable 5 GAAP provision at the time of the options grants set forth herein, an option that is in-the-money on 6 the measurement date has intrinsic value, and the difference between its exercise price and the 7 quoted market price must be recorded as compensation expense to be recognized over the vesting 8 period of the option. If the stock’s market price on the date of grant exceeds the exercise price of the 9 options, the corporation must recognize the difference as an expense, which directly impacts 10 earnings. It is well known that “in-the-money” stock options must be recorded as an expense. But 11 backdated stock options cause a company to not properly expense its option grants because the 12 actual grant date escapes detection. Similarly, under Statement of Financial Accounting Standards 13 No. 123 (“SFAS No. 123”) share-based compensation expense was determined by fair value of the 14 options on the grant date, and therefore options backdated to be “in-the-money” also hid 15 compensation expense. Thus, Costco did not properly expense its backdated options and this was 16 with full knowledge of the defendants who engaged in the backdating and/or received backdated 17 options. 18 162. Although defendants received lucrative “in-the-money” options that were reported as 19 market value options, they and Costco did not disclose this to shareholders or, worse, did not report 20 the compensation expense (and reduced earnings) incurred by the Company as a result of those 21 backdated options. The unreported compensation expense during 1995 to 2005, to which the 22 Company has admitted thus far, alone, totals nearly $175 million: 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 75 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 77 of 141 1 2 Fiscal Year Unreported Compensation Expense 3 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 TOTAL $12,000 $1,540,000 $7,769,000 $28,752,000 $49,521,000 $34,973,000 $22,016,000 $13,386,000 $9,572,000 $5,853,000 $173,394,000 4 5 6 7 8 9 163. The unreported compensation expense above infected Costco’s financial statements, 10 for it caused (among other falsifications) understatement of compensation expense and associated 11 tax liabilities and overstatement of earnings and shareholder equity accounts. The backdated options 12 falsified the Company’s financial statements and periodic reports, not only during the quarterly and 13 annual periods in which they were granted, but also as the options vested and were exercised in the 14 following years. Generally, the stock options at issue in this case vested 20% per year over five 15 years, which means unreported compensation expense for backdated options falsely inflated 16 Costco’s earnings for six fiscal years after the option date. 17 164. Nor did defendants and Costco properly report defendants’ compensation to the 18 Internal Revenue Service (“IRS”) or Canadian tax authorities. For years, defendants caused the 19 Company and rank-and-file employees to violate IRS and Canadian tax authority rules and 20 regulations as a result of backdated stock options. Costco has paid out over $100 million for U.S. 21 and Canadian employee tax liabilities caused by the backdating. Furthermore, Internal Revenue 22 Code §162(m) generally limits a publicly traded company’s tax deductions for compensation paid to 23 each of its named executive officers to $1 million unless the pay is determined to be “performance24 based.” In order for compensation to be performance-based, the compensation committee must have 25 set pre-established and objective performance goals. The goals must then be approved by the 26 shareholders. Section 162(m) defines stock options as performance-based provided they are issued CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 76 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 78 of 141 1 at an exercise price that is no less than the fair market value of the stock on the date of the grant. 2 According to former SEC Chairman Harvey Pitt: “What [162(m)] did was create incentives to find 3 other forms of compensation so people could get over the $1 million threshold without running afoul 4 of the code.”19 Stock options Costco purportedly issued were not taken into account in calculating 5 whether the compensation of certain executives exceeded the $1 million compensation cap when 6 they should have been, because they were backdated to be “in-the-money.” 7 165. Additionally, defendants failed to ensure that the Company maintained a system of 8 internal accounting controls sufficient to provide assurances that stock option grants were recorded 9 as necessary to permit the proper preparation of financial statements in conformity with GAAP, 10 including APB No. 25, SFAS Nos. 123 and 123R and SEC rules and regulations. As stated by 11 Harvey Pitt, former Chairman of the SEC: Options backdating calls a company’s internal controls into question. Many discussions of backdating start with the observation that backdating is not, per se, illegal. That is wrong. Options backdating frequently involves falsification of records used to gain access to corporate assets. . . . If corporate directors were complicit in these efforts, state law fiduciary obligations are violated. Backdating is not only illegal and unethical, it points to a lack of integrity in a company’s internal controls. 12 13 14 15 16 Harvey Pitt, Lessons of the Stock Option Scandal, Fin. Times, June 2, 2006, at 15. Through their 17 fiduciary duties of good faith and loyalty, defendants owed to Costco a duty to ensure that the 18 Company’s financial reporting fairly presented, in all material respects, the operations and financial 19 condition of the Company. In order to adequately carry out these duties, it is necessary for the 20 defendants to know and understand the material non-public information to be either disclosed or 21 omitted from the Company’s public statements. This material non-public information included the 22 problems the Company faced because of its deficient internal controls. 23 24 25 26 19 Brian Graw & Eaman Javers, Executive Pay Practices Under Scrutiny, Bus. Wk., Sept. 5, 2006. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 77 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 79 of 141 1 Audit Committee Members Who Engaged in Backdating Options Turned a Blind Eye to Internal Control Failures and Inadequate Disclosures 2 166. The conduct of certain members of the Board was particularly egregious because of 3 their special obligations as members of Costco’s Audit Committee. Not only did Meisenbach, 4 James, Munger and Ruckelshaus approve backdated option grants in violation of the Company’s 5 stock option plans, they also turned a blind eye to their explicit obligations (as members of the Audit 6 Committee) to report to Costco’s external auditors the internal control failures caused by that 7 conduct and the conduct of their fellow directors in backdating options. Nonetheless, Meisenbach, 8 James, Munger and Ruckelshaus reported no audit failures and recommended that the Company’s 9 financial statements be included in its SEC filings year after year. 10 167. As members of the Audit Committee, Meisenbach, James, Munger and Ruckelshaus 11 had the highest obligation to inform Costco’s external auditors of the backdating deception. Despite 12 possessing knowledge that they and fellow members of the Board had approved millions of 13 backdated option grants, they turned a blind eye to the backdating when performing their duties and 14 their Audit Committee duties in particular. 15 168. The Audit Committee Charters set forth extensive responsibilities, including 16 reviewing with the Company’s independent accountants the adequacy and effectiveness of the 17 accounting and financial controls of the corporation, the plan and results of the annual audit, and 18 material events or transactions and the reasoning for the appropriateness of accounting principles and 19 financial disclosure practices used or proposed to be adopted by the Company. For example, as 20 reported to shareholders in the Audit Committee’s Charter, Meisenbach, James, Munger and 21 Ruckelshaus had the authority and responsibility to, among other things: (i) monitor the integrity of 22 the Company’s financial statements, reports and other financial information provided by Costco to 23 any governmental body or the public; (ii) monitor the reliability and integrity of the Company’s 24 auditing, accounting, and financial and operating reporting; (iii) monitor the independence and 25 performance of the Company’s outside and internal auditors; (iv) monitor the Company’s 26 compliance with legal and regulatory requirements; (v) review the adequacy of and compliance with CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 78 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 80 of 141 1 the Company’s financial policies and procedures and systems of internal accounting controls; and 2 (vi) discuss with the auditors matters relevant to the audit, including suspicion or detection of fraud 3 or concerns about the integrity of management or the Company’s financial reporting. See Audit 4 Committee Charter (as of March 9, 2000 and revised 2003). In so doing, the Audit Committee was 5 empowered and authorized to conduct inquiries into any matters within the committee’s scope of 6 responsibility and obtain advice and assistance from internal or outside counsel or other advisors. 7 See id. 8 169. Indeed, the members of the Audit Committee were charged with the Board’s fiduciary 9 responsibility to ensure the integrity of the Company’s reported financial results and internal control 10 systems. Nonetheless, during Meisenbach’s meetings and communications with the Company’s 11 auditors from 1995 to October 15, 2002, during James’ meetings and communications with the 12 Company’s auditors from October 15, 2002 onward, during Munger’s meetings and communications 13 with the Company’s auditors from 2002 onward, and during Ruckelshaus’ meetings and 14 communications with the Company’s auditors from 2001 to 2007, Meisenbach, James, Munger and 15 Ruckelshaus, respectively, withheld from the Company’s auditors: (i) intentional breaches of the 16 Company’s internal controls, namely the backdating of stock options; (ii) material inflation of the 17 Company’s reported financial results due to the false underreporting of compensation expense; and 18 (iii) the resulting irregularities of the Company’s deceptive stock option granting practices and false 19 financial reporting that would require a restatement of (or charges to) the Company’s financial 20 statements and/or the withdrawal or modification of audit opinions certifying the Company’s 21 financial reports. 22 False Financial Statements 23 170. Specifically, since fiscal 1996, Costco has reported false and misleading fiscal annual 24 and quarterly financial results which materially understated its compensation expenses and thus 25 overstated the Company’s earnings as follows: 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 79 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 81 of 141 Summary of Reported EPS 1 2 3 4 5 6 7 8 9 10 171. Fiscal Year EPS Basic 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 $0.64 $0.76 $1.07 $0.90 $1.41 $1.34 $1.54 $1.58 $1.92 $2.24 Unreported Compensation Expense $12,000 $1,540,000 $7,769,000 $28,752,000 $49,521,000 $34,973,000 $22,016,000 $13,386,000 $9,572,000 $5,853,000 Revised EPS Basic EPS Inflation $0.62 $0.75 $1.05 $0.86 $1.34 $1.29 $1.51 $1.56 $1.91 $2.23 $0.02 $0.01 $0.02 $0.04 $0.07 $0.05 $0.03 $0.02 $0.01 $0.01 Unreported compensation expense directly affected Costco’s bottom line net income, 11 dollar for dollar. The table above illustrates the significant effect Costco’s unreported compensation 12 expense had upon the Company’s reported EPS. That Costco’s annual EPS was overstated by one to 13 seven cents per share is material. Indeed, historically it has not been unusual for Costco’s stock 14 price to plummet in response to an earnings miss of just one cent. For example, in third quarter 15 fiscal 2000 (the year in which Costco’s EPS was overstated by seven cents per share) the Company 16 reported earnings one penny short of analyst consensus estimates and, as reported by Dow Jones, 17 Costco’s stock price “plunged,” falling over 20%. 18 172. Since fiscal 1996, Costco has also reported false and misleading financial statements 19 that materially understated the weighted average fair value per share at date of grant for options 20 granted during the fiscal years as follows: 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 80 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 82 of 141 1 2 Fiscal Year 3 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 4 5 6 7 8 Weighted-average fair value per option granted20 $3.73 $5.74 $9.86 $15.50 $20.35 $15.47 $17.83 $14.84 $16.01 $18.01 $13.87 9 173. The effect of the backdating and the backdating itself is, and always has been, 10 material to Costco’s financial statements and should have been reported long ago. Relevant 11 guidance on whether accounting items are material is found in the Supreme Court’s ruling in TSC 12 Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976), and in SEC Staff Accounting Bulletin No. 99 13 (“SAB 99”), released August 12, 1999. The Court ruled in TSC that a fact is material to investors if 14 there is “a substantial likelihood that the . . . fact would have been viewed by the reasonable investor 15 as having significantly altered the ‘total mix’ of information made available.” 426 U.S. at 449. SAB 16 99 explains that both “quantitative” and “qualitative” factors help determine an item’s materiality, 17 rather than purely quantitative factors alone. Qualitative factors that can make a misstated fact 18 material include, among others: 19 (a) whether the misstatement has the effect of increasing management’s 20 compensation – for example, by satisfying requirements for the award of bonuses or other forms of 21 incentive compensation; 22 (b) whether the misstatement arises from an item “capable of precise 23 measurement”; 24 25 26 20 Adjusted for January 13,2000 2:1 stock split. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 81 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 83 of 141 1 (c) whether the misstatement masks a change in earnings; 2 (d) whether the misstatement concerns a segment or other portion of the 3 registrant’s business that has been identified as playing a significant role in the registrant’s 4 operations or profitability; and 5 (e) whether the misstatement affects the registrant’s compliance with regulatory 6 requirements. 7 174. The backdating in this case and its effect is material under both a qualitative and a 8 quantitative analysis. First, there is a substantial likelihood that the reasonable investor would 9 consider that facts about backdating significantly alter the total mix of information about Costco. 10 That is because, among other things, improper backdating of stock options reflects the degree to 11 which the Company’s insiders promote their own interests ahead of the Company’s. The SEC has 12 stated that the integrity of a company’s management “is always a material factor.” Second, the 13 improper backdating increased management’s and directors’ compensation, and reduced 14 requirements for those insiders to gain bonuses and incentive compensation. Third, the correct dates 15 of option grants and the correct closing prices for stock on those dates can be precisely recorded and 16 measured. Fourth, the improper backdating of stock options masked the Company’s true net income, 17 which should have been reported as lower, due to greater compensation expenses. Fifth, the 18 improper backdating affects the incentives for management and directors to improve the Company’s 19 operations and profitability. Sixth, the improper backdating of stock options violates financial20 reporting requirements of public companies and violates tax laws related to compensation expenses. 