UNITED STATES DISTRICT COURT EASTERN DISTRICT OF NEW...

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UNITED STATES DISTRICT COURT EASTERN DISTRICT OF NEW YORK

BARRY BLANK, on behalf of himself and all others similarly situated

Plaintiff,

-against- VICTOR JACOBS, et. al,

Defendants.

Civil Action No. 03-CV-2353 (Consolidated No. 03-CV-2111) THIRD CONSOLIDATED AMENDED CLASS ACTION COMPLAINT FOR VIOLATIONS OF THE FEDERAL SECURITIES LAWS JURY TRIAL DEMANDED

NATURE OF THE ACTION

Lead Plaintiffs William D. Witter Partners, LLP, David P. Herpst and David Hust,

pursuant to their appointment as Lead Plaintiffs by this Court on September 18, 2003, and

pursuant to the Order of the Honorable Joanna Seybert dated August 17, 2005, on behalf of

themselves and all others similarly situated, by their attorneys, allege the following based upon

the investigation of counsel, except as to allegations specifically pertaining to plaintiffs and their

counsel, which are based on personal knowledge. The investigation of counsel is predicated

upon, among other things, a review of Allou Health & Beauty Care, Inc. (“Allou” or the

“Company”) public filings with the United States Securities and Exchange Commission

(“SEC”), press releases issued by the Company, media reports about the Company and court

filings, including the Complaint and Affidavit in Support of Application for Arrest Warrants in

United States v. Jacobowitz, Case No. M-03-1254 (E.D.N.Y. Aug. 8, 2003), the Complaint

Case 2:03-cv-02111-JS-WDW Document 146 Filed 09/18/2006 of 81

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against Allou filed by the Company’s Interim Chapter 11 Trustee, Silverman v. Jacobs, Case No.

03-82321 (Bankr. E.D.N.Y. Apr. 9, 2003), and the Bankruptcy Trustee’s Complaint against

Allou’s auditors, Silverman v. KPMG LLP, Arthur Andersen LLP and Mayer Rispler &

Company, P.C., No. 03-82321-511 (MLC), Adv. Pro. No. 04-8384 (Bankr. E.D.N.Y.) (and

including as amended – Third Amended Complaint filed June 30, 2006). Plaintiffs believe that

substantial additional evidentiary support will exist for the allegations set forth herein after a

reasonable opportunity for discovery.

SUMMARY OF THE ALLEGATIONS

1. This is a securities fraud class action brought on behalf of all purchasers of the

Class A Common Stock of Allou between June 21, 2000 and April 9, 2003, inclusive (the “Class

Period”) for violations of the Securities Exchange Act of 1934 (the “Exchange Act”).

2. Throughout the Class Period, Allou perpetrated a massive fraud on the investing

public. Since as early as 1994, defendants Victor Herman and Jack Jacobs (who are father and

sons, also known by the family name Jacobowitz) along with defendant David Shamilzadeh and

another son, Aaron Jacobowitz, and others, used a plethora of fraudulent devices to falsify the

financial results of Allou, a distributor of health, beauty and pharmaceutical products. Among

other things, these defendants, who, except for Aaron Jacobowitz, were the key executives of and

controlled Allou through their stock ownership, created false invoices and posted false accounts

receivable on the financial books of Allou. They also falsified inventory records to create non-

existent inventories on the books of the Company. These false transactions permitted these

defendants to transfer cash from Allou to their own pockets and to the pockets of other family

members and associates. The fraud also permitted Allou to borrow large sums from its lenders

in amounts proportionate to the grossly inflated accounts receivable and inventory assets


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appearing on books and in the public financial reports of the Company.

3. When the fraud was finally uncovered in March 2003, not by Allou’s

independent outside auditors or by the supposedly independent Audit Committee of the Allou

Board of Directors, but by a review by one of Allou’s major lenders, it was determined that

Allou’s accounts receivable had been falsely inflated by $75 million to $80 million and the

Company’s inventories were overstated by approximately $35 million, for a total of $110 million

to $115 million of fraudulent transactions. These fraudulent transactions represented a huge

portion of those assets as publicly reported by Allou. As of March 2003, the investigation

revealed that Allou had on its books $129 million of receivables of which only $29 million were

real. The fictitious receivables and inventory therefore constitute a very significant and material

part of Allou’s reported business.

4. That the fraud was broad and not particularly sophisticated is evidenced by the

fact uncovered in the April 2003 investigation that Allou was able to create fictitious invoices in

the millions of dollars to major customers such as Wal-Mart Stores, Inc. (“Wal-Mart”). The

Jacobs and Shamilzadeh then circulated cash from Allou, through fictitious purchases of

inventory by Allou, to one or more undisclosed related entities that were part of the fraud. These

entities, in turn, used Allou’s cash to pay the fictitious invoices purportedly incurred by the

major customers. No goods were actually shipped or received by Allou. This scheme was also

used to siphon money out of Allou to Jacobs family members and associates. In a single year of

this long-running conspiracy, the Jacobs in 2003 took approximately $15 million out of Allou.

These fictitious sales totaled at least $220 million between January 2000 and March 2003, or

almost 40% of Allou’s reported sales for this period.

5. Virtually all of these suspected false purchases of inventory were not


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documented in Allou’s files in the usual manner for legitimate purchases. As the Postal

Inspector stated in the Complaint and Affidavit in Support of Application for Arrest Warrant,

Silverman v. Jacobs, Case No. M-03-1254 (E.D.N.Y. Aug. 8, 2003)(“the Criminal Complaint”),

[V]irtually all of the suspect inventory purchases lack the typical back-up documentation which exists in Allou’s files for legitimately purchased inventory, such as customer invoices, bills of lading, receiving reports and other paperwork. Of the $198 million in suspect inventory purchases from January 2002 through March 2003, approximately $150 million of these supposed purchases were not accompanied by a customer invoice. Even where such an invoice is found, other documentation which an auditor would expect to find in the case of legitimate purchases is not present. 6. The Criminal Complaint also cited evidence that, inter alia, the creation of

fictitious inventory had taken place over many years and that, as of a date as early as the mid-

1990’s, approximately $40 million of Allou’s inventory was non-existent. Defendants Mayer

Rispler & Company PC, Arthur Andersen LLP and KPMG LLP, who were each outside auditors

for Allou at different times during the Class Period, never discovered, or never reported to the

relevant authorities, that the Company had been falsely reporting its results for years. They

failed to discover the fraud, or failed to report the fraud, despite the fact that the fraud was

relatively unsophisticated and left large holes in the back-up documentation that would normally

have been in Allou’s files as evidence of legitimate transactions. Yet, the suspicious nature of

transactions at Allou was apparent enough to be detected by one of the Company’s lenders on a

routine field examination of Allou’s inventory and accounts receivable in March 2003.

7. The outside directors, defendants Stuart Glasser, Jeffrey Berg and Sol Naimark,

also bear legal responsibility for the success and extent of the fraudulent scheme. (See Paragraph

27 below). These directors utterly failed to carry out their duties as members of the Audit

Committee of the Board of Directors of Allou. Their ready willingness to blind themselves to

the possibility of improper acts by Allou management and their failure to make any meaningful


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inquiry as members of the Audit Committee is demonstrated by the following: In September

2002, a fire destroyed the Brooklyn warehouse where Allou purportedly kept over $80 million of

its inventory. By November 8, 2002, officials had determined that the fire was of a suspicious

nature and was probably set intentionally. The business press immediately began to question the

integrity of Allou management. It was revealed for the first time that the warehouse was owned

by defendant Victor Jacobs’ wife and son Aaron. Notwithstanding these events, defendant Sol

Naimark, interviewed for a subsequent November 22, 2002 article in Newsday, stated, “The

Company itself is a very strong company and very well run.”

8. As a result of the investigation that followed, on April 9, 2003, Allou’s senior

creditors filed an involuntary petition against the Company and its subsidiaries in the United

States Bankruptcy Court of the Eastern District of New York.

9. On the day of the bankruptcy filing, the Company’s Class A common stock fell

to $1.07, down from a closing price of $1.44 on the previous day and down from over $8 per

share less than a year before. Also, on April 9, 2003, the American Stock Exchange (“AMEX”)

suspended trading in Allou stock, which had approximately 5.5 million shares of Class A

common stock outstanding in the hands of public shareholders. As a result of the false financial

reporting and unqualified reports by the outside auditor defendants, the investing public,

including Lead Plaintiffs and the other plaintiffs and the Class herein, were deceived and led to

believe that Allou was a successful and growing company with good management. In fact,

Allou, whose stock traded as high as $13.25 during the Class Period, was virtually worthless as a

public company because its business was largely a sham and nothing more than a vehicle for the

Jacobs and their other family and associates to profit personally from a fraudulent enterprise.

Lead Plaintiffs and the other plaintiffs and the Class in this consolidated litigation paid grossly


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inflated prices for their Allou shares and have suffered tens of millions of dollars of damages as a

result.

JURISDICTION AND VENUE

10. This Court has jurisdiction over the subject matter of this action pursuant to 28

U.S.C. §§1331 and 1337, and §27 of the Exchange Act, 15 U.S.C. §78aa.

11. This action arises under Sections 10(b) and of 20(a) of the Exchange Act, 15

U.S.C. §§ 78j(b), 78t and SEC Rule 10b-5, 17 C.F.R. §240.10b-5.

12. Venue is proper in this District pursuant to Section 27 of the Exchange Act, 15

U.S.C. §78aa, and 28 U.S.C. §1391(b) and (c). Substantial acts in furtherance of the alleged

fraud and/or its effects have occurred within this District and defendants conduct substantial

business in this District.

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

directly or indirectly, used the means and instrumentalities of interstate commerce, including, but

not limited to, the mails, interstate telephone communications and the facilities of the national

securities markets.

PARTIES

14. Lead Plaintiffs William D. Witter Partners, LLP, David P. Herpst and David

Hust purchased Allou Class A common shares during the Class Period as set forth in the

certifications accompanying their Motion For the Consolidation of Related Actions, To Be

Appointed Lead Counsel and for Approval of Lead Plaintiffs’ Selection of Counsel, previously

filed in this action. Lead Plaintiffs have suffered in excess of one million dollars of damages as a

result of the wrongs alleged.

15. Allou is a Delaware corporation with principal offices located at 50 Emjay


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Boulevard, Brentwood, New York 11717. Allou at all relevant times was a public company that

distributed consumer personal care products and prescription pharmaceuticals on a national basis

to such merchandisers as Sears Roebuck & Co. (“Sears”), Wal-Mart, J.C. Penney, Target, CVS

and Walgreens. It also manufactured upscale hair and skin care products for sale under private

labels. The Company’s consumer personal care products distribution business included prestige

brand name designer fragrances, brand name health and beauty aids products and non-perishable

packaged food items. Until April 10, 2003, Allou’s Class A common stock was traded on the

American Stock Exchange. At that time, approximately 5.5 million shares of common stock

were outstanding in the hands of public shareholders. Allou also had outstanding 1.2 million

shares of Class B common stock in the hands of the Jacobs family named as defendants herein

and related parties. By virtue of the voting strength of the Class B common shares, the Jacobs

family members had voting control of Allou, including the election of its directors. In April

2003, as a result of the unraveling of the fraudulent scheme explained below, Allou and its

subsidiaries were forced into a Chapter 11 bankruptcy reorganization proceedings in the

Bankruptcy Court for the Eastern District of New York. The Chapter 11 proceeding was

converted to a Chapter 7 liquidation in September 2003. But for the fact that it is the subject of a

bankruptcy proceeding, and an automatic stay pursuant to Section 362 of the U.S. Bankruptcy

Code, Allou would be named a defendant in this litigation.

16. Defendant Victor Jacobs (“V. Jacobs”) a/k/a Victor Jacobowitz a/k/a Victor

Jacobovitz was, at all relevant times, employed by Allou as its Chairman of the Board of

Directors. As of June 15, 2002, V. Jacobs owned 46.1 percent of the Company’s Class B stock

and 2.1 percent of the Company’s Class A stock, which represented 28.3 percent of voting

power. In 2002, V. Jacobs received an annual salary from Allou of $500,000. V. Jacobs is the


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father of defendants Herman and Jack Jacobs. V. Jacobs was named as a defendant in the earlier

complaints filed in this consolidated action, and will hereinafter continue to be referred to as a

defendant. However, civil legal process against V. Jacobs has been automatically stayed

pursuant to Section 362 of the Bankruptcy Code [11 U.S.C. § 362].

17. Defendant Herman Jacobs (“H. Jacobs”) a/k/a Herman Jacobowitz a/k/a

Herman Jacobovitz was, at all relevant times, employed by Allou as its Chief Executive Officer

and Chief Operating Officer, and a director. As of June 15, 2002, H. Jacobs owned 26.3 percent

of the Company’s Class B stock and 2.1% Class A stock, which represented 16.6 percent of

voting power. In 2002, H. Jacobs received an annual salary of $500,000. H. Jacobs was named

as a defendant in the earlier complaints in this consolidated action, and will hereinafter continue

to be referred to as a defendant. However, legal process against H. Jacobs has been

automatically stayed pursuant to Section 362 of the Bankruptcy Code [11 U.S.C. § 362].

18. Defendant Jacob Jacobs (“J. Jacobs”) a/k/a Jack Jacobs a/k/a Jacob Jacobowitz

a/k/a Jacob Jacobovitz was, at all relevant times employed by Allou as Executive Vice President

and a director. As of June 15, 2002, J. Jacobs owned 28.8 percent of the Company’s Class B

stock and 2.1 percent of Class A stock, representing 13.9 percent of voting power. In June 2002,

J. Jacobs received from Allou an annual salary of $500,000. J. Jacobs was named as a defendant

in the earlier complaints in this consolidated action, and will hereinafter continue be referred to

as a defendant. However, legal process against J. Jacobs has been automatically stayed pursuant

to Section 362 of the Bankruptcy Code [11 U.S.C. § 362].

19. On September 9, 2003, the Bankruptcy Court entered Orders for Relief of V.

Jacobs, H. Jacobs and J. Jacobs. On August 12, 2003, V. Jacobs, H. Jacobs and J. Jacobs were

arrested and, on June 17, 2004, indicted for their activities in connection with Allou Companies.


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20. Defendant David Shamilzadeh (“Shamilzadeh”) was, at all relevant times,

employed by the Company as its President and Principal Financial Officer, Principal Accounting

Officer, and a director. As of June 15, 2002, Shamilzadeh owned 2.1 percent of the Company’s

Class B stock and 3.5 percent of the Class A stock, which represents 1.8 percent voting power.

In 2002, Shamilzadeh received an annual salary of $420,000, as well as a $120,000 bonus.

21. According to the Company’s April 24, 2003 Form 8-K filed with the SEC, the

Company terminated its employment of defendants V. Jacobs, H. Jacobs, Shamilzadeh, and J.

Jacobs, but each of them at that time retained his seat on the Company’s board of directors, with

V. Jacobs retaining the board position of Chairman.

22. Defendant Jeffrey Rabinovich (“Rabinovich”) was, since July 2000, employed

by the Company as Vice President, Chief Systems Analyst and Secretary. From January 1999 to

July 2000, defendant Rabinovich served as the Executive Assistant to the then President of

Allou, defendant Herman Jacobs.

23. Defendants V. Jacobs, H. Jacobs, Shamilzadeh, J. Jacobs and Rabinovich are

sometimes referred to collectively herein as the “Individual Defendants.”

24. Because of their positions with the Company, the Individual Defendants had

access to material adverse undisclosed information about the Company’s financial condition.

They had access to internal corporate documents, including the Company’s operating plans,

budgets and forecasts and reports of actual operations. Each of the Individual Defendants were

responsible for the accuracy of the public reports detailed herein and are therefore liable for the

representations contained therein.

25. Defendant Stuart Glasser (“Glasser”) served as a director of the Company since

February 2000. Defendants Jeffrey Berg (“Berg”) and Sol Naimark (“Naimark”) were, at all


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relevant times, directors of the Company. Glasser, Berg and Naimark were not officers or

employees of Allou but, from 2000 to 2003 served as the Audit Committee of Allou’s Board of

Directors. Prior to 2000 and during the Class Period, Berg and Naimark served with defendant

Shamilzadeh on the Audit Committee of Allou.

26. Defendants Glasser, Berg and Naimark are collectively referred to as the

“Additional Director Defendants.”

27. Pursuant to the order of this Court, signed on September 30, 2005, the claims

against Additional Director Defendants were dismissed with prejudice. On October 17, 2005,

plaintiffs timely filed a motion for a reconsideration of the order to the extent it denied plaintiffs

the opportunity to amend the complaint. On October 31, 2005, the Additional Director

Defendants filed a memorandum in opposition to plaintiffs’ motion, and plaintiffs filed a reply

on November 7, 2005. Subsequently, and before a hearing was heard on plaintiffs’ motion,

plaintiffs and the Additional Director Defendants reached an agreement to settle plaintiffs’

claims subject to the approval of this Court. A hearing to approve this partial settlement with the

Additional Director Defendants has been scheduled for October 18, 2006. In this complaint,

plaintiffs include claims against the Additional Director Defendants only to preserve these claims

for further review by this Court or for appeal in the event that the proposed settlement does not

become final.

28. According to Allou’s filings with the SEC, the Additional Director Defendants

were members of the Board’s Audit Committee. According to Allou’s Proxy Statements on

Form 14A for the years 2000 to 2002, the Audit Committee performed the following functions

during the relevant time period: (a) review of periodic financial statements; (b) communication

with independent accountants; (c) review of internal accounting controls; and (d) recommend


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selection of independent auditors to the Company’s Board of Directors.

29. On April 24, 2003, defendants Glasser and Berg resigned as Allou board

members. Defendant Naimark remained on the board.

30. Defendant Mayer Rispler & Company, P.C. (“Mayer Rispler”) is an accounting

firm that maintains an office at 18 Heyward Street, Brooklyn, New York. Mayer Rispler served

as the Company’s auditor at all relevant times until it was replaced by Arthur Andersen, LLP

(“Arthur Andersen”) on June 14, 2001. On April 1, 2000, Mayer Rispler joined an alliance of

accounting firms with BDO Seidman, LLP, the approximately eighth largest accounting firm in

the United States. Mayer Rispler issued unqualified reports on Allou’s financial statements for

the year ending March 31, 2000, certifying, inter alia, that it had audited the financial statements

in accordance with Generally Accepted Accounting Standards (“GAAS”) and that, in its opinion,

the financial statements presented the financial position of Allou fairly and in conformity with

Generally Accepted Accounting Principles (“GAAP”).

31. Defendant Arthur Andersen LLP (“Arthur Andersen”), until June 2002,

provided auditing and accounting services and maintained offices across the United States,

including Melville, New York. Arthur Andersen served as the Company’s independent auditor

for the fiscal year ended March 31, 2001. Arthur Andersen issued an unqualified report on

Allou’s financial statements for fiscal 2001, certifying, inter alia, that it had audited the financial

statements in accordance with GAAS and that, in Andersen’s opinion, the financial statements

presented the financial position of Allou fairly and in conformity with GAAP. In addition, in

2001 and 2002, Arthur Andersen reviewed the financial statements included in the Company’s

Quarterly Reports on Form 10-Q filed with the SEC. Arthur Andersen also performed tax-

related services to the Company during the fiscal year ended March 31, 2002. The Company


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terminated its relationship with Arthur Andersen on June 6, 2002.

32. Arthur Andersen used to be one of the Big Five accounting firms. On June 15,

2002, Arthur Andersen was convicted of obstruction of justice for destroying documents in

connection with the investigation of Enron Corporation. In 2002, the firm lost its auditing

license in the United States as a result of its involvement in the Enron collapse and was replaced

as outside auditor for Allou by defendant KPMG LLP.

33. Defendant KPMG LLP (“KPMG”) is an accounting firm duly organized and

existing under the laws of the State of Delaware, and has its main office located at 345 Park

Avenue, New York, New York, and it maintains an office located in Melville, New York.