21 Further, the backdating here was intentional conduct and therefore, by its nature, was material. 22 175. Although any of the above qualitative factors would have identified the defendants’ 23 stock option backdating as “material,” the backdating also was material under quantitative criteria. 24 Backdating contributed to the defendants’ ability to sell tens of millions of dollars worth of the 25 Company’s stock while in possession of material, non-public adverse information about the 26 backdating practices. Therefore, the defendants’ only appropriate response would be to properly CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 82 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 84 of 141 1 correct the errors for each of the periods affected by the backdating scheme and thus provide the 2 shareholders and the investing public the transparency they deserve. 3 176. In addition, under current accounting rules, a financial misstatement that appears 4 immaterial as to a single reporting period may have a cumulative material impact on other periods. 5 In such a situation, the misstatement must be disclosed, according to SEC Staff Accounting Bulletin 6 No. 108 (“SAB 108”). This principle, which is reflected in SAB 108, has always been recognized in 7 the financial accounting concept of materiality. For over ten years Costco understated compensation 8 expense and overstated its earnings as a result of stock option backdating. The conduct and its effect 9 in these individual years from fiscal 1997 onward was material in and of itself. Cumulatively, the 10 financial statement effect is even more significant. 11 177. Costco’s materially false and misleading financial statements were included in 12 periodic reports filed with the SEC. The results were also included in press releases issued by the 13 Company. 14 Costco’s Materially False and Misleading Reports on Form 10-K 15 178. Costco’s Reports on Form 10-K filed from 1996 through 2007 contained false and 16 misleading financial statements and other statements understating compensation expense, overstating 17 shareholders’ equity, and overstating income (or understating loss), net income (or net loss) and 18 earnings (or loss) per share. The notes to the Company’s financial statements falsely communicated 19 that stock options were being granted in accordance with Costco’s stock option plans, namely by 20 pricing options based on the Company’s stock price on the date of the grant. And they falsely stated 21 the weighted average fair value per share at date of grant for Costco’s options, as well as 22 compensation cost. The notes to the Company’s financial statements further materially overstated 23 pro forma net earnings and EPS (or understated pro forma net loss and loss per share) as if 24 compensation cost for the Company’s stock-based compensation plans had been determined based 25 on the estimated fair value of the options at the grant dates. These Reports on Form 10-K were false 26 and misleading because (among other things) defendants were backdating and mispricing stock CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 83 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 85 of 141 1 options. As those who engaged in the backdating and/or received backdated options knew or in bad 2 faith or with deliberate recklessness disregarded, many purportedly at-market option grants were 3 backdated and retroactively priced to be “in-the-money.” 4 The Fiscal 1996 Report on Form 10-K 5 179. On or about November 8, 1996, the Company filed with the SEC its Report on Form 6 10-K for the fiscal year ended September 1, 1996 (the “1996 10-K”). The 1996 10-K was 7 simultaneously distributed to shareholders and the public. The 1996 10-K included Costco’s 19948 1996 financial statements and selected financial data from the Company’s 1992-1996 financial 9 statements (including income statement and balance sheet data, i.e., net income, net income per share 10 and shareholders’ equity), which were materially false and misleading and presented in violation of 11 GAAP, due to improper accounting for the backdated stock options. Because stock options 12 identified herein were backdated to be “in-the-money,” the option grants constituted significant 13 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 14 understated and its income, net income and shareholders’ equity were overstated. 15 180. The 1996 10-K was signed by defendants Sinegal, Brotman, DiCerchio, Galanti, 16 Petterson, James, Meisenbach and Ruckelshaus. 17 The Fiscal 1997 Report on Form 10-K 18 181. On or about November 10, 1997, the Company filed with the SEC its Report on Form 19 10-K for the fiscal year ended August 31, 1997 (the “1997 10-K”). The 1997 10-K was 20 simultaneously distributed to shareholders and the public. The 1997 10-K included Costco’s 199521 1997 financial statements and selected financial data from the Company’s 1993-1997 financial 22 statements (including income statement and balance sheet data, i.e., net income, net income per share 23 and shareholders’ equity), which were materially false and misleading and presented in violation of 24 GAAP, due to improper accounting for the backdated stock options. Because stock options 25 identified herein were backdated to be “in-the-money,” the option grants constituted significant 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 84 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 86 of 141 1 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 2 understated and its income, net income and shareholders’ equity were overstated. 3 182. The 1997 10-K also falsely communicated that option grants were not granted at less 4 than market value at the date of grant and falsely rationalized the lack of recorded compensation 5 expense, stating under “Accounting Principles Board Opinion No. 25 . . . . no compensation cost has 6 been recognized for the plans.” 1997 10-K at 36. The 1997 10-K also materially understated the 7 weighted average fair value of options granted. Because options had been backdated to be “in-the8 money,” the value of those options was understated, and so too was the weighted average fair value 9 of those options. Similarly, “[p]ro forma” net income and EPS purportedly reported under SFAS 10 No. 123 were materially overstated because the fair value of options granted and related 11 compensation costs were understated. Id. 12 183. The 1997 10-K was signed by defendants Sinegal, Brotman, DiCerchio, Galanti, 13 Petterson, James, Munger, Meisenbach and Ruckelshaus. 14 The Fiscal 1998 Report on Form 10-K 15 184. On or about November 25, 1998, the Company filed with the SEC its Report on Form 16 10-K for the fiscal year ended August 30, 1998 (the “1998 10-K”). The 1998 10-K was 17 simultaneously distributed to shareholders and the public. The 1998 10-K included Costco’s 199618 1998 financial statements and selected financial data from the Company’s 1994-1998 financial 19 statements (including income statement and balance sheet data, i.e., net income, net income per share 20 and shareholders’ equity), which were materially false and misleading and presented in violation of 21 GAAP, due to improper accounting for the backdated stock options. Because stock options 22 identified herein were backdated to be “in-the-money,” the option grants constituted significant 23 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 24 understated and its income, net income and shareholders’ equity were overstated. 25 185. The 1998 10-K also falsely communicated that option grants were not granted at less 26 than market value at the date of grant and falsely rationalized the lack of recorded compensation CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 85 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 87 of 141 1 expense, stating under “Accounting Principles Board Opinion No. 25 . . . . no compensation cost has 2 been recognized for the plans.” 1998 10-K at 35. The 1998 10-K also materially understated the 3 weighted average fair value of options granted. Because options had been backdated to be “in-the4 money,” the value of those options was understated, and so too was the weighted average fair value 5 of those options. Similarly, “[p]ro forma” net income and EPS purportedly reported under SFAS 6 No. 123 were materially overstated because the fair value of options granted and related 7 compensation costs were understated. Id. 8 186. The 1998 10-K was signed by defendants Sinegal, Brotman, DiCerchio, Galanti, 9 Petterson, James, Munger, Meisenbach and Ruckelshaus. 10 The Fiscal 1999 Report on Form 10-K 11 187. On or about November 24, 1999, the Company filed with the SEC its Report on Form 12 10-K for the fiscal year ended August 29, 1999 (the “1999 10-K”). The 1999 10-K was 13 simultaneously distributed to shareholders and the public. The 1999 10-K included Costco’s 199714 1999 financial statements and selected financial data from the Company’s 1995-1999 financial 15 statements (including income statement and balance sheet data, i.e., net income, net income per share 16 and shareholders’ equity), which were materially false and misleading and presented in violation of 17 GAAP, due to improper accounting for the backdated stock options. Because stock options 18 identified herein were backdated to be “in-the-money,” the option grants constituted significant 19 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 20 understated and its income, net income and shareholders’ equity were overstated. 21 188. The 1999 10-K also falsely communicated that option grants were not granted at less 22 than market value at the date of grant and falsely rationalized the lack of recorded compensation 23 expense, stating under “Accounting Principles Board Opinion No. 25 . . . . no compensation cost has 24 been recognized for the plans.” 1999 10-K at 35. The 1999 10-K also materially understated the 25 weighted average fair value of options granted. Because options had been backdated to be “in-the26 money,” the value of those options was understated, and so too was the weighted average fair value CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 86 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 88 of 141 1 of those options. Similarly, “[p]ro forma” net income and EPS purportedly reported under SFAS 2 No. 123 were materially overstated because the fair value of options granted and related 3 compensation costs were understated. Id. 4 189. The 1999 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 5 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 6 The Fiscal 2000 Report on Form 10-K 7 190. On or about November 17, 2000, the Company filed with the SEC its Report on Form 8 10-K for the fiscal year ended September 3, 2000 (the “2000 10-K”). The 2000 10-K was 9 simultaneously distributed to shareholders and the public. The 2000 10-K included Costco’s 199810 2000 financial statements and selected financial data from the Company’s 1995-2000 financial 11 statements (including income statement and balance sheet data, i.e., net income, net income per share 12 and shareholders’ equity), which were materially false and misleading and presented in violation of 13 GAAP, due to improper accounting for the backdated stock options. Because stock options 14 identified herein were backdated to be “in-the-money,” the option grants constituted significant 15 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 16 understated and its income, net income and shareholders’ equity were overstated. 191. 17 The 2000 10-K also falsely communicated that option grants were not granted at less 18 than market value at the date of grant and falsely rationalized the lack of recorded compensation 19 expense, stating “[t]he Company grants stock options at exercise prices equal to fair market value on 20 the date of grant, accordingly, no compensation cost has been recognized for the plans.” 2000 10-K 21 at 35. The 2000 10-K also materially understated the weighted average fair value of options granted. 22 Because options had been backdated to be “in-the-money,” the value of those options was 23 understated, and so too was the weighted average fair value of those options. Similarly, “[p]ro 24 forma” net income and EPS purportedly reported under SFAS No. 123 were materially overstated 25 because the fair value of options granted and related compensation costs were understated. Id. at 3526 36. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 87 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 89 of 141 1 192. The fiscal 2000 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 2 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 3 The Fiscal 2001 Report on Form 10-K 4 193. On or about November 16, 2001, the Company filed with the SEC its Report on Form 5 10-K for the fiscal year ended September 2, 2001 (the “2001 10-K”). The 2001 10-K was 6 simultaneously distributed to shareholders and the public. The 2001 10-K included Costco’s 19997 2001 financial statements and selected financial data from the Company’s 1995-2001 financial 8 statements (including income statement and balance sheet data, i.e., net income, net income per share 9 and shareholders’ equity), which were materially false and misleading and presented in violation of 10 GAAP, due to improper accounting for the backdated stock options. Because stock options 11 identified herein were backdated to be “in-the-money,” the option grants constituted significant 12 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 13 understated and its income, net income and shareholders’ equity were overstated. 194. 14 The 2001 10-K also falsely communicated that option grants were not granted at less 15 than market value at the date of grant and falsely rationalized the lack of recorded compensation 16 expense, stating “[t]he Company grants stock options at exercise prices equal to fair market value on 17 the date of grant, accordingly, no compensation cost has been recognized for the plans.” 2001 10-K 18 at 39. The 2001 10-K also materially understated the weighted average fair value of options granted. 19 Because options had been backdated to be “in-the-money,” the value of those options was 20 understated, and so too was the weighted average fair value of those options. Similarly, “[p]ro 21 forma” net income and EPS purportedly reported under SFAS No. 123 were materially overstated 22 because the fair value of options granted and related compensation costs were understated. Id. at 3923 40. 24 195. The 2001 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 25 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 88 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 90 of 141 1 The Fiscal 2002 Report on Form 10-K 2 196. On or about November 22, 2002, the Company filed with the SEC its Report on Form 3 10-K for the fiscal year ended September 1, 2002 (the “2002 10-K”). The 2002 10-K was 4 simultaneously distributed to shareholders and the public. The 2002 10-K included Costco’s 20005 2002 financial statements and selected financial data from the Company’s 1995-2002 financial 6 statements (including income statement and balance sheet data, i.e., net income, net income per share 7 and shareholders’ equity), which were materially false and misleading and presented in violation of 8 GAAP, due to improper accounting for the backdated stock options. Because stock options 9 identified herein were backdated to be “in-the-money,” the option grants constituted significant 10 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 11 understated and its income, net income and shareholders’ equity were overstated. 