KPMG served as the Company’s independent auditors from 2002 to the present. KPMG issued

unqualified reports on Allou’s financial statements for the year ended March 31, 2002,

certifying, inter alia, that it had audited the financial statements in accordance with GAAS and

that, in its opinion, the financial statements presented the financial position of Allou fairly and in

conformity with GAAP. Fees billed to the Company by KPMG for its audit of the Company’s

financial statements for the fiscal year ended March 31, 2002 totaled approximately $75,000.

34. At various times in this complaint, defendants Mayer Rispler, Arthur Andersen

and KPMG are collective referred to as the “Auditor Defendants”. Mayer Rispler, Arthur

Andersen and KPMG, because of their positions as the Company’s outside auditors during the

Class Period, were responsible for auditing and certifying the financial statements that were

publicly filed. The auditors knew, or recklessly disregarded, the falsity of the financial

statements disseminated by Allou. Mayer Rispler, Arthur Andersen and KPMG were reckless in

that they, among other things, deviated from appropriate audit standards, which if they had

adhered to, would have resulted in the discovery and disclosure of the fraud described herein.


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CLASS ACTION ALLEGATIONS

35. Plaintiffs bring this action as a class action pursuant to Federal Rules of Civil

Procedure 23(a) and (b)(3) on behalf of a class (the “Class”), consisting of all persons who

purchased the Class A Common Stock of Allou during the Class Period, June 21, 2000 to April

9, 2003, inclusive. Excluded from the Class are defendants, the officers and directors of the

Company at all relevant times, members of their immediate families and their legal

representatives, heirs, successors or assigns and any entity in which defendants have or had a

controlling interest.

36. The members of the Class are so numerous that joinder of all members is

impracticable. Throughout the Class Period, Allou had outstanding approximately 6.1 million

shares of Class A Common Stock, of which about 5.5 million were owned by shareholders

unaffiliated with Allou. These shares were actively traded on the American Stock Exchange.

While the exact number of Class members is unknown to plaintiffs at this time and can only be

ascertained through appropriate discovery, plaintiffs believe that there are hundreds or thousands

of members in the proposed Class. Record owners and other members of the Class may be

identified from records maintained by Allou or its transfer agent and may be notified of the

pendency of this action by mail, using the form of notice similar to that customarily used in

securities class actions.

37. Plaintiffs’ claims are typical of the claims of the members of the Class, as all

members of the Class are similarly harmed by defendants’ wrongful conduct in violation of

federal law that is complained of herein.

38. Plaintiffs will fairly and adequately protect the interests of the members of the

Class and has retained counsel competent and experienced in class and securities litigation.


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39. Common questions of law and fact exist as to all members of the Class and

predominate over any questions solely affecting individual members of the Class. Among the

questions of law and fact common to the Class are:

(1) whether the federal securities laws were violated by defendants’ acts as alleged herein;

(2) whether statements made by defendants to the investing public during the Class

Period misrepresented material facts about the business and operations of Allou; and

(3) to what extent the members of the Class have sustained damages and the proper

measure of damages. 40. A class action is superior to other available methods for the fair and efficient

adjudication of this controversy since joinder of all members of the Class is impracticable.

Furthermore, as the damages suffered by individual Class members may be relatively small, the

expense and burden of individual litigation make it impossible for members of the Class to

individually redress the wrongs done to them. Plaintiffs anticipate no unusual difficulties in the

management of this action as a class action.

41. Plaintiffs and the Class will rely, in part, upon the presumption of reliance

established by the fraud-on-the-market doctrine. At all relevant times, the market for the

Company’s securities was an efficient market for the following reasons, among others:

(a) Allou’s stock met the requirements for listing, and was listed and actively

traded on the American Stock Exchange, a highly efficient and automated

market;

(b) As a regulated issuer, the Company filed periodic public reports with the SEC

and the American Stock Exchange;


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(c) The Company regularly communicated with public investors via established

market communication mechanisms, including through regular disseminations

of press releases on the national circuits of major newswire services and

through other wide-ranging public disclosures, such as communications with

the financial press and other similar reporting services; and

(d) The Company was followed by securities analysts employed by major

brokerage firms who wrote reports, which were distributed to the sales force

and certain customers of their respective brokerage firms. Each of these

reports was publicly available and entered the public marketplace.

42. As a result of the foregoing, the market for the Company’s securities promptly

digested current information regarding the Company from all publicly available sources and

reflected such information in the Company’s stock price. Under these circumstances, all

purchasers of Allou's securities during the Class Period suffered similar injury through their

purchase of the Company’s securities at artificially inflated prices and a presumption of reliance

applies.

SUBSTANTIVE ALLEGATIONS

Defendants’ Fraudulent Scheme

43. Since even prior to the Class Period, Allou and the Individual Defendants had

been engaged in an immense fraudulent scheme to falsify the sales, profits, accounts receivable,

inventories and assets of Allou through a pattern of phony transactions and falsified books and

records. In fact, the practice of creating bogus inventory and receivables was in place at Allou at

least as far back as the mid-1990s. The result of the fraud perpetrated by defendants was to

significantly overstate inventory and receivables in order to grossly inflate the Company’s


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reported profits, to enable defendants to increase funds available to Allou from its lenders and to

divert to themselves millions of dollars of corporate funds.

44. In order to implement this scheme, the Company devised a system of computer

passwords that, in effect, created two sets of financial books within its computer system. Under

the system, true and accurate information regarding Allou’s financial condition was available in

Allou’s computer system to the employees who ran its daily operations. However, Allou’s

computer system also permitted the participants in this fraudulent scheme to create fictitious

sales and inventory transactions. Secret computer passwords for certain files were used in an

effort to hide the fictitious transactions from those employees.

45. The Individual Defendants created a fictitious “Salesman No. 2.” The Company

recorded on its books and records millions of dollars of non-existent sales of merchandise by

Salesman No. 2. Access to the Salesman No. 2 invoices was limited to Company officials who

knew to enter a secret computer password in a particular computer on Allou’s system. These

bogus Salesman No. 2 invoices amounted to approximately $220 million in sales from January

2000 to March 2003, which represented approximately 40% of Allou’s reported sales for this

period.

46. The Company produced a huge volume of invoices for the sham transactions

purporting to show sales to Allou’s customers, such as Eckerd, Wal-Mart and Target. However,

these customers were never sent, and never paid, these invoices. Instead, the invoices were paid

by checks from a series of companies located in Brooklyn, which were affiliated with

defendants.

47. With this fraudulent scheme in place, defendants reported on Allou’s books and

records, and in financial statements certified by Mayer Rispler, Arthur Andersen and KPMG,


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millions of dollars of fictitious sales and accounts receivable each year.

48. Allou also created a huge volume of bogus inventory purchases that it reported

to its lenders. The existence of this inventory was only in Allou’s secret computer system, which

was only accessible to those who had a particular user name and password. Approximately $198

million of Allou’s inventory purchased between January 2002 and March 2003 was bogus.

49. At Herman Jacobs’s direction, Shamilzadeh recorded the falsified invoices as

sales on Allou’s accounting books and records.

50. In addition, Allou engaged in sham purchases of inventory from a series of

companies located in Brooklyn, which were affiliated with the Individual Defendants. For

example, Allou purchased over $51 million worth of products between January 2002 and March

2003 from a company named A & M Enterprises. One of the addresses listed in Allou’s files for

this company is 116 Rutledge Street in Brooklyn, which is also defendant Herman Jacobs’s

home address. Defendant Herman Jacobs, his brother and mother all had ownership interests in

this company. As described in more detail below, the $51 million of sham purchases between

January 2002 and March 2003 represented a material amount of Allou’s entire reported

inventories during that period and was therefore material to the decision of Allou’s investors to

buy or sell Allou securities.

51. Allou issued checks to the affiliated entities in Brooklyn purportedly in

exchange for goods. In fact, the inventory did not exist; instead, a portion of the money was sent

back to Allou in payment of phony invoices reflecting non-existent sales.

52. The Individual Defendants would record the checks issued by the Company to

the affiliated Brooklyn entities in Allou’s books and records as payments for prepaid inventory.

53. In addition to the scheme described above, the Individual Defendants also


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directly manipulated the financial results reported by Allou in order to inflate earnings as needed

to meet Allou’s publicly announced earnings projections. This was done by arbitrarily

increasing the value of inventory items, thus decreasing the cost of goods sold and net income

and earnings per share.

54. These practices caused the Company’s inventories and accounts receivable to

be overstated by at least tens of millions of dollars in each and every set of financial statements

published and filed with the SEC during the Class Period. As a result, each of Allou’s financial

statements published and filed with the SEC during the Class Period materially overstated the

Company’s sales, earnings and accounts receivable by material amounts. These false financial

statements as well as the false reports on Allou’s year end financial statements for fiscal years

2000, 2001 and 2002 issued by the Auditor Defendants, were material to investors and the

market.

55. The Individual Defendants also diverted millions of dollars of cash to

themselves. The Company collected cash payments on a periodic basis from certain customers.

The monthly cash collections averaged over $50,000 per month. Those cash collections were

stored in a safe maintained at the Company’s Brentwood facility. The Company would then

issue checks made payable to its Brooklyn affiliates in the exact amount of the monthly cash

receipts. Those checks were then endorsed back to Allou. The Individual Defendants would

then deposit the checks into lockboxes established by Allou’s creditors so as to create the

appearance that it was depositing payment for the merchandise for which it had already received

payment in cash. As a result of this practice, the Individual Defendants caused Allou’s books

and records to report that the Company had received payments for the goods sold when, in fact,

the payments had been diverted to the Individual Defendants themselves.


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The Truth Emerges

56. Despite the fraud detailed above, throughout the entire Class Period, Allou

reported to the public that the Company had substantial inventory, accounts receivable, sales and

earnings and good management. Defendants created this impression through false and

misleading statements in press releases, public filings with the SEC, and financial statements

provided to the public.

57. However, in September 2002, Allou announced that a fire at its Brooklyn

warehouse had destroyed much of the Company’s inventory, and that the warehouse, inventory

and lost business were insured for over $100 million. This reassured the market and the stock

price of Allou shares did not decline significantly. However, on or about November 8, 2002, it

became publicly known that officials had declared the fire suspicious. Allou publicly denied that

the fire was not accidental. Nonetheless, the market price of Allou shares fell from over $4 to

less than $3 per share. Later, in August 2003, the Criminal Complaint alleged that the fire had

resulted from a conspiracy among the Jacobs and others to destroy the warehouse and its

contents in order to cover up the fraudulently reported inventory and obtain the insurance

proceeds.

58. During the week of March 10, 2003, in accordance with the terms of a loan

agreement with one of Allou’s senior lenders, the lender conducted a periodic field examination

of the Company’s inventory and accounts receivable. The lender noticed discrepancies in the

financial information that Allou had been providing to it. As a result, the Company agreed to

retain RAS Management Advisors, Inc. (“RAS”), a crisis management and turnaround firm. The

President of RAS, Richard A. Sebastiao, began his review of the Company’s inventory and

accounts receivable on March 27, 2003.


20

59. Richard A. Sebastiao found that executives at Allou had fabricated

approximately $220 million in sales and recorded nearly $200 million in non-existent inventory.

As described below in detail, the $220 million of fabricated sales and $200 million in non-

existent inventory, as well as tens of millions of dollars of fictitious accounts receivable, resulted

in material overstatements of amounts reported by Allou for, inter alia, sales, net income,

accounts receivable and inventories in each and every set of financial results published and filed

with the SEC during the Class Period, including each of the year end financial statements audited

by the Auditor Defendants and for which the Auditor Defendants issued their respective

unqualified audit reports.

60. On April 9, 2003, as a result of the unraveling of the fraudulent scheme set forth

herein, Allou and its subsidiaries were forced into bankruptcy and trading of Allou stock was

halted.

61. On April 9, 2003, the last day of the Class Period, the Company issued a press

release over the PR Newswire announcing that its lenders had filed an involuntary petition for

bankruptcy in the Eastern District of New York. The Company further announced that it had

consented to the Chapter 11 filing and had retained Richard A. Sebastiao as Chief Restructuring

Officer of the Company.

62. On April 22, 2003 an article in New York Newsday entitled “Discrepancies Led

Allou to Bankruptcy; Suggestion of Fraud Raised for First Time” detailed the massive fraud by

Allou. The article revealed that experts looking into the Company’s key subsidiaries discovered

an inventory shortfall of almost $40 million. The article also stated in relevant part:

Richard Sebastiao also told the U.S. Bankruptcy Court in Central Islip that only $30 million of $108 million in accounts receivable reported by Allou to its banks seemed to be valid. (Emphasis added).


21

“It appears there is a substantial shortfall in accounts receivable, where either goods were not shipped or billings were made without any sign of support,” said Sebastiao, who began reviewing Allou’s operations on March 28. Signs of support typically include such things as freight bills or receipts.

63. Then, on April 24, 2003, Allou announced that it believed that “the levels of

assets collateralizing loans were substantially overstated in recent reports submitted by the

Company to its senior lenders. The preliminary results of the Company’s investigation indicate

that inventory was overstated by approximately $35,000,000 and that accounts receivable may be

overstated by $75,000,000 to $80,000,000, for a total overstatement of $100,000,000 to

$115,000,000.”

64. On April 24, 2003, the Company filed with the SEC a Form 8-K (the “April 24

Form 8-K”). The April 24 Form 8-K stated in part:

On April 9, 2003, a group of lenders led by Congress Financial Corporation (the "Lenders") filed an involuntary petition for bankruptcy against M. Sobol, Inc., Allou Distributors, Inc., Direct Fragrances, Inc., and Stanford Personal Care Manufacturers, Inc., which are principal operating subsidiaries of Allou Healthcare, Inc. (the "Company"). This filing was made under the provisions of chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of New York. Also on April 9, 2003, the subsidiaries consented to this chapter 11 filing by the Lenders, thus converting the proceeding to a "voluntary" case under chapter 11 of the Bankruptcy Code.

65. The April 24 Form 8-K continued:

On April 21, 2003, the Lenders filed an involuntary petition for bankruptcy against the Company and two of its subsidiaries, Rona Beauty Supplies, Inc. and Trans World Grocers, Inc. This filing was made under the provisions of chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Eastern District of New York.

66. The April 24 Form 8-K further stated:

The preliminary results of the investigation indicate that in recent reports to the Company's lenders inventory was overstated by approximately $35,000,000 and that accounts receivable was overstated by between


22

$75,000,000 and $80,000,000, for a total overstatement of between $110,000,000 and $115,000,000.

The Company has terminated its employment of Victor Jacobs, Herman Jacobs, David Shamilzadeh and Jacob Jacobs. Victor Jacobs had been employed by the Company as Chairman of the Board; Herman Jacobs had been employed by the Company as Chief Executive Officer; David Shamilzadeh had been employed by the Company as President and Chief Financial Officer; and Jacob Jacobs had been employed by the Company as Executive Vice President. Each of the four terminated employees has retained his seat on the Company's board of directors, with Victor Jacobs still holding the board position of Chairman.

Stuart Glasser and Jeffrey Berg have resigned from the Company's Board of Directors. Mr. Glasser and Dr. Berg were two of the Company's three outside directors. The remaining five directors are Mr. Sol Naimark, who is not employed by the Company, and Victor Jacobs, Herman Jacobs, David Shamilzadeh and Jacob Jacobs, each of whom was previously employed by the Company as noted above.

67. The overstatements of Allou’s receivables and inventory and resulting

overstatements of the Company’s revenues and earnings during the Class Period artificially

inflated the price of Allou’s stock.

68. On May 12, 2003, an article entitled “U.S. Seeking Trustee in Allou

Bankruptcy” in Newsday reported that the Justice Department had asked the bankruptcy judge to

name an independent trustee to run Allou’s subsidiaries. The article stated, in relevant part:

The government filing on Thursday followed allegations earlier in the week by Allou’s biggest creditor that a key subsidiary was riddled with phony orders. The creditor’s court filing says Allou recorded millions of dollars owed by retail giants J.C. Penney Co. and Wal-Mart Stores, Inc. for merchandise, even though Allou shipped nothing to J.C. Penney, and Wal-Mart’s books showed only pennies due to the Brentwood-based health and beauty products distributor. The creditor, Congress Financial Corp., is already seeking the appointment of a trustee to run the company and has asked U.S. Bankruptcy Judge Melanie Cyganiowski in Central Islip to give the job to Richard Sebastiao, the turnaournd consultant of Newport, R.I., who is already running the Allou subsidiaries. Now lawyers for the Justice Department agency,


23

known as the U.S. Trustee Program, are asking for the same things. But papers filed by the government’s lawyers did not offer any names for the job, and the assistant U.S. Trustee Terese Cavanagh declined to comment. Appointment of a trustee is rare in Chapter 11 bankruptcy cases, in which a company is protected from creditors while it tries to come up with a plan to pay its debts. The move comes only in cases where here are allegations of fraud, dishonesty, incompetence or gross management – and Allou has faced a withering barrage of such charges since its collapse early last month. Congress Financial, along with the other lenders is owed $173 million, and Sebastiao have alleged that Allou’s subsidiaries overstated the amounts due from customers by $86 million and inflated inventories by $35 million. They cited five invoices dated Feb. 3 billed to J.C. Penney totaling $1.2 million. According to court papers, Allou’s sales personnel said no goods had been shipped to the Plano, Texas-based retailer since August. Also, Allou allegedly issued four invoices totaling $2,479,500 to Wal-Mart, based in Bentonville, Ark., even though Wal-Mart carried them on its own books in the amount of one or two cents each. What’s more, Congress and Sebastiao had been unable to verify millions of dollars supposedly owed to other companies. ‘The insiders presided over staggering amounts of false inventory and accounts receivable,’ said Congress in papers seeking the appointment of a trustee. ‘The insiders have totally refused to try to explain the discrepancies in the records.’

69. Once the Company’s lenders became aware of the overstatements in inventory

and accounts receivable, defendants Victor, Herman and Jack Jacobs were informed not to enter

Allou’s offices. Despite the locks and security codes being changed, defendant Herman Jacobs

convinced an employee to give him the keys to the new locks. On March 28, 2003, at

approximately 1:00 a.m., defendants Herman and Jack Jacobs entered the facility and removed

several boxes of documents evidencing the fraudulent activities detailed herein.

70. Defendants Herman and Jack Jacobs then provided to the Company’s lenders a

false list of the allegedly personal items taken from Allou’s offices.


24

71. On June 30, 2003, involuntary bankruptcy petitions were filed against Victor,

Herman and Jacob Jacobs in the United States Bankruptcy Court of the Eastern District of New

York. In its 50-page decision on the motion to appoint an interim trustee, the Bankruptcy court

concluded, among other things, that the Jacobs had engaged in transactions that appeared to be

“money laundering” and that “certainly the record is more sufficient for this Court to find that

the Jacobs knowingly and intentionally have indeed engaged in a pattern where monies have

been remitted into the Allou accounts only thereafter to be remitted to others or to be fictitiously

related to another account….”

72. On August 12, 2003, Herman, Victor, Jacob, Aaron Jacobs and other

accomplices were arrested for bank fraud, among other things. The criminal defendants were

indicted for their activities in connection with the Allou Companies on or about June 17, 2004.

The 20-count indictment charged defendants with bank fraud and conspiracy to commit bank

fraud, securities fraud, false SEC filings, false Sarbanes-Oxley certifications, mail fraud, arson,

bribery and obstruction of justice.

73. Upon information and belief, Shamilzadeh, Allou’s President and Accounting

Officer, assisted the Jacobs in committing the fraud but is now cooperating with authorities.

Summary of the Auditor Defendants’ Fraudulent Acts and the Material Impact of those Acts on Allou’s Financial Statements

74. The following is a summary of the Auditor Defendants’ fraudulent acts and the

material impact of those acts on Allou’s financial statements. The precise details of the Auditor

Defendants’ fraudulent accounting behavior are presented in more detail later in the complaint.