197. 12 The 2002 10-K also falsely communicated that option grants were not granted at less 13 than market value at the date of grant and falsely rationalized the lack of recorded compensation 14 expense, stating: “The Company grants stock options at exercise prices equal to fair market value on 15 the date of grant. Accordingly, no compensation cost has been recognized for the plans.” 2002 1016 K at 44. The 2002 10-K also materially understated the weighted average fair value of options 17 granted. Because options had been backdated to be “in-the-money,” the value of those options was 18 understated, and so too was the weighted average fair value of those options. Similarly, “[p]ro 19 forma” net income and EPS purportedly reported under SFAS No. 123 were materially overstated 20 because the fair value of options granted and related compensation costs were understated. Id. at 4421 46. 22 198. The 2002 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 23 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 24 The Fiscal 2003 Report on Form 10-K 25 199. On or about November 21, 2003, the Company filed with the SEC its Report on Form 26 10-K for the fiscal year ended August 31, 2003 (the “2003 10-K”). CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 89 - The 2003 10-K was Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 91 of 141 1 simultaneously distributed to shareholders and the public. The 2003 10-K included Costco’s 19952 2003 financial statements and selected financial data from the Company’s 2001-2003 financial 3 statements (including income statement and balance sheet data, i.e., net income, net income per share 4 and shareholders’ equity), which were materially false and misleading and presented in violation of 5 GAAP, due to improper accounting for the backdated stock options. Because stock options 6 identified herein were backdated to be “in-the-money,” the option grants constituted significant 7 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 8 understated and its income, net income and shareholders’ equity were overstated. 9 200. The 2003 10-K also falsely communicated that option grants were not granted at less 10 than market value at the date of grant and falsely rationalized the lack of recorded compensation 11 expense, stating: “Because the Company granted stock options to employees at exercise prices equal 12 to fair market value on the date of grant . . . no compensation cost was recognized for option grants.” 13 2003 10-K at 37, 44. The 2003 10-K also materially understated the weighted average fair value of 14 options granted. Id. at 45. Because options had been backdated to be “in-the-money,” the value of 15 those options was understated, and so too was the weighted average fair value of those options. 16 Similarly, “[p]ro forma” net income and EPS purportedly reported under SFAS No. 123 were 17 materially overstated because the fair value of options granted and related compensation costs were 18 understated. Id. at 37. 19 201. The 2003 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 20 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 21 The Fiscal 2004 Report on Form 10-K 22 202. On or about November 12, 2004, the Company filed with the SEC its Report on Form 23 10-K for the fiscal year ended August 29, 2004 (the “2004 10-K”). The 2004 10-K was 24 simultaneously distributed to shareholders and the public. The 2004 10-K included Costco’s 200225 2004 financial statements and selected financial data from the Company’s 1995-2004 financial 26 statements (including income statement and balance sheet data, i.e., net income, net income per share CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 90 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 92 of 141 1 and shareholders’ equity), which were materially false and misleading and presented in violation of 2 GAAP, due to improper accounting for the backdated stock options. Because stock options 3 identified herein were backdated to be “in-the-money,” the option grants constituted significant 4 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 5 understated and its income, net income and shareholders’ equity were overstated. 6 203. The 2004 10-K also falsely communicated that option grants were not granted at less 7 than market value at the date of grant and falsely rationalized the lack of recorded compensation 8 expense, stating: “Because the Company granted stock options to employees at exercise prices equal 9 to fair market value on the date of grant, no compensation cost was recognized for option grants.” 10 2004 10-K at 40. The 2004 10-K also materially understated the weighted average fair value of 11 options granted. Id. at 49. Because outstanding options had been backdated to be “in-the-money,” 12 the value of those options was understated, and so too was the weighted average fair value of those 13 options. Similarly, “[p]ro forma” net income and EPS purportedly reported under SFAS No. 123 14 were materially overstated because the fair value of options granted and related compensation costs 15 were understated. Id. at 41. 16 204. The 2004 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 17 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 18 The Fiscal 2005 Report on Form 10-K 19 205. On or about November 10, 2005, the Company filed with the SEC its Report on Form 20 10-K for the fiscal year ended August 28, 2005 (the “2005 10-K”). The 2005 10-K was 21 simultaneously distributed to shareholders and the public. The 2005 10-K included Costco’s 200322 2005 financial statements and selected financial data from the Company’s 1996-2005 financial 23 statements (including income statement and balance sheet data, i.e., net income, net income per share 24 and shareholders’ equity), which were materially false and misleading and presented in violation of 25 GAAP, due to improper accounting for the backdated stock options. Because stock options 26 identified herein were backdated to be “in-the-money,” the option grants constituted significant CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 91 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 93 of 141 1 unreported non-cash compensation expense. As a result, Costco’s compensation expense was 2 understated and its income, net income and shareholders’ equity were overstated. 3 206. In discussing the Company’s stock options accounted for under APB No. 25, which 4 included all options prior to fiscal 2003, the 2005 10-K also falsely communicated that such option 5 grants were not granted at less than market value at the date of grant and falsely rationalized the lack 6 of recorded compensation expense, stating: “Because the Company granted stock options to 7 employees at exercise prices equal to fair market value on the date of grant prior to fiscal 2003, no 8 compensation cost was recognized for these option grants.” 2005 10-K at 48. The 2005 10-K also 9 materially understated the weighted average fair value of options granted. Because outstanding 10 options had been backdated to be “in-the-money,” the value of those options was understated, and so 11 too was the weighted average fair value of those options. Id. at 58. Similarly, “[p]ro forma” net 12 income and EPS purportedly reported under SFAS No. 123 were materially overstated because the 13 fair value of options granted and related compensation costs were understated. Id. at 48. 14 207. The 2005 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 15 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 16 The Fiscal 2006 Report on Form 10-K 17 208. On or about November 17, 2006, the Company filed with the SEC its Report on Form 18 10-K for the fiscal year ended September 3, 2006 (the “2006 10-K”). The 2006 10-K was 19 simultaneously distributed to shareholders and the public. The 2006 10-K included Costco’s 200420 2006 financial statements and selected financial data from the Company’s 2002-2006 financial 21 statements (including income statement and balance sheet data, i.e., net income, net income per share 22 and shareholders’ equity), which the Company admitted (in Note 11 to its financial statements) were 23 false for overstating reported net income and understating compensation expense. In Note 11 to the 24 Company’s financial statements, defendants reported on the results of a review of a “Special 25 Committee,” formed by the Company to “review” Costco’s historical stock option grants. The 26 Special Committee included one defendant who approved backdated options, and two other CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 92 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 94 of 141 1 members of the Board who signed false and misleading SEC filings and who directly submitted for 2 dissemination false and misleading financial statements. Insofar as the vague generalities and other 3 discussion of the “review” in Note 11 suggested stock options were not backdated, it was false and 4 misleading and omitted material facts, as set forth in “Concealment and Tolling of the Statute of 5 Limitations,” infra ¶¶233-238, presented in violation of GAAP, due to improper accounting for the 6 backdated stock options. 7 209. Furthermore, insofar as Costco’s financial statements reflected compensation expense 8 and related accounts as if the backdated April 1, 2004 stock options, supra ¶94, (or any other alleged 9 backdated options not repriced) were granted at fair market value on the option date, Costco’s 10 compensation expense was understated and its income, net income and shareholders’ equity were 11 overstated. Likewise, insofar as Costco’s notes to financial statements recorded compensation 12 expense and related accounts as if the backdated April 1, 2004 stock options, supra ¶94, (or any 13 other alleged backdated options not repriced) were granted at fair market value on the option date, 14 the 2006 10-K also materially understated stock-based compensation expense determined under the 15 fair value based method, because outstanding options had been backdated to be “in-the-money” and 16 the value of those options was understated. Similarly, “[p]ro forma” net income and EPS 17 purportedly reported under SFAS No. 123R were materially overstated because stock-based 18 compensation expense was understated. 19 210. The 2006 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 20 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 21 The Fiscal 2007 Report on Form 10-K 22 211. On or about October 25, 2007, the Company filed with the SEC its Report on Form 23 10-K for the fiscal year ended September 2, 2007 (the “2007 10-K”). The 2007 10-K was 24 simultaneously distributed to shareholders and the public. The 2007 10-K included Costco’s 200525 2007 financial statements and selected financial data from the Company’s 2003-2007 financial 26 statements (including income statement and balance sheet data, i.e., net income, net income per share CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 93 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 95 of 141 1 and shareholders’ equity), which financial statements for fiscal periods prior to 2006 the Company 2 previously admitted were false for understating compensation expense and overstating reported net 3 income, among other accounts. 4 212. Furthermore, insofar as Costco’s financial statements reflected compensation expense 5 and related accounts as if the backdated April 1, 2004 stock options, supra ¶94, (or any other alleged 6 backdated options not repriced) were granted at fair market value on the option date, Costco’s 7 compensation expense was understated and its income, net income and shareholders’ equity were 8 overstated. Likewise, insofar as Costco’s notes to financial statements recorded compensation 9 expense and related accounts as if the backdated April 1, 2004 stock options, supra ¶94, (or any 10 other alleged backdated options not repriced) were granted at fair market value on the option date, 11 the 2007 10-K also materially understated stock-based compensation expense determined under the 12 fair value based method, because outstanding options had been backdated to be “in-the-money” and 13 the value of those options was understated. Similarly, “[p]ro forma” net income and EPS 14 purportedly reported under SFAS No. 123R were materially overstated because stock-based 15 compensation expense was understated. 16 213. The 2007 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 17 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 18 The Fiscal 2008 Report on Form 10-K 19 214. On or about October 16, 2008, the Company filed with the SEC its Report on Form 20 10-K for the fiscal year ended August 31, 2008 (the “2008 10-K”). The 2008 10-K was 21 simultaneously distributed to shareholders and the public. The 2008 10-K included Costco’s 200622 2008 financial statements and selected financial data from the Company’s 2004-2008 financial 23 statements (including income statement and balance sheet data, i.e., net income, net income per share 24 and shareholders’ equity), which financial statements for fiscal periods prior to 2006 the Company 25 previously admitted were false for understating compensation expense and overstating reported net 26 income, among other accounts. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 94 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 96 of 141 1 215. Furthermore, insofar as Costco’s financial statements reflected compensation expense 2 and related accounts as if the backdated April 1, 2004 stock options, supra ¶94, (or any other alleged 3 backdated options not repriced) were granted at fair market value on the option date, Costco’s 4 compensation expense was understated and its income, net income and shareholders’ equity were 5 overstated. Likewise, insofar as Costco’s notes to financial statements recorded compensation 6 expense and related accounts as if the backdated April 1, 2004 stock options, supra ¶94, (or any 7 other alleged backdated options not repriced) were granted at fair market value on the option date, 8 the 2008 10-K also materially understated stock-based compensation expense determined under the 9 fair value based method, because outstanding options had been backdated to be “in-the-money” and 10 the value of those options was understated. Similarly, “[p]ro forma” net income and EPS 11 purportedly reported under SFAS No. 123R were materially overstated because stock-based 12 compensation expense was understated. 13 216. The 2008 10-K was signed by defendants Sinegal, Brotman, Carson, DiCerchio, 14 Galanti, Petterson, James, Munger, Meisenbach and Ruckelshaus. 