The 2000 Audit

75. Mayer Rispler was responsible for auditing the financial results of Allou’s fiscal


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year ending on March 31, 2000 (the “2000 Audit”). As described in more detail herein, Mayer

Rispler had a duty to perform the 2000 Audit in accordance with acceptable accounting

principles and guidelines, something Mayer Rispler failed to do. As described in detail herein,

Mayer Rispler’s failure to properly perform the 2000 Audit resulted in Allou reporting financial

results for its fiscal year 2000 that were grossly inflated by material amounts. Mayer Rispler’s

failure to adhere to the standards of the auditing profession in auditing Allou’s financial

statements and in issuing its unqualified report on those financial statements adversely impacted

the market for Allou’s shares, which traded at prices which were fraudulently inflated. Plaintiffs

and other class members therefore paid higher prices for their Allou shares than they would have

paid had the market known the true financial condition and results of Allou, or they would not

have purchased those shares.

76. The false and misleading statements attributable to Mayer Rispler began on

June 21, 2000, in a press release issued by Allou, which purported to describe Allou’s fiscal

results for the fiscal year 2000. The Company’s fiscal year 2000 financial results were then

reported in Allou’s Form 10-K filed with the SEC on June 29, 2000, which included the

following fraudulent financial results purported to have been audited by Mayer Rispler:

Revenues $421,046,773 Net Income $14,959,185 Accounts Receivable $75,853,958 Inventories $163,752,266 Total Assets $259,955,452

77. Mayer Rispler purportedly audited the financial results for Allou for the twelve

month period ended March 31, 2000. However, during that period, Allou reported financial

results that were fraudulently and materially inflated. The fraudulent financial results reported

by Allou, and audited by Mayer Rispler in the 2000 Audit, contained fraudulently overstated


26

figures which were material in relation to the reported financial results set forth above and which

were material to investors and the market for Allou shares, which relied on the accuracy of the

reported results and on Mayer Rispler’s unqualified report on the 2000 financial statements. At

the very least, Allou’s financial results were materially overstated by the following:

1) During its purported audit of Allou for the 2000 Audit, Mayer Rispler performed a test of cash collections by Allou and found that approximately $24.5 million had not been collected. Included in these uncollected receivables were $9.4 million from Sears and $13.7 million from Wal-Mart, totaling $23.1 million, all of which were fictitious. Therefore, out of the $75.8 million reported accounts receivable of Allou reported in March 31, 2000, $23.1 million, or 30.4% were fictitious. For all accounts, out of the $75.8 million of reported accounts receivable of Allou reported in March 31, 2000, approximately $25 million were fictitious, or 33%. 2) Had the fictitious receivables described above been properly accounted for, Allou would have been required to record a reserve and/or a charge against earnings in the amount of the false receivables, thus reducing its net income by at least $23.1 million. Allou would therefore have reported, rather than net income of $14.9 million, a net loss of over $8 million. That Allou was suffering net losses rather than net income would have been highly material to investors and the market. 3) In addition to the material overstatement of accounts receivable described above, between at least January 2000 and March 2003, Allou also recorded revenues inflated by $220 million or approximately 40% of the total revenues reported by Allou during that time period. Although plaintiffs have been unable to determine the exact amount of these fraudulently recorded revenues attributable to the 2000 fiscal year, it is reasonable to infer that a material amount of that fraudulent revenue was recorded in fiscal 2000 and that any such amounts recorded in fiscal 2000, in addition to the fraudulent accounts receivable identified above, would render the reported financial results and the Mayer Rispler unqualified report on those financial results more material to investors and the market.

4) Also, according to papers filed in bankruptcy proceedings against Allou, individuals associated with Allou’s executive board stole approximately $1 million in cash from Allou in the fiscal year 2000. The ability of individuals to steal such a large sum of cash from Allou without the theft being discovered in the course of and reported subsequent to the 2000 Audit of Allou’s financial results by Mayer Rispler is material to Allou’s shareholders.

5) As part of its 2000 Audit Mayer Rispler improperly audited millions of dollars of fraudulent inventory, in part because Mayer Rispler failed to properly observe the physical inventory of Allou as they were required to by the relevant accounting requirements of AU §312 and AU §331. In preparing the 2000 Audit, Mayer Rispler


27

improperly audited at least seven fraudulent accounts with a value of $6.6 million. Therefore, of the $163.7 million of inventories Allou reported as of March 31, 2000, at least $6.6 million, or 4% was fictitious, a material amount, independently and in combination with the other inflated financial results described above. The failure of Allou to report the fictitious inventory for the 2000 Audit was more egregious because Mayer Rispler did conduct a rollback analysis of Allou’s inventory that included $8.3 million of adjustments, a ‘red-flag’ indicating a potential material misstatement which should have led Mayer Rispler to investigate further.

The 2001 Audit

78. Allou’s financial results for its fiscal year ended March 31, 2001, were reported

by Allou in a press release published by Allou on July 2, 2001 and a Form 10-K filed with the

SEC on July 3, 2001. The financial results reported by Allou in the Form 10-K filed on July 3,

2001 were purported to have been audited by Arthur Andersen, which replaced Mayer Rispler on

June 14, 2001 (the “2001 Audit”). In addition to Arthur Andersen, the fraudulent financial

results reported by Allou in the Form 10-K filed in July 3, 2001 are also attributable to Mayer

Rispler because Mayer Rispler still served as an internal auditor for Allou in July 2001, and

Mayer Rispler assisted Arthur Andersen in disseminating the 2001 Audit. Mayer Rispler is

therefore jointly liable with Arthur Andersen for the dissemination of the fraudulently overstated

figures reported in the Form 10-K filed on July 3, 2001 and July 2, 2001 press release. In fact,

because Arthur Andersen was retained to serve as Allou’s auditor only a few weeks before Allou

was to file with the SEC its Form 10-K for fiscal year 2001, Arthur Andersen relied extensively

on the work of Mayer Rispler in performing the 2001 Audit. Arthur Andersen failed to perform

a single physical inventory observation in connection with the 2001 Audit but instead relied on

observations of Mayer Rispler, which as discussed in more detail herein were wholly inadequate.

Mayer Rispler knew therefore that Arthur Andersen would be using the work results of Mayer

Rispler in performing the 2001 Audit. Both Arthur Andersen and Mayer Rispler are therefore

liable for the dissemination of the fraudulently overstated financial results reported in the Form


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10-K filed with the SEC on July 3, 2001, and the July 2, 2001 press release.

79. In the Form 10-K filed by Allou with the SEC on July 3, 2001 for the fiscal year

ended March 31, 2001, Allou reported the following fraudulent, false financial results:


80. As described in more detail herein, the financial results reported in the Form 10-

K filed with the SEC on July 3, 2001, were materially over-inflated by the following amounts:

1) Of the $85.5 million of accounts receivables reported by Allou for the fiscal year 2001, $20.3 million of reported receivables from Sears and Wal-Mart were almost entirely non-existent, or 23.7% of Allou’s reported receivables in the fiscal year 2001. For all accounts, of the $85.5 million of accounts receivables recorded by Allou for the fiscal year 2001, $35.1 million of the accounts receivables were fictitious, or 41% of the recorded accounts receivable for the fiscal 2001, a material amount. 2) Had the fictitious receivables described above been properly accounted for, Allou would have been required to record a reserve and/or a charge against earnings in the amount of the false receivables, thus reducing its net income by at least $20.3 million. Allou would therefore have reported, rather than net income of $2.4 million, a net loss of over $18 million. That Allou was suffering net losses rather than net income would have been highly material to investors and the market.

3) In addition to the material overstatement of accounts receivable described above, between at least January 2000 and March 2003, Allou also recorded revenues inflated by $220 million or approximately 40% of the total revenues reported by Allou during that time period. Although plaintiffs have been unable to determine the exact amount of these fraudulently recorded revenues attributable to the 2001 fiscal year, it is reasonable to infer that a material amount of that fraudulent revenue was recorded in fiscal 2001 and that any such amounts recorded in fiscal 2001, in addition to the fraudulent accounts receivable identified above, would render the reported financial results and the Arthur Andersen unqualified report on those financial results more material to investors and the market.

4) Also according to papers filed in bankruptcy proceedings against Allou, individuals associated with Allou’s executive board stole approximately $0.6 million in cash from Allou in the fiscal year 2001. The ability of individuals to steal such a large sum of cash from Allou without the theft being discovered in the course of and reported subsequent to


29

the 2001 audit of Allou’s financial results by Arthur Andersen is of material concern to Allou’s shareholders.

5) According to papers filed in bankruptcy proceedings against Allou, millions of dollars of Allou’s reported inventory for the fiscal year 2001 was fictitious. That millions of dollars of fictitious inventory was not reported during the auditing of Allou’s finances is of material concern to Allou’s shareholders, and in addition to the fraudulent accounts receivable and revenues identified above, would render the reported financial results and the Arthur Andersen unqualified report on those financial results more material to investors and the market.

81. Arthur Andersen and Mayer Rispler, in their reports on the 2001 Allou financial

statements, made material misrepresentations and omissions with respect to those financial

statements. Such extensive fraudulent accounting demonstrates, in part, that Arthur Andersen

and Mayer Rispler knew, or were reckless in not knowing, of the accounting fraud at Allou,

especially when considering the numerous ‘red flags’ overlooked by Arthur Andersen and Mayer

Rispler during the audit of Allou’s financial results for the fiscal year 2001 as described in more

detail herein.

The 2002 Audit

82. On July 15, 2002, Allou filed with the SEC its Form 10-K for its fiscal year

2002 ended on March 31, 2002. The Form 10-K contained Allou’s financial results for the fiscal

year 2002 which were purported to have been audited by KPMG (the “2002 Audit”). Allou’s

financial results for the fiscal year 2002 were also published by Allou in a press release dated

July 1, 2002. KPMG, Arthur Andersen and Mayer Rispler were all responsible for the

dissemination of the 2002 Audit. In addition to KPMG, Arthur Andersen and Mayer Rispler

knew that their work product was to be disseminated as part of the 2002 Audit. Indeed, Arthur

Andersen performed work on the 2002 Audit before they were replaced as external auditors on

June 6, 2002. Three of the four principal partners of the Arthur Andersen audit team also


30

performed the 2002 Audit, initially as Arthur Andersen employees and then as employees of

KPMG. In addition, many areas of the 2002 Audit identify Mayer Rispler as Allou’s internal

auditor, including work performed by Mayer Rispler in the 2002 consolidated financial

statements being clearly marked with the designation “PBIA” (prepared by internal audit).

83. The Form 10-K filed with the SEC July 15, 2002, and the July 1, 2002 press

release contained false and misleading financial results for Allou’s fiscal year 2002, financial

results that were materially overstated. The financial results reported by Allou in the Form 10-K

filed on July 15, 2002 included the following:


84. As described in more detail herein, the financial results reported in the Form 10-

K filed with the SEC on July 14, 2002, were materially over-inflated by at least the following,

material amounts:

1) Of the $109.7 million of accounts receivables reported by Allou for the fiscal year 2002, $31.8 million of reported receivables from Sears and Wal-Mart were almost entirely non-existent, or 29% of Allou’s reported receivables in the fiscal year 2002, a material amount. 2) Of the $109.7 million of accounts receivables reported by Allou for the fiscal year 2002, $2.9 million of reported receivables from a company called Tereza Merchandising Inc., were almost entirely non-existent, or 2.6% of Allou’s reported receivables in the fiscal year 2002. For all accounts for the fiscal year 2002, of the $109.7 million of reported accounts receivable of Allou, $60 million was fictitious, or 55% of the total reported accounts receivable, a material amount.

3) Had the fictitious receivables described above been properly accounted for, Allou would have been required to record a reserve and/or a charge against earnings in the amount of the false receivables, thus reducing its net income by at least $34.7 million. Allou would therefore have reported, rather than net income of $6.5 million, a net loss of


31

over $28 million. That Allou was suffering net losses rather than net income would have been highly material to investors and the market.

4) In addition to the material overstatement of accounts receivable described above, between at least January 2000 and March 2003, Allou also recorded revenues inflated by $220 million or approximately 40% of the total revenues reported by Allou during that time period. Although plaintiffs have been unable to determine the exact amount of these fraudulently recorded revenues attributable to the 2002 fiscal year, it is reasonable to infer that a material amount of that fraudulent revenue was recorded in fiscal 2002 and that any such amounts recorded in fiscal 2002, in addition to the fraudulent accounts receivable identified above, would render the reported financial results and the KPMG unqualified report on those financial results more material to investors and the market.

5) Also according to papers filed in bankruptcy proceedings against Allou, individuals associated with Allou’s executive board stole approximately $0.54 million in cash from Allou in the fiscal year 2002. The ability of individuals to steal such a large sum of cash from Allou without the theft being discovered in the course of and reported subsequent to the 2002 Audit of Allou’s financial results by KPMG is of material concern to Allou’s shareholders.

6) According to papers filed in bankruptcy proceedings against Allou, millions of dollars of Allou’s reported inventory for the fiscal year 2002 was fictitious. That millions of dollars of fictitious inventory was not reported during the auditing of Allou’s finances is of material concern to Allou’s shareholders and in addition to the fraudulent accounts receivable and revenues identified above, would render the reported financial results and the KPMG unqualified report on those financial results more material to investors and the market.

Materially False and Misleading Statements Issued During the Class Period

85. The Class Period commences on June 21, 2000. On that date, Allou issued a

press release over the PR Newswire announcing its financial results for the fiscal year ended

March 31, 2000. The Company announced that revenues were $421.0 million and that earnings

per share were $0.97. The press release quoted defendant Shamilzadeh, in pertinent part, as

follows:

We are extremely pleased to report our record performance for our forth quarter and fiscal year. These results clearly reflect Allou’s strength in its distribution and manufacturing businesses.


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86. On June 29, 2000, Allou filed with the SEC its Form 10-K for the year ended

March 31, 2000. This 10-K was signed by defendants Victor Jacobs, Herman Jacobs,

Shamilzadeh, Naimark, Glasser and Berg. The 10-K was purportedly audited and certified by

Mayer Rispler. Mayer Rispler represented in its independent audit report date June 19, 2000, the

following:

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Allou Health and Beauty Care, Inc.: We have audited the consolidated balance sheets of Allou Health & Beauty Care, Inc. as of March 31, 2000 and 1999 and the related consolidated statements of income, stockholders’ equity and cash flows for each of the year in the three-year period ended March 31, 2000. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Allou Health and Beauty Care, Inc. at March 31, 2000 and 1999, and the result of its year ended March 31, 2000, in conformity with generally accepted accounting principles. New York, New York June 19, 2000

87. On July 2, 2001, Allou issued a press release over the PR Newswire announcing

its financial results for the fiscal year ended March 31, 2001. The Company reported a record

$548.1 million in revenue and income of $0.82 cents per share. Defendant Shamilzadeh is


33

quoted as stating, “[o]ur record revenues clearly demonstrate Allou’s ability to grow in all

economic cycles.”

88. On July 3, 2001, Allou filed a Form 10-K with the SEC for the year ended

March 31, 2001. The 10-K was signed by defendants Victor, Herman and Jack Jacobs, as well

as defendants Shamilzadeh and Berg. The financial results in this 10-K were purportedly audited

and certified by Arthur Andersen. Arthur Andersen represented in its independent audit report

date July 2, 2001, the following:

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Allou Health & Beauty Care, Inc.: We have audited the accompanying consolidated balance sheet of Allou Health & Beauty Care, Inc. (a Delaware corporation) and subsidiaries as of March 31, 2001, and the related consolidated statements of income, stockholders’ equity and cash flows for the fiscal year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Allou Health & Beauty Care, Inc. and subsidiaries as of March 31, 2001, and the result of their operations and their cash flows for the fiscal year then ended in conformity with accounting principles generally accepted in the United States. /s/ ARTHUR ANDERSEN LLP Melville, New York July 2, 2001

89. On July 1, 2002, Allou issued a press release over PR Newswire announcing its


34

financial results for the fiscal year ended March 31, 2002. The Company reported:

Record financial results for its fiscal year ended March 31, 2002. The company reported record revenue of $564.2 million, versus $548.1 million for the same period last year. The company generated $6.6 million in earnings, or $0.91 per diluted share, a 168% increase versus $2.5 million or $0.34 per diluted share for the same period last year.

90. The Company also issued guidance and stated that it “expects that revenues for its

fiscal year will be approximately $600 million and earnings should be $1.00 per share.” The

press release quoted defendant Shamilzadeh, in pertinent part, as stating:

We are gratified that the many initiatives we took during fiscal 2002 resulted in a substantial improvement in our operating results. We demonstrated that despite a challenging environment we are able to grow revenues and substantially improve profitability. The predictability of our revenue base and diversification of products should enable us to continue to grow revenues and earnings during our current fiscal year. Although our results were favorably impacted by the current interest rate environment, we are taking steps to ensure that we aggressively manage interest expense. We changed lenders during the past year, allowing the company to access capital under more favorable terms. We are taking further steps to ensure interest rate protection in order to negate the impact on our company should interest rates rise in the future. Finally, while we are confident that we can continue to grow earnings at a double-digit rate, we continue to aggressively seek accretive acquisitions that will compliment Allou’s core business.

91. On July 15, 2002, Allou filed a Form 10-K with the SEC for the year ended

March 31, 2002. The 10-K was signed by the Individual Defendants, as well as the Additional

Director Defendants, and confirmed the financial results announced in the July 1, 2002 press

release. The 10-K was purportedly audited and certified by KPMG. The Form 10-K contained

an opinion letter from KPMG dated July 3, 2002:

INDEPENDENT AUDITORS’ REPORT

To the Board of Directors and Stockholders Allou Health and Beauty Care, Inc.:


35

We have audited the accompanying consolidated balance sheet of Allou Health and Beauty Care, Inc. and subsidiaries as of March 31, 2002, and the related consolidated statements of income, stockholders' equity, and cash flows for the year then ended. In connection with our audit of the consolidated financial statements, we also audited the accompanying financial statement schedule (Item 14(a)(2) - Valuation and Qualifying Accounts and Reserves). These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Allou Health and Beauty Care, Inc. and subsidiaries at March 31, 2002, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

/s/ KPMG LLP

Melville, New York July 3, 2002

92. In addition, throughout the Class Period, Allou filed with the SEC its Quarterly

Reports on Form 10-Q. Each of these reports included certifications signed by at least one of the

Individual Defendants attesting to the accuracy of the financial information contained therein.

93. As set forth above, on September 25, 2002, the Brooklyn warehouse at 40 Noll


36

Street used by Allou caught fire. The Company reported that it lost more than $80 million in

Company inventory, but that the losses and resulting lost business were covered by an insurance

policy for over $100 million. On November 22, 2002, an article entitled “Allou Blaze Raises

Concerns; Fire under investigation, and insurers still haven’t paid” appeared in Newsday New

York, and reported the following:

Among the other questions shareholders are asking is why they didn’t know that the Brooklyn warehouse was owned by Mom & Sons Realty, a company that is owned by Eva and Ari Jacobs, the wife and son of chairman [Victor] Jacobs. Even Shamilzadeh said he wasn’t aware that the Jacobs family had ties to the warehouse, and he agreed with a shareholder who suggested that such ties ought to be disclosed in the future.

94. Each of the financial statements publicly disseminated by the defendants and filed

with the SEC, the press releases describing Allou’s financial results and the other statements

and/or omissions provided by defendants to the public, as set forth above, were materially false

and misleading in that:

95. Allou was materially overstating its revenues by tens of millions, or even

hundreds of millions of dollars, and was reporting grossly inflated assets, net worth and earnings;

96. Allou was materially overstating its inventory and accounts receivable by tens of

millions of dollars, thereby overstating its assets, net worth and earnings;

97. Allou failed to disclose the numerous related party transactions with the Jacobs

family described above as herein;

98. Allou’s financial statements were not prepared in accordance with GAAP or

GAAS; and

99. Mayer Rispler, Arthur Andersen and KMPG did not conduct their audits in

accordance with GAAS, and either knew of or recklessly disregarded their failure to utilize


37

sufficient audit procedures to satisfy GAAS and/or either knew of or recklessly disregarded the

accounting fraud at Allou.