15 False and Misleading Sarbanes-Oxley Certifications 16 217. The Reports on Form 10-K for fiscal years ended September 1, 2002, August 31, 17 2003, August 29, 2004, August 28, 2005 and September 3, 2006 each contained Sarbanes-Oxley 18 Certifications. Sinegal and Galanti signed the Certifications for the 2002-2006 Forms 10-K. Those 19 Certifications provided (among other things) that: (i) the “report does not contain any untrue 20 statement of a material fact or omit to state a material fact necessary to make the statements made, in 21 light of the circumstances under which such statements were made, not misleading”; (ii) the 22 “financial statements, and other financial information included in this annual report, fairly present in 23 all material respects the financial condition, results of operations and cash flows” of the Company; 24 and (iii) they had “disclosed . . . to [Costco’s] auditors and the audit committee of registrant’s board 25 of directors . . . [a]ll significant deficiencies and material weakness in the design or operation of 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 95 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 97 of 141 1 internal control . . . and . . . [a]ny fraud, whether or not material, that involves management or other 2 employees who have a significant role in [Costco’s] internal control over financial reporting.” 3 218. The Sarbanes-Oxley Certifications were false because, as defendants knew or in bad 4 faith or with deliberate recklessness disregarded, the Reports on Form 10-K contained false and 5 misleading statements as a result of the backdating alleged herein. Backdating by Board members, 6 including Sinegal, Galanti, James, Meisenbach, Ruckelshaus, Carson and Munger, had been 7 concealed from the Company’s auditors, and the backdating scheme constituted a fraud that involved 8 the top levels of management (including Sinegal, Brotman, DiCerchio and Galanti) and Audit 9 Committee members – those who had the most significant role in Costco’s internal controls. 10 False and Misleading Reports on Form 10-Q 11 219. Sinegal and Galanti signed the Reports on Form 10-Q filed by Costco on or about 12 April 2, 1996, June 5, 1996, December 20, 1996, April 2, 1997, June 5, 1997, December 22, 1997, 13 March 20, 1998, June 12, 1998, December 23, 1998, March 11, 1999, June 25, 1999, December 20, 14 1999, March 14, 2000, June 14, 2000, December 20, 2000, March 26, 2001, June 18, 2001, 15 December 28, 2001, March 19, 2002, June 14, 2002, December 20, 2002, March 28, 2003, June 24, 16 2003, January 2, 2004, March 25, 2004, June 17, 2004, December 17, 2004, March 24, 2005, June 17 16, 2005, December 21, 2005, March 23, 2006, June 16, 2006, and December 22, 2006. 18 220. The Reports on Form 10-Q identified contained the Company’s interim unaudited 19 financial statements for current and previous reporting periods, which were false and misleading for 20 understating compensation expense and overstating income, net income and EPS. These reports 21 were false and misleading because (among other things) defendants were backdating stock options. 22 As Sinegal and Galanti knew through receiving and approving backdated options, as alleged herein, 23 option grants were being backdated and thus constituted significant unreported compensation 24 expense. 25 221. The Reports on Form 10-Q filed on December 20, 2002, March 28, 2003, June 24, 26 2003, January 2, 2004, March 25, 2004, June 17, 2004, December 17, 2004, March 24, 2005, June CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 96 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 98 of 141 1 16, 2005, December 21, 2005, March 23, 2006, June 16, 2006, and December 22, 2006 each 2 contained Sarbanes-Oxley Certifications signed by Sinegal and Galanti. 3 222. Those Sarbanes-Oxley Certifications provided (among other things) that: (i) the 4 “report does not contain any untrue statement of a material fact or omit to state a material fact 5 necessary to make the statements made, in light of the circumstances under which such statements 6 were made, not misleading”; (ii) the “financial statements, and other financial information included 7 in this report, fairly present in all material respects the financial condition, results of operations and 8 cash flows” of the Company; and (iii) they had “disclosed . . . to [Costco’s] auditors and the audit 9 committee of registrant's board of directors (or persons performing the equivalent function): (a) all 10 significant deficiencies and material weakness in the design or operation of internal control . . . and 11 (b) any fraud, whether or not material, that involves management or other employees who have a 12 significant role in [Costco]’s internal control over financial reporting.” 13 223. The Sarbanes-Oxley Certifications were false because, as Sinegal and Galanti knew 14 or in bad faith or with deliberate recklessness disregarded, the Reports on Form 10-Q contained false 15 and misleading statements as a result of the backdating alleged herein. Backdating by Board 16 members, including Sinegal, Galanti, James, Meisenbach, Ruckelshaus, Carson and Munger, had 17 been concealed from the Company’s auditors, and the backdating scheme constituted a fraud that 18 involved the top levels of management (including Sinegal, Brotman, DiCerchio and Galanti) and 19 Audit Committee members – those who had the most significant role in Costco’s internal controls. INSIDER TRADING 20 21 224. While defendants issued false and misleading periodic reports and proxy statements, 22 causing Costco shares to trade at artificially inflated levels, they were also causing the Company to 23 grant them millions of stock options, many of which were backdated to be priced at prices lower 24 than if the option were dated on the true but concealed grant date. Insiders, including defendants, 25 exercised many of these stock options, contributing to their ability to sell over $559 million worth of 26 Costco’s stock: CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 97 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 99 of 141 1 2 Last Name BROTMAN First Name JEFFREY Date 3/25/1997 5/21/1997 2/16/1999 2/17/1999 1/22/2001 4/23/2001 5/2/2001 5/17/2002 9/6/2002 11/20/2002 11/21/2002 1/21/2003 1/28/2003 3/21/2003 3/21/2003 4/15/2003 10/20/2003 1/22/2004 3/11/2005 1/20/2006 1/25/2006 10/20/2006 10/23/2006 10/23/2006 10/26/2006 10/26/2006 10/26/2006 10/26/2006 10/26/2006 Shares 1,556 40,000 89,000 31,000 159,166 100,000 100,000 120,000 150,000 145,000 55,000 75,000 25,000 70,000 30,000 200,000 100,000 100,000 100,000 266,700 33,300 50,000 25,000 25,000 20,000 10,000 10,000 5,000 5,000 2,140,722 Price $14.62 $16.94 $40.85 $40.08 $42.19 $39.45 $35.61 $41.41 $34.44 $32.00 $32.18 $30.10 $29.16 $31.06 $31.06 $33.63 $33.37 $36.45 $45.06 $50.13 $50.05 $51.75 $52.26 $52.29 $53.04 $52.95 $53.01 $52.65 $52.65 Proceeds $22,749 $677,600 $3,635,650 $1,242,480 $6,715,214 $3,945,000 $3,561,000 $4,969,200 $5,166,000 $4,640,000 $1,769,900 $2,257,500 $729,000 $2,174,200 $931,800 $6,726,000 $3,337,000 $3,645,000 $4,506,000 $13,369,671 $1,666,665 $2,587,500 $1,306,500 $1,307,250 $1,060,800 $529,500 $530,100 $263,250 $263,250 $83,535,778 CARSON BENJAMIN 4/27/2006 4/27/2006 10,000 2,000 12,000 $54.62 $54.63 $546,200 $109,260 $655,460 DICERCHIO RICHARD 3/19/1997 3/19/1997 3/21/1997 9/16/1997 11/10/1997 11/10/1997 11/10/1997 2/11/1998 3/16/1998 12/9/1998 1/29/1999 5/4/1999 30,000 20,000 10,000 20,000 60,000 60,000 10,000 197,250 101,440 10,000 100,000 8,000 $14.75 $14.78 $14.87 $19.22 $20.03 $20.03 $20.03 $22.81 $27.50 $32.69 $40.57 $42.50 $442,500 $295,600 $148,700 $384,400 $1,201,800 $1,201,800 $200,300 $4,499,273 $2,789,600 $326,900 $4,057,000 $340,000 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 98 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 100 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 GALANTI RICHARD 6/30/1999 7/15/1999 7/20/1999 11/8/1999 11/12/1999 11/29/1999 1/14/2000 3/6/2000 3/7/2000 3/7/2000 3/15/2000 3/15/2000 3/16/2000 3/16/2000 3/24/2000 3/24/2000 4/4/2000 4/10/2000 4/12/2000 4/25/2000 9/5/2000 10/3/2000 11/7/2000 11/15/2000 11/28/2000 1/2/2001 1/2/2001 2/20/2001 4/26/2001 6/4/2001 6/11/2001 6/21/2001 7/16/2001 12/20/2001 2/15/2002 2/21/2002 6/19/2002 11/11/2003 11/1/2004 12/21/2005 20,000 10,000 10,000 20,000 14,000 6,000 10,000 4,000 6,000 6,000 10,000 10,000 20,000 20,000 15,000 15,000 7,500 7,500 15,000 15,000 20,000 20,000 20,000 20,000 56,823 6,000 4,000 30,000 40,000 34,002 30,000 10,000 20,000 20,000 10,000 10,000 25,000 20,000 24,000 10,000 1,297,515 $39.50 $42.71 $42.50 $42.26 $45.00 $45.50 $98.13 $50.06 $50.06 $50.06 $49.75 $49.75 $52.50 $52.50 $54.87 $54.87 $55.00 $55.00 $59.50 $56.00 $35.69 $35.69 $35.00 $36.63 $35.20 $41.25 $41.25 $44.00 $35.01 $38.65 $40.03 $44.00 $44.00 $44.00 $46.00 $46.58 $41.00 $34.50 $47.51 $49.50 $790,000 $427,100 $425,000 $845,200 $630,000 $273,000 $981,300 $200,240 $300,360 $300,360 $497,500 $497,500 $1,050,000 $1,050,000 $823,050 $823,050 $412,500 $412,500 $892,500 $840,000 $713,800 $713,800 $700,000 $732,600 $2,000,170 $247,500 $165,000 $1,320,000 $1,400,400 $1,314,177 $1,200,900 $440,000 $880,000 $880,000 $460,000 $465,800 $1,025,000 $690,000 $1,140,240 $495,000 $45,343,419 6/11/1997 6/12/1997 6/13/1997 6/19/1997 6/19/1997 11/11/1997 11/21/1997 20,000 10,000 10,000 10,000 10,000 10,000 10,000 $16.97 $17.31 $17.50 $17.40 $17.50 $20.48 $22.04 $339,400 $173,100 $175,000 $174,000 $175,000 $204,800 $220,400 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 99 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 101 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 3/20/1998 4/13/1998 6/18/1998 6/18/1998 12/22/1998 12/22/1998 12/22/1998 12/22/1998 1/29/1999 2/18/1999 3/8/1999 3/15/1999 3/26/1999 6/16/1999 6/16/1999 6/30/1999 11/9/1999 11/11/1999 11/11/1999 11/30/1999 12/30/1999 1/14/2000 1/18/2000 2/1/2000 3/16/2000 4/12/2000 4/12/2000 1/11/2001 1/12/2001 1/31/2001 1/31/2001 1/31/2001 11/14/2001 12/19/2001 4/14/2003 4/14/2003 4/15/2003 5/30/2003 6/9/2004 6/10/2004 8/19/2004 8/26/2004 11/16/2004 3/8/2005 6/6/2005 11/18/2005 12/14/2005 3/8/2006 3/15/2006 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 100 - 20,420 10,000 12,792 10,000 40,000 10,000 10,000 3,930 10,000 16,000 6,000 6,000 6,000 6,000 4,000 4,000 10,000 10,000 6,000 24,000 20,000 10,000 10,000 20,000 40,000 20,000 20,000 10,000 20,000 54,000 12,000 10,000 16,070 7,090 10,000 10,000 7,500 17,500 30,000 30,000 30,000 20,000 20,000 15,000 40,000 30,000 25,000 20,000 20,000 $28.98 $27.82 $30.94 $31.37 $33.15 $33.41 $33.56 $33.27 $40.71 $41.87 $44.95 $45.42 $45.33 $37.53 $38.15 $39.93 $42.45 $44.17 $44.60 $45.95 $45.65 $98.13 $51.14 $51.01 $52.71 $59.17 $59.92 $41.06 $43.37 $45.77 $46.08 $46.00 $43.17 $43.39 $33.75 $33.75 $34.40 $36.96 $40.59 $41.30 $41.67 $42.50 $49.00 $46.19 $45.73 $49.89 $48.95 $53.71 $55.15 $591,772 $278,200 $395,784 $313,700 $1,326,000 $334,100 $335,600 $130,751 $407,100 $669,920 $269,700 $272,520 $271,980 $225,180 $152,600 $159,720 $424,500 $441,700 $267,600 $1,102,800 $913,000 $981,300 $511,400 $1,020,200 $2,108,400 $1,183,400 $1,198,400 $410,600 $867,400 $2,471,580 $552,960 $460,000 $693,742 $307,635 $337,500 $337,500 $258,000 $646,800 $1,217,700 $1,239,000 $1,250,100 $850,000 $980,000 $692,850 $1,829,200 $1,496,700 $1,223,750 $1,074,200 $1,103,000 Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 102 of 141 1 2 3 4 5 6 7 8 4/28/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 1/11/2007 1/11/2007 1/11/2007 20,000 13,800 5,000 4,800 3,800 3,600 3,300 2,400 1,600 1,400 300 9,532 7,928 2,540 979,302 $54.38 $52.99 $52.95 $53.01 $53.07 $53.05 $52.98 $53.03 $53.02 $52.96 $53.00 $55.26 $55.30 $55.28 $1,087,600 $731,262 $264,750 $254,448 $201,666 $190,980 $174,834 $127,272 $84,832 $74,144 $15,900 $526,738 $438,418 $140,411 $42,362,500 9 JAMES HAMILTON 3/9/1999 12/30/1999 1/10/2000 9/17/2002 3/4/2005 48,000 135,000 48,000 45,000 16,000 292,000 $44.89 $45.65 $47.50 $34.01 $44.72 $2,154,720 $6,162,750 $2,280,000 $1,530,450 $715,520 $12,843,440 JELINEK WALTER 7/29/1997 6/23/1998 11/27/1998 1/28/1999 12/27/1999 4/18/2001 1/25/2002 8/6/2002 11/2/2004 2/2/2007 2/2/2007 2/2/2007 2/2/2007 2/2/2007 30,000 42,000 42,000 16,000 11,200 35,270 1,098 55,908 27,000 10,000 2,800 2,300 300 100 275,976 $17.50 $31.25 $31.10 $40.00 $44.75 $39.19 $44.23 $33.10 $48.50 $56.39 $56.34 $56.32 $56.25 $56.26 $525,000 $1,312,500 $1,306,200 $640,000 $501,200 $1,382,231 $48,565 $1,850,555 $1,309,500 $563,900 $157,752 $129,536 $16,875 $5,626 $9,749,440 LAZARUS FRANZ 5/5/1997 2/11/1998 2/17/1998 4/6/1998 4/14/1998 5/1/1998 6/1/1998 6/8/1998 11/10/1998 11/10/1998 156,000 40,000 30,500 9,828 30,172 8,000 3,892 4,108 6,326 5,674 $14.87 $23.00 $23.00 $27.50 $27.75 $28.06 $28.59 $29.78 $30.18 $30.03 $2,319,720 $920,000 $701,500 $270,270 $837,273 $224,480 $111,272 $122,336 $190,919 $170,390 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 101 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 103 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 LIBENSON RICHARD LOGE DAVID 14 15 16 17 18 19 2/17/1999 4/28/1999 6/15/1999 6/16/1999 6/21/1999 10/29/1999 3/7/2000 3/15/2000 3/17/2000 4/3/2000 4/10/2000 9/5/2000 10/30/2000 10/31/2000 1/2/2001 4/18/2001 5/21/2001 5/22/2001 2/14/2002 6/18/2002 5/12/2003 20,000 20,000 8,000 8,000 20,000 12,000 15,500 17,500 7,000 20,000 20,000 8,000 5,000 7,000 15,000 20,000 20,000 20,000 40,000 40,000 20,000 657,500 $40.25 $44.03 $35.93 $37.50 $38.00 $40.00 $50.10 $48.97 $50.00 $51.75 $54.87 $36.00 $35.00 $35.50 $41.00 $40.00 $37.00 $37.50 $45.94 $40.65 $36.10 $805,000 $880,600 $287,440 $300,000 $760,000 $480,000 $776,550 $856,975 $350,000 $1,035,000 $1,097,400 $288,000 $175,000 $248,500 $615,000 $800,000 $740,000 $750,000 $1,837,600 $1,626,000 $722,000 $21,299,225 6/10/1997 3/16/1998 7/22/1998 1/4/1999 1/4/1999 3/15/2000 3/16/2000 4/6/2004 4/6/2004 4/16/2004 4/16/2004 3/29/2006 14,800 50,000 19,800 40,200 20,000 20,000 20,000 34,230 34,230 35,870 2,900 19,000 311,030 $16.72 $27.07 $32.60 $35.37 $35.12 $48.34 $49.25 $38.03 $38.03 $38.03 $38.04 $54.54 $247,456 $1,353,500 $645,480 $1,421,874 $702,400 $966,800 $985,000 $1,301,767 $1,301,767 $1,364,136 $110,316 $1,036,260 $11,436,756 6/10/1997 6/23/1998 7/20/1998 12/28/1998 12/28/1998 12/28/1998 3/22/2000 3/22/2000 3/23/2000 3/23/2000 3/24/2000 4/10/2000 153,274 30,178 24,734 20,992 20,000 4,000 21,784 10,840 12,352 12,000 20,000 20,000 $16.75 $31.62 $32.37 $34.56 $34.59 $34.62 $53.07 $54.63 $53.63 $53.50 $54.81 $54.25 $2,567,340 $954,228 $800,640 $725,484 $691,800 $138,480 $1,156,077 $592,189 $662,438 $642,000 $1,096,200 $1,085,000 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 102 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 104 of 141 1 2 4/10/2000 4/10/2000 9/8/2000 10,000 10,000 58,216 428,370 $54.19 $54.38 $37.69 $541,900 $543,800 $2,194,161 $14,391,736 3/17/1997 2/23/1998 12/8/1998 1/28/1999 1/3/2000 1/8/2001 1/9/2001 92,412 84,000 68,000 22,500 17,600 59,610 20,390 364,512 $15.00 $23.55 $32.50 $40.00 $44.50 $42.00 $42.00 $1,386,180 $1,978,200 $2,210,000 $900,000 $783,200 $2,503,620 $856,380 $10,617,580 3 4 MARON EDWARD MEISENBACH JOHN 8/5/1997 10/30/1997 11/11/1997 8/21/1998 12/21/1998 12/21/1998 12/21/1998 12/29/1998 1/29/1999 7/9/1999 10/22/1999 10/22/1999 10/22/1999 2/13/2002 7/7/2003 4/15/2004 1/14/2005 3/6/2006 5/15/2006 6/15/2006 7/17/2006 8/15/2006 9/15/2006 10/16/2006 11/15/2006 12/15/2006 1/16/2007 60,000 30,000 30,000 20,000 25,000 25,000 10,000 45,000 30,000 50,000 20,000 20,000 10,000 45,000 16,000 45,000 16,000 16,000 750 2,250 1,500 1,500 1,500 1,500 1,500 1,500 1,500 526,500 $18.50 $18.76 $20.50 $28.60 $32.69 $32.78 $32.84 $37.31 $40.76 $42.53 $36.94 $36.97 $37.28 $44.95 $36.22 $37.40 $48.25 $53.02 $54.50 $53.06 $53.49 $52.40 $50.56 $52.94 $52.40 $54.40 $55.76 $1,110,000 $562,800 $615,000 $572,000 $817,250 $819,500 $328,400 $1,678,950 $1,222,800 $2,126,500 $738,800 $739,400 $372,800 $2,022,750 $579,520 $1,683,000 $772,000 $848,320 $40,875 $119,385 $80,235 $78,600 $75,840 $79,410 $78,600 $81,600 $83,640 $18,327,975 MOULTON PAUL 1/8/2001 1/9/2001 10/19/2001 6/7/2004 6/22/2004 6/22/2004 36,000 10,000 88,000 20,000 7,800 2,100 $40.58 $42.44 $37.50 $38.47 $42.01 $42.00 $1,460,880 $424,400 $3,300,000 $769,400 $327,678 $88,200 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 103 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 105 of 141 1 2 3 4 5 6 6/22/2004 10/28/2004 10/28/2004 10/25/2005 10/25/2005 10/25/2005 4/18/2006 4/18/2006 4/18/2006 10/17/2006 10/17/2006 100 6,000 6,000 20,000 10,000 10,000 20,000 20,000 20,000 50,000 25,000 351,000 $42.03 $48.15 $48.20 $47.95 $47.90 $47.89 $55.00 $55.05 $55.10 $52.35 $52.33 $4,203 $288,900 $289,200 $959,000 $479,000 $478,900 $1,100,000 $1,101,000 $1,102,000 $2,617,500 $1,308,250 $16,098,511 6/14/1996 8/2/1996 1/2/1997 1/7/1997 2/26/1997 2/27/1997 4/4/1997 5/19/1997 9/12/1997 9/12/1997 9/16/1997 10/16/1997 10/23/1997 10/23/1997 10/23/1997 10/30/1997 11/21/1997 11/21/1997 2/9/1998 6/8/1998 7/16/1998 7/22/1998 8/11/1998 9/1/1998 9/1/1998 9/1/1998 9/1/1998 9/1/1998 9/1/1998 9/1/1998 9/1/1998 9/1/1998 9/16/1998 12/9/1998 1/4/1999 1/4/1999 4,000 8,000 26,000 30,000 20,000 20,000 20,000 6,400 4,000 2,000 20,000 18,000 10,000 6,000 6,000 20,000 20,000 10,000 20,000 6,000 1,066 4,000 6,000 30,000 20,000 20,000 10,000 10,000 4,000 4,000 4,000 4,000 2,000 4,000 24,500 10,000 $10.12 $10.50 $12.40 $12.34 $12.72 $12.97 $14.47 $16.31 $18.53 $18.40 $19.47 $19.37 $18.75 $18.57 $18.80 $19.00 $21.00 $22.00 $22.56 $30.15 $31.87 $32.37 $28.75 $24.75 $24.74 $25.00 $24.81 $24.87 $24.87 $25.00 $25.03 $25.09 $27.56 $32.81 $36.00 $35.44 $40,480 $84,000 $322,400 $370,200 $254,400 $259,400 $289,400 $104,384 $74,120 $36,800 $389,400 $348,660 $187,500 $111,420 $112,800 $380,000 $420,000 $220,000 $451,200 $180,900 $33,973 $129,480 $172,500 $742,500 $494,800 $500,000 $248,100 $248,700 $99,480 $100,000 $100,120 $100,360 $55,120 $131,240 $882,000 $354,400 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 PAULSELL FREDERICK CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 104 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 106 of 141 1 2 3 4 5 6 1/4/1999 1/4/1999 6/7/1999 11/11/1999 12/27/1999 2/7/2000 3/31/2000 4/4/2000 1/30/2001 6/18/2001 12/28/2001 10,000 10,000 32,000 4,000 200 4,000 3,000 2,000 4,000 2,000 3,000 508,166 $35.62 $35.69 $38.10 $42.56 $44.69 $51.73 $52.56 $54.68 $43.63 $42.30 $44.23 $356,200 $356,900 $1,219,200 $170,240 $8,938 $206,920 $157,680 $109,360 $174,520 $84,600 $132,690 $12,007,485 1/15/1997 5/2/1997 5/5/1997 6/3/1997 6/13/1997 7/15/1997 7/15/1997 7/31/1997 8/21/1997 9/16/1997 11/24/1997 4/13/1998 4/30/1998 6/1/1998 6/2/1998 6/8/1998 6/18/1998 9/1/1998 9/1/1998 11/9/1998 2/18/1999 5/3/1999 7/22/1999 10/29/1999 11/12/1999 1/12/2000 3/15/2000 3/16/2000 4/4/2000 4/11/2000 1/2/2001 1/31/2001 6/5/2001 6/12/2001 12/24/2001 1/23/2002 10,000 10,000 8,000 6,000 11,544 6,000 6,000 4,000 10,000 2,456 10,000 2,000 1,000 3,000 4,000 4,000 8,000 15,000 10,000 4,000 10,000 4,000 6,000 6,000 16,000 8,000 10,000 10,000 10,000 10,000 6,000 4,000 5,000 5,000 5,000 5,000 $13.50 $14.00 $14.50 $16.25 $17.50 $16.50 $16.50 $18.50 $18.12 $19.19 $22.03 $27.75 $27.50 $28.62 $28.75 $30.03 $30.50 $25.00 $23.97 $30.12 $41.50 $40.87 $39.49 $40.47 $45.00 $45.75 $48.19 $55.00 $53.54 $54.75 $41.19 $45.00 $39.63 $40.10 $44.01 $44.33 $135,000 $140,000 $116,000 $97,500 $202,020 $99,000 $99,000 $74,000 $181,200 $47,131 $220,300 $55,500 $27,500 $85,860 $115,000 $120,120 $244,000 $375,000 $239,700 $120,480 $415,000 $163,480 $236,940 $242,820 $720,000 $366,000 $481,900 $550,000 $535,400 $547,500 $247,140 $180,000 $198,150 $200,500 $220,050 $221,650 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 PETTERSON DAVID CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 105 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 107 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 4/14/2003 5/30/2003 7/14/2003 8/29/2003 11/20/2003 12/18/2003 2/10/2004 6/7/2004 6/15/2004 8/26/2004 10/19/2004 11/23/2004 6/7/2005 7/26/2005 7/28/2005 10/14/2005 10/14/2005 10/14/2005 10/14/2005 11/10/2005 11/18/2005 12/14/2005 12/14/2005 12/23/2005 12/23/2005 12/23/2005 12/23/2005 12/23/2005 12/23/2005 3/6/2006 3/14/2006 3/14/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/26/2006 10/26/2006 10/26/2006 1/9/2007 1/18/2007 5,000 5,000 5,000 5,000 5,000 5,000 5,000 5,000 7,500 10,000 10,000 2,500 15,000 5,000 10,000 9,600 9,600 400 400 5,000 5,000 4,000 1,000 3,464 1,200 900 800 700 436 10,000 9,136 864 6,500 600 300 100 4,364 2,624 512 10,000 7,500 450,000 $33.62 $36.96 $37.49 $32.24 $34.12 $36.39 $39.27 $39.41 $41.63 $42.40 $46.22 $49.50 $46.24 $46.08 $46.59 $46.41 $46.41 $46.00 $46.40 $50.04 $49.82 $49.41 $49.40 $50.22 $50.20 $50.17 $50.21 $50.19 $50.18 $53.66 $55.17 $55.18 $53.34 $53.33 $53.31 $53.32 $53.15 $53.16 $53.17 $54.00 $57.00 $168,100 $184,800 $187,450 $161,200 $170,600 $181,950 $196,350 $197,050 $312,225 $424,000 $462,200 $123,750 $693,600 $230,400 $465,900 $445,536 $445,536 $18,400 $18,560 $250,200 $249,100 $197,640 $49,400 $173,962 $60,240 $45,153 $40,168 $35,133 $21,878 $536,600 $504,033 $47,676 $346,710 $31,998 $15,993 $5,332 $231,947 $139,492 $27,223 $540,000 $427,500 $17,385,825 7/31/1996 2/24/1997 2/24/1997 2/24/1997 6/12/1997 2/24/1998 31,200 24,800 22,500 4,000 70,320 22,500 $10.12 $12.50 $12.50 $12.50 $17.34 $24.69 $315,744 $310,000 $281,250 $50,000 $1,219,349 $555,525 23 24 25 26 PORTERA JOSEPH CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 106 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 108 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 6/8/1998 11/9/1998 2/17/1999 4/5/1999 4/12/1999 5/4/1999 6/17/1999 10/11/1999 10/28/1999 10/28/1999 2/9/2000 3/6/2000 4/3/2000 4/10/2000 7/10/2000 10/27/2000 2/28/2001 4/10/2001 4/10/2001 6/19/2001 2/19/2002 4/15/2002 5/14/2002 3/14/2003 6/7/2004 6/24/2004 6/6/2005 4/10/2006 4/10/2006 4/24/2006 54,000 13,500 20,000 20,000 20,000 6,000 8,000 440 12,000 1,500 20,000 20,000 20,000 20,000 8,000 12,000 2,000 40,000 18,000 20,000 40,000 20,000 15,000 20,000 85,000 30,000 135,000 60,000 15,000 15,000 945,760 $29.25 $30.25 $40.00 $45.01 $45.00 $42.50 $38.01 $40.87 $38.19 $38.19 $52.45 $49.60 $52.00 $52.50 $35.06 $33.50 $42.00 $35.51 $35.50 $42.70 $45.90 $42.25 $41.30 $29.50 $39.37 $42.85 $45.85 $55.00 $43.79 $54.25 $1,579,500 $408,375 $800,000 $900,200 $900,000 $255,000 $304,080 $17,983 $458,280 $57,285 $1,049,000 $992,000 $1,040,000 $1,050,000 $280,480 $402,000 $84,000 $1,420,400 $639,000 $854,000 $1,836,000 $845,000 $619,500 $590,000 $3,346,450 $1,285,500 $6,189,750 $3,300,000 $656,850 $813,750 $35,706,251 10/11/2004 3/16/2006 16,000 16,000 32,000 $44.20 $55.00 $707,200 $880,000 $1,587,200 17 18 RUCKELSHAUS JILL SCHUTT DOUGLAS 1/19/2005 1/10/2007 1/10/2007 2,000 133,000 25,000 160,000 $48.90 $53.95 $53.97 $97,800 $7,175,350 $1,349,250 $8,622,400 SINEGAL JAMES 2/9/1998 2/9/1998 2/10/1998 2/10/1998 2/10/1998 2/10/1998 2/10/1998 2/10/1998 54,000 4,000 140,000 50,000 40,000 20,000 20,000 20,000 $22.50 $22.56 $22.75 $22.69 $22.62 $22.50 $22.87 $22.94 $1,215,000 $90,240 $3,185,000 $1,134,500 $904,800 $450,000 $457,400 $458,800 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 107 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 109 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 2/10/1998 2/11/1998 2/11/1998 2/11/1998 2/11/1998 2/11/1998 2/11/1998 2/11/1998 3/8/1999 3/8/1999 3/8/1999 3/8/1999 1/30/2001 2/6/2001 4/17/2002 12/17/2002 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 108 - 20,000 40,000 30,000 30,000 30,000 30,000 10,000 26 325,000 34,000 21,000 20,000 127,332 100,000 116,360 53,071 15,000 10,784 8,643 6,691 6,600 6,338 5,400 5,400 5,239 4,955 4,520 4,400 4,350 4,253 4,200 4,200 3,800 3,543 3,400 3,357 3,200 3,152 3,000 3,000 3,000 3,000 3,000 2,700 2,562 2,500 2,400 2,400 2,400 $23.00 $22.62 $22.53 $22.75 $22.81 $22.87 $22.69 $22.50 $44.00 $44.37 $44.62 $44.69 $43.64 $44.28 $42.97 $27.83 $37.17 $37.26 $37.07 $37.24 $37.35 $37.16 $37.36 $37.32 $37.05 $37.34 $37.31 $37.28 $37.33 $37.14 $37.35 $37.18 $37.32 $37.32 $37.19 $37.00 $37.15 $37.26 $37.16 $37.24 $37.31 $37.06 $37.23 $37.34 $37.19 $37.29 $37.33 $37.35 $37.19 $460,000 $904,800 $675,900 $682,500 $684,300 $686,100 $226,900 $585 $14,300,000 $1,508,580 $937,020 $893,800 $5,556,768 $4,428,000 $4,999,989 $1,476,966 $557,550 $401,812 $320,396 $249,173 $246,510 $235,520 $201,744 $201,528 $194,105 $185,020 $168,641 $164,032 $162,386 $157,956 $156,870 $156,156 $141,816 $132,225 $126,446 $124,209 $118,880 $117,444 $111,480 $111,720 $111,930 $111,180 $111,690 $100,818 $95,281 $93,225 $89,592 $89,640 $89,256 Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 110 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 3/17/2004 6/17/2004 6/17/2004 3/17/2005 3/17/2005 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 109 - 2,400 2,100 2,000 1,926 1,800 1,800 1,800 1,800 1,800 1,800 1,700 1,700 1,553 1,500 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,200 1,169 1,142 1,100 852 813 759 733 662 638 636 616 600 600 600 590 540 367 300 200 147 100 100 70 120,163 24,033 14,957 11,155 $37.12 $37.17 $37.29 $37.22 $37.31 $37.37 $37.25 $37.28 $37.20 $37.12 $37.32 $37.03 $37.29 $37.30 $37.30 $37.28 $37.37 $37.25 $37.30 $37.23 $37.39 $37.32 $33.21 $37.38 $37.33 $37.35 $37.19 $37.36 $37.36 $37.36 $37.35 $37.00 $37.28 $37.14 $37.17 $37.09 $37.34 $37.32 $37.32 $37.36 $37.27 $37.39 $37.24 $37.02 $37.31 $41.61 $41.60 $44.11 $44.12 $89,088 $78,057 $74,580 $71,686 $67,158 $67,266 $67,050 $67,104 $66,960 $66,816 $63,444 $62,951 $57,911 $55,950 $44,760 $44,736 $44,844 $44,700 $44,760 $44,676 $44,868 $44,784 $38,822 $42,688 $41,063 $31,822 $30,235 $28,356 $27,385 $24,732 $23,829 $23,532 $22,964 $22,284 $22,302 $22,254 $22,031 $20,153 $13,696 $11,208 $7,454 $5,496 $3,724 $3,702 $2,612 $4,999,982 $999,773 $659,753 $492,159 Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 111 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 3/17/2005 6/6/2005 6/6/2005 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 110 - 7,796 5,200 5,062 4,678 4,400 4,342 3,800 3,736 3,686 3,400 3,376 3,100 2,532 2,116 2,100 2,100 2,100 1,930 1,780 1,254 1,100 700 700 300 200 200 200 188 186 153 114 100 100 100 100 100 100 100 100 100 100 100 87 76 58 20 18 18,108 11,969 $44.10 $44.23 $44.23 $44.15 $44.31 $44.17 $44.29 $44.19 $44.32 $44.13 $44.23 $44.26 $44.10 $44.23 $44.33 $44.36 $44.28 $44.12 $44.39 $44.23 $44.33 $44.34 $44.40 $44.37 $44.18 $44.31 $44.33 $44.14 $44.17 $44.18 $44.34 $44.35 $44.32 $44.38 $44.31 $44.28 $44.19 $44.22 $44.29 $44.30 $44.29 $44.33 $44.12 $44.32 $44.24 $44.34 $44.10 $45.88 $45.83 $343,804 $229,996 $223,892 $206,534 $194,964 $191,786 $168,302 $165,094 $163,364 $150,042 $149,320 $137,206 $111,661 $93,591 $93,093 $93,156 $92,988 $85,152 $79,014 $55,464 $48,763 $31,038 $31,080 $13,311 $8,836 $8,862 $8,866 $8,298 $8,216 $6,760 $5,055 $4,435 $4,432 $4,438 $4,431 $4,428 $4,419 $4,422 $4,429 $4,430 $4,429 $4,433 $3,838 $3,368 $2,566 $887 $794 $830,795 $548,539 Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 112 of 141 1 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 111 - 10,635 10,000 7,400 6,858 5,470 4,971 4,000 3,600 3,300 3,118 2,975 2,940 2,838 2,800 2,700 2,700 2,599 2,500 2,477 2,470 2,400 2,200 2,200 2,051 1,900 1,897 1,800 1,800 1,705 1,640 1,614 1,600 1,600 1,537 1,500 1,500 1,449 1,428 1,400 1,390 1,369 1,343 1,337 1,319 1,290 1,273 1,200 1,200 1,200 $45.84 $45.71 $45.38 $45.78 $45.74 $45.91 $45.75 $45.78 $45.83 $45.80 $45.83 $45.74 $45.88 $45.80 $45.83 $45.88 $45.84 $45.86 $45.81 $45.85 $45.85 $45.90 $45.84 $45.81 $45.83 $45.88 $45.85 $45.82 $45.85 $45.87 $45.83 $45.85 $45.70 $45.87 $45.75 $45.77 $45.84 $45.85 $45.85 $45.91 $45.86 $45.84 $45.79 $45.82 $45.76 $45.84 $45.87 $45.83 $45.82 $487,508 $457,100 $335,812 $313,959 $250,198 $228,219 $183,000 $164,808 $151,239 $142,804 $136,344 $134,476 $130,207 $128,240 $123,741 $123,876 $119,138 $114,650 $113,471 $113,250 $110,040 $100,980 $100,848 $93,956 $87,077 $87,034 $82,530 $82,476 $78,174 $75,227 $73,970 $73,360 $73,120 $70,502 $68,625 $68,655 $66,422 $65,474 $64,190 $63,815 $62,782 $61,563 $61,221 $60,437 $59,030 $58,354 $55,044 $54,996 $54,984 Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 113 of 141 1 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 112 - 1,197 1,149 1,144 1,100 1,100 1,092 1,071 1,000 997 951 942 914 911 900 900 900 900 900 900 900 895 820 800 797 768 756 750 734 701 700 700 700 684 600 600 600 584 550 550 500 482 440 439 409 400 375 306 240 215 $45.89 $45.86 $45.88 $45.96 $45.81 $45.87 $45.85 $45.80 $45.91 $45.86 $45.88 $45.84 $45.88 $45.90 $45.94 $45.88 $45.89 $45.85 $45.79 $45.77 $45.75 $45.87 $45.75 $45.85 $45.87 $45.85 $45.86 $45.88 $45.83 $45.89 $45.83 $45.77 $45.76 $45.98 $45.89 $45.82 $45.78 $45.84 $45.83 $45.86 $45.86 $45.85 $45.91 $45.81 $45.90 $45.83 $45.79 $45.82 $45.91 $54,930 $52,693 $52,487 $50,556 $50,391 $50,090 $49,105 $45,800 $45,772 $43,613 $43,219 $41,898 $41,797 $41,310 $41,346 $41,292 $41,301 $41,265 $41,211 $41,193 $40,946 $37,613 $36,600 $36,542 $35,228 $34,663 $34,395 $33,676 $32,127 $32,123 $32,081 $32,039 $31,300 $27,588 $27,534 $27,492 $26,736 $25,212 $25,207 $22,930 $22,105 $20,174 $20,154 $18,736 $18,360 $17,186 $14,012 $10,997 $9,871 Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 114 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 6/6/2005 3/9/2006 5/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 113 - 200 200 191 136 112 100 100 100 100 100 100 100 90 85 71 63 22 16 15 6 200,000 1,700 43,686 11,300 9,581 9,400 8,600 8,500 7,700 5,700 5,646 5,400 4,680 4,200 3,400 3,300 3,300 3,200 2,900 2,900 2,897 2,765 2,600 2,520 2,400 2,300 2,200 2,189 2,057 $45.84 $45.82 $45.89 $45.76 $45.90 $45.88 $45.88 $45.85 $45.82 $45.74 $45.79 $45.80 $45.72 $45.85 $45.92 $45.78 $45.80 $45.77 $45.75 $45.96 $53.37 $53.11 $52.80 $53.19 $52.90 $53.19 $53.12 $53.20 $53.10 $52.95 $52.92 $53.20 $53.09 $53.18 $52.88 $53.08 $52.96 $53.28 $53.23 $52.95 $52.93 $53.12 $53.25 $53.11 $53.26 $52.94 $53.09 $52.99 $52.93 $9,168 $9,164 $8,765 $6,223 $5,141 $4,588 $4,588 $4,585 $4,582 $4,574 $4,579 $4,580 $4,115 $3,897 $3,260 $2,884 $1,008 $732 $686 $276 $10,674,000 $90,287 $2,306,621 $601,047 $506,835 $499,986 $456,832 $452,200 $408,870 $301,815 $298,786 $287,280 $248,461 $223,356 $179,792 $175,164 $174,768 $170,496 $154,367 $153,555 $153,338 $146,877 $138,450 $133,837 $127,824 $121,762 $116,798 $115,995 $108,877 Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 115 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 10/16/2006 2,000 2,000 1,918 1,800 1,705 1,600 1,600 1,540 1,111 1,100 1,000 900 900 900 800 800 800 700 700 700 600 600 600 600 600 500 500 500 400 400 300 300 300 206 200 200 100 100 100 100 100 95 4 2,379,425 $53.08 $53.13 $52.92 $53.07 $53.21 $53.21 $52.89 $52.91 $53.03 $53.10 $53.10 $53.23 $53.16 $52.99 $53.24 $53.23 $53.08 $53.28 $53.18 $52.88 $53.27 $53.28 $52.98 $52.98 $52.91 $53.13 $52.94 $52.90 $53.25 $53.09 $53.19 $53.16 $52.93 $53.00 $53.07 $52.94 $53.24 $53.18 $53.11 $53.07 $52.98 $53.17 $53.26 $106,160 $106,260 $101,501 $95,526 $90,723 $85,136 $84,624 $81,481 $58,916 $58,410 $53,100 $47,907 $47,844 $47,691 $42,592 $42,584 $42,464 $37,296 $37,226 $37,016 $31,962 $31,968 $31,788 $31,788 $31,746 $26,565 $26,470 $26,450 $21,300 $21,236 $15,957 $15,948 $15,879 $10,918 $10,614 $10,588 $5,324 $5,318 $5,311 $5,307 $5,298 $5,051 $213 $94,634,313 10/14/2004 10/10/2005 4/28/2006 50,000 70,000 280,000 400,000 $45.36 $45.33 $54.35 $2,268,000 $3,173,100 $15,218,000 $20,659,100 24 25 26 WALKER THOMAS CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 114 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 116 of 141 1 ZOOK DENNIS 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 10/16/1996 1/13/1997 3/21/1997 