The Wrongful Conduct of Defendant Mayer Rispler

100. Mayer Rispler served as the Company’s auditors from prior to the beginning of

the Class Period until 2001, when it was replaced by Arthur Andersen. Mayer Rispler was not

one of the major accounting and auditing firms servicing major publicly traded companies. This,

and the fact that Mayer Rispler had been engaged by Allou for several years as its internal

auditor, resulted in Mayer Rispler lacking sufficient independence to properly plan and carry out

an audit of the financial statements of Allou.

101. Mayer Rispler audited and certified Allou’s financial statements for the year

ending March 31, 2000, as set forth in above. Mayer Rispler also consented to the incorporation

of its reports on Allou’s financial statements in the Company’s Form 10-K for fiscal year 2000.

102. In addition, in Allou’s 10-Ks for the years ending March 31, 2001 and March 31,

2002, Mayer Rispler reissued reports certifying the Company’s Schedule II, Valuation and

Qualifying Accounts and Reserves. Mayer Rispler reissued these reports despite the fact that

they were officially no longer the Company’s independent auditors. Mayer Rispler represented

in its report dated June 19, 2000, the following:

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE To Allou Health and Beauty Care, Inc.: We have audited, in accordance with auditing standards generally accepted in the United States, the financial statements of Allou Health and Beauty Care, Inc. included in this Form 10-K and have issued our report thereon dated June 19, 2000. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. This schedule (Schedule II – Schedule of Valuation and Qualifying Accounts) is presented for purposes of complying with the Securities and Exchange Commission’s rules and is not part of the procedures applied in our audits of the basic financial statements. This schedule, for the year


38

ended March 31, 2000, has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Mayer Rispler & Company, P.C. Mayer Rispler & Company, P.C. Certified Public Accountants

103. This representation was materially false and misleading because the amounts

listed as reserves for doubtful accounts in Schedule II, in both years ended March 31, 2001 and

March 31, 2002, were grossly understated as a result of the millions of dollars of fictitious

accounts receivables the Company created and recorded on its books and records, as described in

detail herein.

104. Mayer Rispler violated the public’s trust and violated the American Institute of

Certified Public Accountants (“AICPA”)’s Code of Professional Ethics: ET §51.02. These

principles of the Code of Professional Conduct of the AICPA express the profession’s

recognition of its responsibilities to the public, clients, and colleagues. They guide members in

the performance of their professional responsibilities and express the basic tenets of ethical and

professional conduct. The principles call for an unswerving commitment to honorable behavior,

even at the sacrifice of personal advantage. ET §53.03

105. Mayer Rispler was required to apply GAAS when auditing Allou’s financial

statements. GAAS, as approved and adopted by the AICPA, are measures of the quality of the

performance of audit procedures, the professional qualities the auditor should possess, and the

judgment exercised by the auditor in the performance of the audit and issuance of the report.

Statements on Auditing Standards (“SAS”) (codified and referred to as AU §__) are recognized

by the AICPA as the interpretation of GAAS.

106. Mayer Rispler’s reports were false and misleading due to its failure to conduct its


39

audits in compliance with GAAS and because Allou’s financial statements were not prepared in

conformity with GAAP. Mayer Rispler knew its reports would be relied upon by present and

potential investors in Allou common stock.

Mayer Rispler’s Misconduct in Connection With the 2000 Audit

107. As detailed herein, Allou’s disclosures with respect to its accounting practices

were woefully inadequate. In violation of GAAS, Mayer Rispler failed to expand the scope of its

audit in light of the fact that it either actually knew about many of these issues or recklessly

ignored the many inconsistencies, lack of documentation and red flags that would have put it on

notice of the massive overstatements of inventory and receivables.

108. Out of the $75.8 million of reported accounts receivable of Allou at March 31,

2000, approximately $25.0 million, or 33% was fictitious. Therefore, the sheer size of the

accounting fraud at Allou during the fiscal year 2000 demonstrates the inadequacy of Mayer

Rispler’s auditing of Allou’s financial results, and that the audit represented an extreme

deviation from acceptable auditing standards.

109. The primary procedure for verifying accounts receivable performed by Mayer

Rispler in the 2000 Audit was to send out written confirmation requests to Allou customers.

When the customers failed to respond to the request, Mayer Rispler was required to perform

additional procedures, such as those set forth in AU § 330. When the level of risk assessment is

high, GAAS requires that accounts receivable confirmations be obtained and evaluated by “a

direct communication from a third-party in response to a request for information about a

particular item affecting financial statement assertions.” AU § 330. However, upon information

and belief, those additional procedures were not performed or, if they were, were recklessly

mishandled. Had Mayer Rispler properly planned and performed such tests, then some of the


40

fraudulent receivables would have been detected.

110. Mayer Rispler performed a test of subsequent cash collections (i.e., the March

31, 2000 balances that were collected through the end of audit field work) and found that

approximately $24.5 million had not been collected. Included in these uncollected receivables

were $9.4 million reported as due from Sears and $13.7 million reported as due form Wal-Mart,

all of which were fictitious. Had Mayer Rispler performed the requisite procedures to test

accounts receivables, the fraud would have been discovered.

111. Mayer Rispler merely accepted management’s explanation for why the Sears

and Wal-Mart invoices were more than 60 days past due. Mayer Rispler was told by Allou

management that Sears, WalMart and three other customers whose receivables were more than

60 days past due (i.e., Walgreen’s CVS and McKesson Corporation) had received “special

dating”. In light of the materiality of the amounts in question, Mayer Rispler was reckless in not

performing additional procedures to investigate these receivables.

112. Had Mayer Rispler performed required tests of, inter alia, accounts receivable

and subsequent receipts, it would have detected the unsubstantiated bogus Salesman No. 2

invoices to such major customers as Eckerd, Wal-Mart and J.C. Penney. As previously alleged,

the Company created phony invoices comprising approximately $220 million in sales from

January 2000 to March 2003.

113. Mayer Rispler also failed to detect millions of dollars of fraudulent inventory in

its audit of Allou’s 2000 financial statements. For instance, Mayer Rispler elected to perform

test counts on May 17, 2000 instead of observing the May 11, 2000 physical inventory of the

Brooklyn warehouse as required under AU § 312 and AU § 331. Included in these counts were

seven fraudulent balances with a combined balance of $6.6 million and per-unit costs ranging


41

from $16.25 to $31. These seven fraudulent balances were counted as a combined group rather

than on an individual basis. As a result, Mayer Rispler’s existence procedure paid no attention to

product numbers or product descriptions. More importantly, because of the way Mayer Rispler

counted the seven balances, it could not determine if Allou made an approximate $1.4 million

costing error or if potentially overstocked products were omitted from net realizable value

analyses.

114. Mayer Rispler did perform a rollback analysis of Allou’s May 11, 2000 physical

inventory, but did not verify underlying transactions included in the rollback. Included in the

rollback are $8.3 million of adjustments that reduced Allou’s March 31, 2000 inventory.

Although these adjustments could indicate a potential material misstatement to Allou’s March

31, 2000 consolidated financial statements, Mayer Rispler failed to investigate them.

115. Had Mayer Rispler performed the tests required by GAAS for the confirmation

of inventory balances, it would have discovered inconsistencies that would have led to the

disclosure of the fraud. GAAS states that “[w]hen (inventory) quantities are determined solely

on physical count and all counts are made as of the balance sheet date or within a reasonable

time before or after the balance sheet date, the auditor should ordinarily be present when

inventory is counted.” AU § 331. If there is a perpetual inventory system, GAAS states that

“[i]f these records are well kept and checked by the client periodically by comparisons with

physical counts, the auditor may observe inventory either during or after the end of the period

under audit.” Id. Mayer Rispler utterly failed to properly observe inventory counts and/or test

inventory values. Had Mayer Rispler performed the required tests of inventory it would have

detected that substantial amounts of inventory reported on the trial balance of Allou were non-

existent or materially overvalued.


42

116. Mayer Rispler’s failure to detect these inventory irregularities and accounts

receivable discrepancies demonstrates an extreme departure from the standards of ordinary care

common to auditors, presenting an obvious danger of misleading investors that was known to

Mayer Rispler or was so obvious that the inference that it knew of the danger is inescapable.

117. Mayer Rispler also knew that Allou had dealings with numerous entities owned

and/or controlled by the Jacobs and members of their families. In fact, Mayer Rispler provided

professional services to Mom & Sons Realty, Ever Ready, Four Jacobs Realty and A-1 Medical,

all of which are related parties that participated in the fraud at Allou. Despite the fact that Mayer

Rispler was required to identify related parties and evaluate the transactions between the related

parties, the only procedure that Mayer Rispler applied during the 2000 Audit was to ask the

Jacobs if Allou was dealing with any related third-parties.

118. Allou’s 2000 consolidated financial statements disclose approximately $12

million of related party purchases during the year ended March 31, 2000. Ever Ready First Aid

(“Ever Ready”) and A&M Enterprises (“A&M”) were vendors and related parties to Allou. A-1

Medical was also was identified as a related party. In 2000, Ever Ready, A&M and A-1 Medical

“advanced” $8 million to Allou, which was used to cover up fraudulent accounts receivable.

Mayer Rispler failed to investigate these transactions with related parties. Had Mayer Rispler

properly performed required related party procedures and verified subsequent cash receipts

transaction, it would have detected Allou’s accounts receivable fraud.

119. Mayer Rispler’s investigative and analytical failures are particularly egregious

based upon its failure to recognize obvious indicators that Allou’s financial statements and the

representations of the Jacobs required further serious and independent inquiry and scrutiny.


43

Mayer Rispler Failed to Conduct Its Audits In Accordance With Professional Standards 120. Mayer Rispler acted with knowledge or reckless disregard as to (a) the false and

misleading nature of the certifications they provided, (b) the false and misleading nature of the

financial statements and their failure to conduct proper audit tests and examinations of the books,

records and financial statements of the Company, and (c) the false representations that the

financial statements had been properly audited in accordance with GAAS.