6/2/1997 9/17/1997 1/12/1998 3/17/1998 7/13/1998 12/21/1998 1/4/1999 5/10/1999 6/21/1999 10/11/1999 1/13/2000 3/16/2000 3/16/2000 1/2/2001 6/20/2001 11/19/2001 2/1/2002 4/3/2003 3/5/2004 10/21/2004 10/26/2004 11/8/2004 11/11/2004 6/16/2005 6/16/2005 6/16/2005 10/25/2005 3/6/2006 3/6/2006 3/6/2006 3/6/2006 4/10/2006 10/16/2006 24,000 24,000 21,930 20,000 50,204 20,000 80,806 22,426 28,000 33,926 20,000 2,426 8,000 64,000 10,000 6,324 40,000 20,000 2,426 50,000 40,000 40,000 25,000 25,000 25,000 25,000 60,000 20,000 10,000 75,000 28,000 12,000 10,000 10,000 60,000 15,000 1,028,468 $10.64 $12.69 $14.87 $16.75 $19.31 $21.62 $27.70 $31.52 $32.50 $35.65 $39.75 $37.69 $40.69 $47.47 $54.13 $48.88 $40.74 $42.90 $42.87 $45.56 $31.80 $37.93 $46.03 $47.23 $48.94 $48.69 $45.75 $45.92 $45.76 $47.85 $53.00 $52.93 $53.23 $53.15 $55.00 $53.32 $255,360 $304,560 $326,099 $335,000 $969,439 $432,400 $2,238,326 $706,868 $910,000 $1,209,462 $795,000 $91,436 $325,520 $3,038,080 $541,300 $309,117 $1,629,600 $858,000 $104,003 $2,278,000 $1,272,000 $1,517,200 $1,150,750 $1,180,750 $1,223,500 $1,217,250 $2,745,000 $918,400 $457,600 $3,588,750 $1,484,000 $635,160 $532,300 $531,500 $3,300,000 $799,800 $40,211,530 7/17/1997 7/17/1997 7/17/1997 7/17/1997 1/13/1998 1/13/1998 1/13/1998 3/16/1998 3/16/1998 3/16/1998 70,000 40,000 20,000 10,000 70,000 30,000 20,000 60,000 20,000 20,000 $16.81 $16.87 $16.94 $16.90 $21.72 $21.69 $21.75 $27.03 $27.00 $27.06 $1,176,700 $674,800 $338,800 $169,000 $1,520,400 $650,700 $435,000 $1,621,800 $540,000 $541,200 21 22 23 24 25 26 1984 Brotman Family Trust CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 115 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 117 of 141 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 4/1/1998 4/1/1998 4/1/1998 6/29/1998 6/29/1998 6/29/1998 6/29/1998 6/30/1999 6/30/1999 6/30/1999 6/30/1999 6/30/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 7/15/1999 11/12/1999 11/12/1999 2/11/2000 2/11/2000 2/11/2000 2/11/2000 2/11/2000 3/10/2000 3/10/2000 3/10/2000 3/10/2000 3/16/2000 3/16/2000 3/16/2000 3/16/2000 3/16/2000 4/13/2000 Total: 45,000 40,000 15,000 80,000 50,000 50,000 20,000 30,000 30,000 20,000 10,000 10,000 20,000 15,000 10,000 10,000 10,000 8,000 7,000 5,000 5,000 5,000 5,000 100,000 50,000 15,000 10,000 7,500 7,500 7,500 25,000 20,000 5,000 2,500 37,500 27,500 22,500 10,000 2,500 5,000 1,215,000 14,755,246 $27.00 $27.03 $27.06 $31.50 $31.62 $31.81 $31.44 $38.47 $38.79 $38.72 $38.54 $38.50 $42.59 $42.62 $41.62 $42.22 $42.53 $41.72 $41.94 $41.87 $42.44 $42.50 $42.56 $45.07 $44.46 $52.06 $52.13 $51.94 $52.00 $52.19 $44.55 $44.61 $44.80 $44.67 $55.42 $55.80 $55.48 $55.67 $55.55 $58.17 $1,215,000 $1,081,200 $405,900 $2,520,000 $1,581,000 $1,590,500 $628,800 $1,154,100 $1,163,700 $774,400 $385,400 $385,000 $851,800 $639,300 $416,200 $422,200 $425,300 $333,760 $293,580 $209,350 $212,200 $212,500 $212,800 $4,507,000 $2,223,000 $780,900 $521,300 $389,550 $390,000 $391,425 $1,113,750 $892,200 $224,000 $111,675 $2,078,250 $1,534,500 $1,248,300 $556,700 $138,875 $290,850 $42,174,665 $559,650,590 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 116 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 118 of 141 1 225. This also does not account for hundreds of thousands of “in-the-money” backdated 2 stock options, and backdated and subsequently re-priced options, Company insiders continue to hold 3 and which continue to vest. DERIVATIVE AND DEMAND FUTILITY ALLEGATIONS 4 5 226. Plaintiffs bring this action derivatively in the right and for the benefit of Costco to 6 redress injuries suffered and to be suffered by the Company as a direct result of defendants’ 7 violations of state and federal law, breaches of fiduciary duty, abuse of control, constructive fraud, 8 gross mismanagement, corporate waste and unjust enrichment, as well as the aiding and abetting 9 thereof, by the defendants. This is not a collusive action to confer jurisdiction on this Court which it 10 would not otherwise have. 11 227. Plaintiffs will adequately and fairly represent the interests of Costco and its 12 shareholders in enforcing and prosecuting their rights. 13 228. Plaintiffs own Costco’s stock and continuously held the Company’s stock during the 14 times relevant to defendants’ alleged illegal and wrongful course of conduct. To the extent plaintiffs 15 allege facts that occurred prior to when they owned Costco stock, such allegations are to demonstrate 16 a pattern and practice of backdating, repeated breaches of the duty of loyalty, ultra vires acts, 17 violations of state and federal law, false statements, and the state of mind of defendants, among other 18 things, in support of plaintiffs’ claims, which are only for the false statements, transactions and other 19 wrongful conduct that occurred when plaintiffs owned Costco stock. 20 229. Based upon the facts set forth throughout this Complaint, applicable law, and the 21 longstanding rule that equity does not compel a useless and futile act, a pre-filing demand upon the 22 Costco Board to institute this action against the officers and members of Costco’s Board is excused 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 117 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 119 of 141 1 as futile. A majority of Costco’s directors as of the lawsuit’s filing approved backdated stock 2 options, four received backdated options, and all approved false and misleading SEC filings.21 3 Disabled Costco Board of Directors as of Lawsuit Filing 4 Defendant Director 5 Board Tenure 6 DiCerchio 7 Galanti 8 Sinegal 9 Brotman 10 11 James 12 Meisenbach 13 Ruckelshaus 14 Carson 15 Munger 16 17 230. 1986filing 1995filing 1983filing 1983filing 1988filing 1983filing 1996filing 1999filing 1997filing Received Backdated Options Approved Backdated Options √ Signed and/or Approved False & Misleading SEC Filings √ (1997-2005) Member of Compensation and/or Audit Committee Stock Trading Proceeds $45.3MM √ √ √ (1997-2005) $42.3MM √ √ √ (1997-2005) $94.6MM √ (1997-2005) $83.5MM √ √ √ (1997-2005) √ √ (1997-2005) √ √ (1997-2005) √ √ (2002-2005) √ √ (2002-2005) Compensation: 1994-2008 Audit: 2002-filing Compensation: 1994-2002 Audit: 1994-2002 Compensation: 1997-2003, 2008-filing Audit: 2001-2006 Compensation: 2002-filing $12.8MM $18.3MM $1.5MM $.65MM Compensation: 2002-filing Audit: 2001-filing Indeed, through their deceptive conduct alleged herein, including backdating stock 18 options and making false and misleading statements and omissions in Forms 4 and 5, proxy 19 statements, and Reports on Forms 10-K and 10-Q, more than a majority of Costco’s Board engaged 20 in bad faith and ultra vires acts and through their deception controlled the Company to accomplish 21 and perpetuate the backdating of stock options. 22 231. In addition, a pre-filing demand would be a useless and futile act because: 23 24 25 26 21 Each of the directors on the Board as of this lawsuit’s filing but not identified in the table of directors herein, Susan L. Decker (“Decker”), Richard M. Libenson (“Libenson”), Daniel J. Evans (“Evans”) and William H. Gates (“Gates”), signed false and misleading SEC filings. Decker signed false and misleading Reports on Forms 10-K from 2005 to 2006. Libenson signed false and misleading Reports on Forms 10-K from 1995 to 2006. Both Evans and Gates signed false and misleading Reports on Forms 10-K from 2003 to 2006. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 118 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 120 of 141 1 (a) The members of Costco’s Board have demonstrated their unwillingness and/or 2 inability to act in compliance with their fiduciary obligations and/or to sue themselves and/or their 3 fellow directors and allies in the top ranks of the corporation for the violations of law complained of 4 herein. These are people they have developed professional relationships with, who are their friends 5 and with whom they have entangling financial alliances, interests and dependencies, and therefore, 6 they are not able to and will not vigorously prosecute any such action. 7 (b) Costco’s Board and senior management participated in, approved and/or 8 permitted the wrongs alleged herein to have occurred and participated in efforts to conceal or 9 disguise those wrongs from Costco’s stockholders or recklessly and/or negligently disregarded the 10 wrongs complained of herein, and are therefore not disinterested parties. As a result of their access 11 to and review of internal corporate documents, or conversations and connections with other 12 corporate officers, employees, and directors and attendance at management and/or Board meetings, 13 each of the defendants knew the adverse non-public information regarding the improper stock option 14 grants and financial reporting. Pursuant to their specific duties as Board members, the director 15 defendants are charged with the management of the Company and to conduct its business affairs. 16 Defendants breached the fiduciary duties that they owed to Costco and its shareholders in that they 17 failed to prevent and correct the improper stock option granting and financial reporting. Certain 18 directors are also dominated and controlled by other directors and cannot act independently of them. 19 Thus, Costco’s Board cannot exercise independent objective judgment in deciding whether to bring 20 this action or whether to vigorously prosecute this action because each of its members participated 21 personally in the wrongdoing or are dependent upon other defendants who did. (c) 22 The acts complained of constitute violations of the fiduciary duties of loyalty 23 owed by Costco’s officers and directors, ultra vires acts and illegal acts, and are incapable of 24 ratification. 25 (d) The defendants control a significant portion of Costco’s voting stock. 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 119 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 121 of 141 1 (e) The members of Costco’s Board have benefitted, and will continue to benefit, 2 from the wrongdoing herein alleged and have engaged in such conduct to preserve their positions of 3 control and the perquisites derived thereof, and are incapable of exercising independent objective 4 judgment in deciding whether to bring this action. 5 (f) Any suit by the directors of Costco to remedy these wrongs would likely 6 further expose their own liability under the federal securities laws, which could result in additional 7 civil and/or criminal actions being filed against one or more of the defendants, thus, they are 8 hopelessly conflicted in making any supposedly independent determination whether to sue 9 themselves. 10 (g) Costco has been and will continue to be exposed to significant damages due to 11 the wrongdoing complained of herein, yet the current Board has not filed any lawsuits against itself 12 or others who were responsible for that wrongful conduct to attempt to recover for Costco any part 13 of the damages the Company suffered and will suffer thereby. 14 (h) In order to properly prosecute this lawsuit, it would be necessary for the 15 directors to sue themselves and the other defendants, requiring them to expose themselves and their 16 comrades to millions of dollars in potential civil liability and criminal sanctions, or IRS penalties. 17 This they will not do. 18 (i) Costco’s current and past officers and directors are protected against personal 19 liability for their acts of mismanagement, waste and breach of fiduciary duty alleged in this 20 Complaint by directors’ and officers’ liability insurance which they caused the Company to purchase 21 for their protection with corporate funds, i.e., monies belonging to the stockholders of Costco. 22 However, due to certain changes in the language of directors’ and officers’ liability insurance 23 policies in the past few years, the directors’ and officers’ liability insurance policies covering the 24 defendants in this case contain provisions which eliminate coverage for any action brought directly 25 by Costco against these defendants, known as, inter alia, the “insured versus insured exclusion.” As 26 a result, if these directors were to sue themselves or certain of the officers of Costco, there would be CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 120 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 122 of 141 1 no directors’ and officers’ insurance protection and thus, this is a further reason why they will not 2 bring such a suit. On the other hand, if the suit is brought derivatively, as this action is brought, such 3 insurance coverage exists and will provide a basis for the Company to effectuate a recovery. 4 (j) In order to bring this action for breaching their fiduciary duties, the members 5 of Costco’s Board would have been required to sue themselves and/or their fellow directors and 6 allies in the top ranks of the Company, who are their personal friends or relatives and with whom 7 they have entangling financial alliances, interests and dependencies, which they would not do. 8 232. Plaintiffs have not made any demand on shareholders of Costco to institute this action 9 since such demand would be a futile and useless act for the following reasons: (a) 10 The conduct of which plaintiffs complain cannot be ratified, for it involves 11 ultra vires, illegal and/or fraudulent acts; (b) 12 Costco is a publicly traded company with over 431 million shares outstanding 13 and thousands of beneficial owners of stock; (c) 14 Making demand on such a number of shareholders would be impossible for 15 plaintiffs who have no way of finding out the names, addresses or phone numbers of shareholders; 16 and (d) 17 Making demand on all shareholders would force plaintiffs to incur huge 18 expenses, assuming all shareholders could be individually identified. 19 CONCEALMENT AND TOLLING OF THE STATUTE OF LIMITATIONS 20 233. The Counts alleged herein are timely. As an initial matter, defendants wrongfully 21 concealed their manipulation of the stock option plans and options grants, by issuing false and 22 misleading proxy statements and other SEC filings, including Reports on 10-Q and 10-K, Forms 3, 4 23 and 5, and Sarbanes-Oxley Certifications. See supra ¶¶101-158 (false proxy statements); ¶159 24 (Forms 3, 4 and 5); ¶¶160-218 (false Forms 10-K); ¶¶219-220 (false Forms 10-Q); ¶¶217-218, 22125 223 (false Sarbanes-Oxley Certifications). Indeed, defendants took affirmative steps to conceal the 26 backdating at Costco by authorizing or otherwise causing the Company to issue these SEC filings CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 121 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 123 of 141 1 and shareholder communications. Defendants falsely assured public investors that Costco’s option 2 grants were made in accordance with the Company’s stock option plans, and omitted that backdated 3 or otherwise manipulated options were, in fact, actually issued on dates other than those disclosed. 4 These SEC filings omitted the true grant date and proper price for backdated options, and failed to 5 disclose that options were being backdated and mispriced. Many of these SEC filings also contained 6 affirmative misrepresentations that stock options were being priced based on fair market value as of 7 the date of the grant and were otherwise determined and granted in accordance with Costco’s stock 8 option plans. 9 234. Sinegal, Galanti and the defendant directors who are or were members of Costco’s 10 Audit Committee also misrepresented the adequacy of the Company’s internal controls and 11 disclosures, the integrity of the Company’s financial statements, and that Costco’s auditors were 12 apprised of all material facts including fraudulent acts by members of management. See supra 13 ¶¶101-102, 123, 127, 132, 137, 141, 145, 150, 154, 158 (alleging false and misleading Audit 14 Committee reports); ¶¶217-218, 221-223 (same, Sarbanes-Oxley Certifications). (One of these 15 directors, Munger, is a member of the “Special Committee” that was purportedly formed to review 16 the Company’s option grants.) These false and misleading SEC filings prevented plaintiffs and 17 Costco’s other public shareholders from becoming aware of the backdating practices at the Company 18 and the Company’s false and misleading financial statements. 19 235. Other facts suggesting defendants’ concealment include the admitted lack of adequate 20 documentation or recordation in connection with stock option grants. The Company has admitted 21 that “in several instances, it was impossible to determine with precision the appropriate measurement 22 date for specific grants,” i.e., supposedly the actual grant date of options could not be determined. 23 “Given the lack of historical documentation, it was not possible to precisely determine the amount of 24 the adjustments that should be made.” Indeed, the “Special Committee” purportedly was “unable to 25 identify the likely grant date of the options” in many cases. Indeed, plaintiffs had no reason to 26 suspect defendants breached their fiduciary duties and violated securities laws until Costco admitted CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 122 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 124 of 141 1 on October 12, 2006 that it had formed a “Special Committee,” which had made findings on a 2 review of the Company’s historical stock option practices. 3 236. Still though, the Company’s admissions to date do not disclose or tend to reveal the 4 full extent of the conduct (backdating) alleged herein and thereby omit the material facts plaintiffs 5 allege. Even the Company admits that it still has not determined the full impact of the backdating. 6 237. Finally, as fiduciaries of Costco and its public shareholders, the defendants cannot 7 rely on any limitations defense where they withheld from the Company’s public shareholders the 8 facts that give rise to the claims asserted herein, e.g., that the Company’s Board had abdicated its 9 fiduciary responsibilities to oversee the Company’s executive compensation practices, and that the 10 option grant dates had been manipulated to maximize the profit for the grant recipients and, 11 accordingly, to maximize the costs for the Company. 12 238. Plaintiffs allege the following Counts for redress of all alleged conduct that occurred 13 during the period in which they have owned Costco stock, except as follows. Plaintiffs assert claims 14 under Counts II and III for conduct and statements that occurred starting from September 29, 2003, 15 i.e., five years prior to the date the first filed of the consolidated actions was initiated. To the extent 16 plaintiffs allege facts that occurred prior to September 29, 2003, in support of plaintiffs’ claims 17 under Counts II and III, respectively, it is to demonstrate a pattern and practice of backdating and 18 issuing false statements, and the state of mind of defendants, among other things, in support of 19 plaintiffs’ claims that seek redress only for wrongful conduct and statements that occurred on or 20 after September 29, 2003. 21 COUNT I 22 Breach of Fiduciary Duty and/or Aiding and Abetting Against All Defendants 23 239. Plaintiffs incorporate by reference and reallege each and every allegation set forth 24 above, as though fully set forth herein. 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 123 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 125 of 141 1 240. Each of the defendants agreed to and did participate with the other defendants and/or 2 aided and abetted one another in a deliberate course of action designed to divert corporate assets in 3 breach of fiduciary duties the defendants owed to the Company. 4 241. Defendants engaged in ultra vires, bad faith and/or fraudulent acts by backdating 5 and/or accepting backdated stock options in violation of Costco’s stock plans, and (having backdated 6 and/or accepted backdated stock options) by causing Costco to file false and misleading SEC filings 7 and financial statements in violation of SEC rules and regulations. This conduct could not have been 8 ratified by a simple majority of shareholders. Furthermore, the Board, through its deceptive conduct 9 pleaded herein, acquired de facto control of Costco to accomplish and perpetuate its self dealing in 10 backdated “in-the-money” options. 11 242. The conduct of each defendant constitutes actual omissions involving negligence, 12 default, breach of duty or breach of trust. Indeed, the defendants have violated fiduciary duties of 13 care, loyalty, candor and independence owed to Costco and its public shareholders, have engaged in 14 unlawful self dealing, and have acted to put their personal interests and/or their colleagues’ interests 15 ahead of the interests of Costco and its shareholders. 16 243. As demonstrated by the allegations above, defendants failed to exercise the care 17 required and breached their duties of loyalty, good faith, candor and independence owed to Costco 18 and its public shareholders, and they failed to disclose material information and/or made material 19 misrepresentations to shareholders regarding defendants’ option backdating scheme. 20 244. Defendants Sinegal, Galanti, Brotman, DiCerchio, Petterson, Carson, James, 21 Meisenbach and Ruckelshaus also profited from sales of Costco stock they made while in possession 22 of material inside information, namely that Costco’s reported earnings were falsely inflated by 23 understatement of compensation expense and that the Company’s internal controls were materially 24 impaired. (Meanwhile, Costco was purchasing its stock on the open market during the periods of 25 time in which certain of the defendants were selling their shares. See infra ¶251.) Defendants 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 124 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 126 of 141 1 selling their stock notwithstanding their unique knowledge of Costco’s backdating was in breach of 2 their fiduciary duties and in violation of the Exchange Act. 3 245. By reason of the foregoing acts, practices and course of conduct, the defendants have 4 failed to exercise ordinary care and diligence in the exercise of their fiduciary obligations toward 5 Costco and its public shareholders. 6 246. As a proximate result of defendants’ conduct, Costco has been injured and is entitled 7 to damages. 8 COUNT II 9 Violations of §10(b) of the Exchange Act and Rule 10b-5 Against All Defendants 10 247. Plaintiffs incorporate by reference and reallege each and every allegation set forth 11 above, as though fully set forth herein. 12 248. Defendants signed and/or otherwise approved SEC filings that were false and 13 misleading and that did not disclose the backdating practices that were occurring at Costco and the 14 resulting affects of those practices on the Company’s financial results. Costco’s SEC filings, as 15 identified above, included false and misleading financial statements that understated compensation 16 expense and overstated income, net income and EPS. The Company’s SEC filings, including 17 Reports on Form 10-K and proxy statements, also otherwise made false and misleading statements 18 concerning Costco’s stock option grants and granting practices. Forms 3, 4 and 5 falsely stated the 19 option grant dates of options. Defendants knew or deliberately recklessly disregarded the fact that 20 the Company’s SEC filings were false and misleading – due to the backdating – in that the financial 21 statements contained misrepresentations and failed to disclose material facts necessary in order to 22 make the statements made, in light of the circumstances under which they were made, not 23 misleading. 24 249. Throughout the relevant period, the defendants identified herein individually and in 25 concert, directly and indirectly, by the use and means of instrumentalities of interstate commerce 26 and/or of the mails, also engaged and participated in a continuous course of conduct which caused CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 125 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 127 of 141 1 the Company to issue artificially low-priced options to officers, directors and other employees, 2 including defendants. Those persons thereby received option grants that improperly priced the 3 common stock to be sold by the Company at prices lower than the fair market value as of the date of 4 the grant and otherwise lower than what the option exercise price would have been had the option 5 been dated properly as of the date of the grant. Defendants and others subsequently exercised many 6 of those options (some of which are identified herein) and thereby purchased stock from the 7 Company at a lower price than they would have, had the options been correctly dated and priced. 8 Defendants knew their options were backdated when they did this. The Company, on the other hand, 9 relied on defendants’ conduct and statements in connection with the dating and pricing of options, 10 option values, compliance with Costco’s stock option plans, compensation expense, and financial 11 reporting and internal recordation related to option grants. 12 250. Thus, defendants violated §10(b) of the Exchange Act and Rule 10b-5 in that they: 13 (a) Employed devices, schemes and artifices to defraud; 14 (b) Made untrue statements of material facts or omitted to state material facts 15 necessary in order to make the statements made, in light of the circumstances under which they were 16 made, not misleading; or (c) 17 Engaged in acts, practices and a course of business that operated as a fraud or 18 deceit upon Costco and others in connection with their purchases of Costco’s common stock during 19 the relevant period. 20 251. As a result of the misconduct by the defendants named in this Count, Costco has 21 suffered and will suffer damages in that it would not have issued options and stock to defendants and 22 others at the prices indicated on backdated options had it known of the backdating. Costco has also 23 suffered damages in that it paid artificially inflated prices for the Company’s common stock 24 purchased on the open market. Pursuant to a stock repurchase program caused by defendants, 25 Costco began repurchasing shares in 1998 and purchased over three million shares on the open 26 market between November 5, 1998 and September 3, 2000. The Company began repurchasing CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 126 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 128 of 141 1 shares again, pursuant to another repurchase program caused by defendants, and between June 7 and 2 August 28, 2005, purchased over 9 million shares on the open market, and between May 8, 2006 and 3 September 3, 2006, purchased over 9.9 million shares on the open market. 4 252. Costco would not have purchased its common stock at the prices it paid had the 5 market previously been aware that the market price of Costco’s stock was falsely inflated by 6 defendants’ misleading statements. As a direct and proximate result of these defendants’ wrongful 7 conduct, Costco suffered damages in connection with its issuances of the Company’s options and 8 purchases and issuances of common stock. By reason of such conduct, the defendants named in this 9 Count are liable to the Company pursuant to §10(b) of the Exchange Act and Rule 10b-5 10 promulgated thereunder. 11 COUNT III 12 Violations of §29(b) of the Exchange Act Against Defendants Sinegal, Brotman, Galanti, DiCerchio and Petterson 13 253. Plaintiffs incorporate by reference and reallege each and every allegation set forth 14 above, as though fully set forth herein. 15 254. The backdated options contracts identified herein and all backdated options contracts 16 entered by the Company were entered in violation of the Exchange Act and rules prescribed 17 thereunder, including Rule 10b-5. The backdated options contracts were authorized by defendants 18 pursuant to materially false statements, omissions, and/or schemes or practices that acted as a fraud 19 upon Costco. There is contractual privity between Costco and the recipients of the backdated option 20 contracts. Costco and its public investors are in the class of persons the Exchange Act was designed 21 to protect. 22 255. Accordingly, the backdated option contracts that have been exercised must be 23 rescinded and the remaining backdated option contracts are void. 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 127 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 129 of 141 1 COUNT IV 2 Accounting Against Defendants Sinegal, Brotman, Galanti, DiCerchio, Carson, James, Petterson, Meisenbach and Ruckelshaus 3 4 256. Plaintiffs incorporate by reference and reallege each and every allegation set forth 5 above, as though fully set forth herein. 6 257. At all relevant times, defendants, as directors and/or officers of Costco, owed the 7 Company and its shareholders fiduciary duties of good faith, care, candor and loyalty. 8 258. In breach of their fiduciary duties owed to Costco and its shareholders, the defendants 9 caused Costco, among other things, to grant backdated stock options to themselves and/or certain 10 other officers and directors of Costco and/or failed to properly investigate whether these grants had 11 been improperly made. Defendants also used the Company’s proprietary information for their own 12 gain, in selling stock at inflated prices on the open market, including during periods in which the 13 Company was purchasing stock on the open market. By this wrongdoing, the defendants breached 14 their fiduciary duties owed to Costco and its shareholders. 259. 15 The defendants possess complete and unfettered control over the improperly issued 16 stock option grants and the books and records of the Company concerning the details of such 17 improperly backdated stock option grants to certain of the defendants. 260. 18 As a result of defendants’ misconduct, Costco has been substantially injured and 19 damaged financially and is entitled to a recovery as a result thereof, including the proceeds of those 20 improperly granted options which have been exercised and sold, and the ill-gotten profits of stock 21 sales. 22 261. Plaintiffs demand an accounting be made of all stock option grants made to any of the 23 defendants and defendants’ stock sales, including, without limitation, the dates of the grants, the 24 amounts of the grants, the value of the grants, the recipients of the grants, the exercise date of stock 25 options granted to any of the defendants, as well as the disposition of any proceeds received by any 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 128 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 130 of 141 1 of the defendants via sale or other exercise of backdated stock option grants received by those 2 defendants and defendants’ sales of stock. 3 COUNT V 4 Abuse of Control Against All Defendants 5 262. Plaintiffs incorporate by reference and reallege each and every allegation set forth 6 above, as though fully set forth herein. 7 263. The defendants employed the alleged scheme for the purpose of maintaining and 8 entrenching themselves in their positions of power, prestige and profit at, and control over, Costco, 9 and to continue to receive the substantial benefits, salaries and emoluments associated with their 10 positions at Costco. As a part of this scheme, defendants actively made and/or participated in the 11 making of or aided and abetted the making of, misrepresentations regarding Costco. 12 264. Defendants’ conduct constituted an abuse of their ability to control and influence 13 Costco. 14 265. By reason of the foregoing, Costco has been damaged. 15 COUNT VI 16 Gross Mismanagement Against All Defendants 17 18 266. Plaintiffs incorporate by reference and reallege each and every allegation set forth 19 above, as though fully set forth herein. 20 267. Defendants had a duty to Costco and its shareholders to prudently supervise, manage, 21 and control the operations, business, and internal financial accounting and disclosure controls of 22 Costco. 23 268. Defendants, by their actions and by engaging in the wrongdoing described herein, 24 abandoned and abdicated their responsibilities and duties with regard to prudently managing the 25 businesses of Costco in a manner consistent with the duties imposed upon them by law. By 26 committing the misconduct alleged herein, defendants breached their duties of due care, diligence, CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 129 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 131 of 141 1 and candor in the management and administration of Costco’s affairs and in the use and preservation 2 of Costco’s assets. 3 269. During the course of the discharge of their duties, defendants knew or recklessly 4 disregarded the unreasonable risks and losses associated with their misconduct, yet defendants 5 caused Costco to engage in the scheme complained of herein which they knew had an unreasonable 6 risk of damage to Costco, thus breaching their duties to the Company. As a result, defendants 7 grossly mismanaged Costco. 8 270. By reason of the foregoing, Costco has been damaged. 9 COUNT VII 10 Constructive Fraud Against All Defendants 11 271. Plaintiffs incorporate by reference and reallege each and every allegation set forth 12 above, as though fully set forth herein. 13 272. As corporate fiduciaries, defendants owed to Costco and its shareholders a duty of 14 candor and full accurate disclosure regarding the true state of Costco’s business and assets and their 15 conduct with regard thereto. 16 273. As a result of the conduct complained of, defendants made, or aided and abetted the 17 making of, numerous misrepresentations to and/or concealed material facts from Costco’s 18 shareholders despite their duties to, inter alia, disclose the true facts regarding their stewardship of 19 Costco. Thus they have committed constructive fraud and violated their duty of candor. 20 274. By reason of the foregoing, Costco has been damaged. 21 COUNT VIII 22 23 Corporate Waste Against Defendants Sinegal, Galanti, James, Meisenbach, Ruckelshaus, Carson and Munger 24 275. Plaintiffs incorporate by reference and reallege each and every allegation set forth 25 above, as though fully set forth herein. 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 130 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 132 of 141 1 276. By failing to properly consider the interests of the Company and its public 2 shareholders, by failing to conduct proper supervision, and by giving away millions of dollars to 3 defendants via the option backdating scheme, defendants have caused Costco to waste valuable 4 corporate assets. 5 277. As a result of defendants’ corporate waste, they are liable to the Company. 6 COUNT IX 7 Unjust Enrichment Against All Defendants 8 278. Plaintiffs incorporate by reference and reallege each and every allegation set forth 9 above, as though fully set forth herein. 10 279. As a result of the conduct described above, defendants will be and have been unjustly 11 enriched at the expense of Costco, in the form of unjustified salaries, benefits, bonuses, stock option 12 grants and other emoluments of office. 13 280. All the payments and benefits provided to the defendants were at the expense of 14 Costco. The Company received no benefit from these payments. Costco was damaged by such 15 payments. 16 281. Certain of the defendants sold Costco stock (derived from options or stock grants by 17 the Company to defendants) for a profit during the period of deception, misusing confidential non18 public corporate information, and unjustly exploiting the backdating of options and the effect of the 19 backdating on the Company and its financial statements. These defendants should be required to 20 disgorge the gains which they have and/or will otherwise unjustly obtain at the expense of Costco. 21 A constructive trust for the benefit of the Company should be imposed thereon. 22 COUNT X 23 24 25 Common Law Rescission Against Defendants Sinegal, Brotman, Galanti, DiCerchio and Petterson 282. Plaintiffs incorporate by reference and reallege each and every allegation contained 26 above as though fully set forth herein. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 131 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 133 of 141 1 283. As a result of the acts alleged herein, the stock option contracts between the 2 defendants and Costco entered into during the relevant period were obtained through defendants’ 3 fraud, deceit and abuse of control. Further, the backdated stock options were illegal grants and thus 4 invalid as they were not authorized in accordance with the terms of the publicly filed contracts 5 regarding the defendants’ employment agreements and the Company’s stock option plan which was 6 also approved by Costco’s shareholders and filed with the SEC. 7 284. All contracts which provide for stock option grants between the defendants and 8 Costco and were entered into during the relevant period should, therefore, be rescinded, with all 9 sums paid under such contracts returned to the Company, and all such executory contracts cancelled 10 and declared void. PRAYER FOR RELIEF 11 12 WHEREFORE, plaintiffs demand judgment as follows: 13 A. Awarding money damages against all defendants, jointly and severally, for all losses 14 and damages suffered as a result of the acts and transactions complained of herein, together with pre15 judgment interest, to ensure defendants do not participate therein or benefit thereby; 16 B. Directing all defendants to account for all damages caused by them and all profits and 17 special benefits and unjust enrichment they have obtained as a result of their unlawful conduct, 18 including all salaries, bonuses, fees, stock awards, options and common stock sale proceeds, and 19 imposing a constructive trust thereon; 20 C. Directing Costco to take all necessary actions to reform and improve its corporate 21 governance and internal control procedures to comply with applicable law, including, but not limited 22 to, putting forward for a shareholder vote resolutions for amendments to the Company’s By-Laws or 23 Articles of Incorporation and taking such other action as may be necessary to place before 24 shareholders for a vote adoption of improved Corporate Governance policies, including the 25 following proposals to: 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 132 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 134 of 141 1 (i) strengthen Costco’s Board structure by improving the independence of (ii) strengthen the Costco Board’s supervision of operations and develop 2 the Board; 3 4 and implement procedures for greater shareholder input into the policies and guidelines of the Board; 5 (iii) appropriately test and then strengthen the internal audit and control (iv) rotate independent auditing firms or audit partners every four years; (v) control and limit insider stock selling and the terms and timing of 6 function; 7 8 and 9 10 stock option grants; and (vi) 11 ensure that all stock options are properly awarded, valued and 12 administered in accordance with the stock option plans and all applicable laws, regulations and rules; D. 13 Ordering the imposition of a constructive trust over defendants’ stock options and any 14 proceeds derived therefrom; 15 E. Awarding punitive damages; 16 F. As to all improperly dated and/or improperly priced options that have been exercised, 17 ordering defendants to make a payment to the Company in an amount equal to the difference 18 between the prices at which the options were exercised and the exercise prices the options should 19 have carried if they were priced at fair market value on the actual date of grant; G. 20 As to all improperly dated and/or improperly priced options that have been granted 21 but not yet exercised or expired, ordering the Company to rescind such options so they carry the 22 exercise prices they should have carried if they were priced at fair market value on the actual date of 23 grant; 24 H. Awarding costs and disbursements of this action, including reasonable attorneys’, 25 accountants’ and experts’ fees; and 26 I. Granting such other and further relief as this Court may deem just and proper. CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 133 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 135 of 141 JURY DEMAND 1 2 Plaintiffs hereby demand a trial by jury. 3 DATED: October 2, 2009 4 5 6 COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP TRAVIS E. DOWNS III JAMES I. JACONETTE (Admitted Pro Hac Vice) KATHLEEN A. HERKENHOFF ANDREW J. BROWN BENNY C. GOODMAN III LUCAS F. OLTS 7 8 s/ JAMES I. JACONETTE JAMES I. JACONETTE 9 655 West Broadway, Suite 1900 San Diego, CA 92101-3301 Telephone: 619/231-1058 619/231-7423 (fax) E-mail: jamesj@csgrr.com 10 11 12 17 COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP SHAWN A. WILLIAMS JOHN K. GRANT CHRISTOPHER M. WOOD 100 Pine Street, Suite 2600 San Francisco, CA 94111 Telephone: 415/288-4545 415/288-4534 (fax) 18 Lead Counsel for Plaintiffs 19 BARRETT, JOHNSTON & PARSLEY GEORGE E. BARRETT (Admitted Pro Hac Vice) DOUGLAS S. JOHNSTON, JR. (Admitted Pro Hac Vice) TIMOTHY L. MILES (Admitted Pro Hac Vice) 217 Second Avenue, North Nashville, TN 37201-1601 Telephone: 615/244-2202 615/252-3798 (fax) E-mail: gbarrett@barrettjohnston.com djohnston@barrettjohnston.com tmiles@barrettjohnston.com 13 14 15 16 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 134 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 136 of 141 1 LOVELL MITCHELL & BARTH LLP KARL P. BARTH, WSBA No. 22780 911 Western Avenue, Suite 308 Seattle, WA 98104 Telephone: 206/432-8330 206/432-8331 (fax) E-mail: kbarth@lmbllp.com 2 3 4 5 Attorneys for Plaintiff Pirelli Armstrong Tire Corporation Retiree Medical Benefits Trust 6 SARRAF GENTILE LLP RONEN SARRAF (Admitted Pro Hac Vice) JOSEPH GENTILE (Admitted Pro Hac Vice) 116 John Street, Suite 2310 New York, NY 10038 Telephone: 212/868-3610 212/918-7967 (fax) E-mail: ronen@sarrafgentile.com joseph@sarrafgentile.com 7 8 9 10 11 VIANALE & VIANALE LLP KENNETH J. VIANALE (Admitted Pro Hac Vice) JULIE PRAG VIANALE 2499 Glades Road, Suite 112 Boca Raton, FL 33431 Telephone: 561/392-4750 516/392-4775 (fax) E-mail: kvianale@vianalelaw.com 12 13 14 15 16 17 18 Document1 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 135 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 Case Document 43 Filed 10/02/09 Page 137 of 141 Seymour, hmby declam IS follows: I am Chairman of the Bonn! of Pim?i mm Tin: Corpomion Retiree Medical Benc?ts Trust Pim?i in a shareholder of Costco Wholcsalt Cmmlion and has ham at the mlcvant time pertinent hmm. I certify under of pcsjuzy than hum: the Consolidated Vui?ed Shacholder Duivnivc Complaint and anthem: its ?xing and. based upon the investigation of my mum-:1. that!? contains in the Complaint are true to m: be? of my knowledge. infon'm?on and bc?ef. DATED: October 2, 2009 . mm. SEYMO Chairman Beard Pirnlli Amman; ?It Cmtion Retina Medial! Bene?t: This! 2485696737 Document 43 Filed 10/03/619111Elage 18824260141 1, Daniel Back?re, hereby declare as follows: I am a shareholder of Costco Wholesale Corporation and have been at the relevant time pertinent hereto. I certify under penalty of perjury that I have reviewed the foregoing Consolidated Veri?ed Shareholder Derivative Complaint (?Complaint?), and authorize its ?ling and, based upon the investigation of my counsel, that the contents in the Complaint are true to the best of my knowledge, information and belief. 04' 722? DANIEL BUCKFIRE DATED: October 2, 2009 2l2 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 139 of 141 1 2 CERTIFICATE OF SERVICE I hereby certify that on October 2, 2009, I electronically filed the foregoing with the Clerk of 3 the Court using the CM/ECF system which will send notification of such filing to the e-mail 4 addresses denoted on the attached Electronic Mail Notice List, and I hereby certify that I have 5 mailed the foregoing document or paper via the United States Postal Service to the non-CM/ECF 6 participants indicated on the attached Manual Notice List. 7 I certify under penalty of perjury under the laws of the United States of America that the 8 foregoing is true and correct. Executed on October 2, 2009. 9 s/ JAMES I. JACONETTE JAMES I, JACONETTE 10 14 COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP 655 West Broadway, Suite 1900 San Diego, CA 92101-3301 Telephone: 619/231-1058 619/231-7423 (fax) 15 E-mail: jamesj@csgrr.com 11 12 13 16 17 18 19 20 21 22 23 24 25 26 CONSOLIDATED VERIFIED SHAREHOLDER DERIVATIVE COMPLAINT (2:08-cv-01450-TSZ) - 136 - Coughlin Stoia Geller Rudman & Robbins LLP 655 West Broadway, Suite 1900, San Diego, CA 92101 Telephone: (619) 231-1058 • Fax: (619) 231-7423 WAWD CM/ECF Version 3.2.2 Page 1 of 2 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 140 of 141 Mailing Information for a Case 2:08-cv-01450-TSZ Electronic Mail Notice List The following are those who are currently on the list to receive e-mail notices for this case. George Edward Barrett gbarrett@barrettjohnston.com Karl Phillip Barth kbarth@lmbllp.com,shelby@lmbllp.com Brad D Brian brianbd@mto.com Robert L Dell Angelo robert.dellangelo@mto.com,cynthia.silvas@mto.com Kimberly D Encinas kimberly.encinas@mto.com,cynthia.silvas@mto.com Juli E. Farris jfarris@KellerRohrback.com,lgerber@kellerrohrback.com,kwesterlin@KellerRohrback.com Joseph Gentile joseph@sarrafgentile.com James I Jaconette jamesj@csgrr.com,e_file_sd@csgrr.com Douglas S Johnston , Jr djohnston@barrettjohnston.com Laurel A Johnston ljohnston@barrettjohnston.com Stellman Keehnel stellman.keehnel@dlapiper.com,patrick.jordan@dlapiper.com,patsy.howson@dlapiper.com Joseph D Lee joseph.lee@mto.com,cynthia.silvas@mto.com Angela R Martinez AMartinez@perkinscoie.com,docketsea@perkinscoie.com,SSundmark@perkinscoie.com Bradley T. Meissner bradley.meissner@dlapiper.com https://ecf.wawd.uscourts.gov/cgi-bin/MailList.pl?271143610039511-L_497_0-1 10/2/2009 WAWD CM/ECF Version 3.2.2 Page 2 of 2 Case 2:08-cv-01450-TSZ Document 43 Filed 10/02/09 Page 141 of 141 Timothy L Miles tmiles@barrettjohnston.com Ronen Sarraf ronen@sarrafgentile.com J Ronald Sim jrsim@stoel.com,jalorton@stoel.com,SEA_DOCKET@stoel.com David F Taylor DFTaylor@perkinscoie.com,docketsea@perkinscoie.com,KKlemperer@perkinscoie.com Kenneth Jerome Vianale kvianale@vianalelaw.com Manual Notice List The following is the list of attorneys who are not on the list to receive e-mail notices for this case (who therefore require manual noticing). You may wish to use your mouse to select and copy this list into your word processing program in order to create notices or labels for these recipients. (No manual recipients) https://ecf.wawd.uscourts.gov/cgi-bin/MailList.pl?271143610039511-L_497_0-1 10/2/2009