121. In accordance with GAAS, Mayer Rispler was required to consider whether

Allou’s disclosures accompanying its financial statements were adequate. SAS No. 32, as set

forth in AU §431.02-03.

122. In accordance with SAS No. 1 (AU § 230) and SAS No. 82 (effective Dec. 15,

1997) Mayer Rispler had, but failed to fulfill, “a responsibility to plan and perform the audit to

obtain reasonable assurance about whether the financial statements are free of material

misstatements, whether caused by error or fraud.” If there is a material misstatement, whether by

fraud or mistake, the auditors’ procedures need to be designed and performed to detect it.

Further, the auditor is required to view the audit evidence with professional skepticism, a

standard which, is particularly important when, as here, the Company in question is controlled by

a family group such as the Jacobs.

123. Mayer Rispler knowingly or recklessly failed to obtain reasonable assurances as

to whether the Allou’s financial statements were free of material misstatements caused by fraud.

Mayer Rispler closed its eyes to the massive fraud detailed above. Instead, the massive fraud

was detected by a lender’s routine inspection of the Company’s books and records.

124. One of Mayer Rispler’s responsibilities as Allou’s independent auditor, was to

obtain “[s]ufficient competent evidential matter . . . to afford a reasonable basis for an opinion


44

regarding the financial statements under audit” as to the fairness with which they present, in all

material respects, financial position, results of operations, and its cash flows in conformity with

generally accepted accounting principles.” AU §§ 150,110.

125. SAS No. 85, Client Representations, and AU § 333, Client Representations,

state that representations from management are not a substitute for the application of these

auditing procedures necessary to afford a reasonable basis for an opinion regarding the financial

statements under audit.

126. In violation of GAAS, and contrary to the representations in its report on

Allou’s financial statements, Mayer Rispler did not obtain sufficient, competent, evidential

matter to support Allou’s assertions regarding its inventory and accounts receivable. Moreover,

the auditors deliberately or recklessly ignored information indicating that Allou’s financial

statements did not “present fairly” the Company’s financial position.

127. Due to Mayer Rispler’s false statements, knowledge of the improper

accounting, failure to identify and modify its reports to identify Allou’s false financial reporting,

and lack of independence, the auditors violated, among others, the following GAAS standards:

a) The first general standard that the audit should be performed by

persons having adequate technical training and proficiency as auditors;

b) The second general standard that the auditors should maintain an

independence in mental attitude in all matters relating to the engagement;

c) The third general standard that due professional care is to be

exercised in the performance of the audit and preparation of the report;

d) The first standard of field work that the audit is to be adequately

planned and that assistants should be properly supervised;


45

e) The second standard of field work that the auditor should obtain a

sufficient understanding of internal controls so as to plan the audit and determine the

nature, timing and extent of tests to be performed;

f) The third standard of field work that sufficient, competent,

evidential matter is to be obtained to afford a reasonable basis for an opinion on the

financial statements under audit.

128. In an extreme departure from professional standards, Mayer Rispler failed to

audit the financial statements of the Company as of and for the fiscal year ending March 31,

2000 in conformity with GAAS.

The Wrongful Conduct of Defendant Arthur Andersen

129. Arthur Andersen audited and certified Allou’s financial statement for the year

ending March 31, 2001, as set forth below. In addition, in 2001 and 2002, Arthur Andersen

reviewed the financial statements included in the Form 10-Qs filed by Allou with the SEC for the

quarters ended June 30, 2001, September 30, 2001 and December 31, 2001. For the reasons set

forth herein, Andersen is liable in whole or in part for the damages suffered by Plaintiffs and

class members as a result of purchases of Allou Class A common stock from July 2, 2001, the

date that the audited financial results of Allou for fiscal year 2001 were announced, through the

end of the Class Period.

130. Arthur Andersen’s reports were false and misleading due to its failure to

conduct its audits in compliance with GAAS and because Allou’s financial statements were not

prepared in conformity with GAAP, as alleged herein, so that issuing the reports was in violation

of GAAS and SEC rules. Andersen knew their reports would be relied upon by present and

potential investors in Allou common stock.


46

Arthur Andersen’s Misconduct in Connection With the 2001 Audit


were woefully inadequate. In violation of GAAS, Arthur Andersen either actually knew about

many of these issues or recklessly ignored the many inconsistencies, lack of documentation and

red flags that would have put Andersen on notice of the massive overstatements of inventory and

receivables.

132. For instance, as set forth in the Bankruptcy Trustee’s Complaint against Allou’s

auditors, in performing the 2001 Audit, Arthur Andersen evaluated the services provided by

Mayer Rispler to Allou and elected to rely on those services as work performed by internal

auditors. However, the decision to rely on work performed by Mayer Rispler was critically

flawed, as those procedures had significant departures from GAAS. For instance, as described

herein, Mayer Rispler failed to complete required audit procedures as required by AU §§ 330,

350.

133. Out of the $85.6 million of reported accounts receivable of Allou at March 31,

2001, approximately $35.1 million, or 41% were fictitious. Therefore, the sheer size of the

accounting fraud at Allou during the fiscal year 2001 demonstrates the inadequacy of Arthur

Andersen’s auditing of Allou’s financial results, and that the audit represented an extreme

deviation from acceptable auditing standards.

134. In connection with the 2001 Audit, the primary procedure relied upon by Arthur

Andersen to test the existence of accounts receivable was the confirmation of accounts selected

by Mayer Rispler. That procedure called for the confirmation of $80.2 million of accounts

receivable that were purportedly tested by Mayer Rispler. However, those procedures were only

able to verify the existence of approximately $27.6 million, leaving $52.6 million in accounts


47

receivable without verification of existence. As such, Mayer Rispler and Arthur Andersen failed

to complete their testing and, therefore, failed to comply with the provisions of AU § 330, which

requires that accounts receivable confirmations be obtained and evaluated by “a direct

communication from a third-party in response to a request for information about a particular item

affecting financial statement assertions.” Had such tests been properly planned and performed,

then at least some of the fraudulent receivables would have been detected.

135. The projected error based upon the entire population of reported receivables

(i.e., approximately $87 million) was approximately $57.0 million. Because of the enormity of

the projected error, Mayer Rispler and Arthur Andersen knew, or should have known, that the

test could not be relied upon.

136. Arthur Andersen performed only limited testing of the work performed by

Mayer Rispler. Among other things, Arthur Andersen failed to properly test for the existence of

Sears and Wal-Mart receivables, which were reflected as still being outstanding as of June 12,

2001 in the combined amount of approximately $20.3 million. Arthur Andersen relied upon the

statement by Allou's management that Sears and Wal-Mart were given extended payment terms

because the receivables were allegedly related to merchandise to be sold during the 2001

Christmas season, and failed to conduct any further investigation. Arthur Andersen accepted this

explanation without question. As set forth below, the same Arthur Andersen audit team that

accepted this excuse in connection with the 2001 Audit, accepted the Mother's Day/Father's Day

excuse in connection with 2002 Audit, as embellished by management's claim that Wal-Mart

was having difficulties because of 9/11. As with the 2002 Audit, substantially all of these

purported Sears and Wal-Mart accounts receivables were fraudulent.

137. Allou had approximately $41.8 million of unverified accounts receivable.


48

Arthur Andersen tested this amount by vouching approximately 22 invoices to underlying proof

of delivery documentation. Selecting only 22 invoices for testing approximately $41.8 million of

accounts receivable was grossly inadequate, and Mayer Rispler and Arthur Andersen knew, or

should have known, that they had not performed sufficient procedures to support the reported

accounts receivable.

138. Had Arthur Andersen performed other required tests of, inter alia, accounts

receivable and subsequent receipts, it would have detected the bogus Salesman No. 2 invoices to

such customers as Eckerd, Wal-Mart and J.C. Penney. As previously alleged, the Company

created phony invoices that amounted to approximately $220 million in sales from January 2000

to March 2003.

139. In addition, if Arthur Andersen had performed the tests required by GAAS for

confirmation of inventory balances, it would have discovered inconsistencies that would have led

to the disclosure of the fraud. GAAS states that “[w]hen [inventory] quantities are determined

solely on physical count and all counts are made as of the balance sheet date or within a

reasonable time before or after the balance sheet date, the auditor should ordinarily be present

when inventory is counted.” AU § 331. If there is a perpetual inventory system, GAAS suggests

that “[i]f these records are well kept and checked by the client periodically by comparisons with


under audit.” Id. Arthur Andersen utterly failed to properly observe inventory counts and/or test

inventory values. Had Arthur Andersen performed the required tests of inventory Arthur

Andersen would have detected that substantial amounts of inventory reported on the trial balance

of Allou were non-existent or materially overvalued.

140. In connection with the 2001 Audit, Arthur Andersen also did not perform a


49

single physical inventory observation, despite a reported $176.4 million of inventory at March

31, 2001. Instead, Arthur Andersen relied upon inventory observations performed by Mayer

Rispler prior to the time that Arthur Andersen was engaged by Allou. Mayer Rispler itself did

not perform all of the inventory observation but, instead, arranged for yet another accounting

firm, BDO Seidman, LLP, (“BDO”) to perform the inventory observation at the Brooklyn

warehouse, as well as observations pertaining to Direct Fragrances, Inc. (“Direct”) and Stanford

Personal Care Manufactures, Inc. (“Stanford”).

141. Upon information and belief, BDO was retained by Mayer Rispler to assist Mayer

Rispler in performing the inventory observation and, therefore, Mayer Rispler is responsible for

any deficiencies in the work performed by its agent, BDO.

142. Although Arthur Andersen apparently performed some test counts to verify the

work previously performed by Mayer Rispler and BDO, its test counts involved only 80 out of

approximately 22,000 different products and, thus, were grossly inadequate to satisfy the

requirements under GAAS for evaluating the existence of inventory.

143. In order to determine whether the reported inventory was properly valued,

“costing” tests were performed. Costing tests are procedures whereby vendor invoice data is

gathered as evidence in support of unit costs reflected on the client’s inventory records. The

inventory costing test work performed by Arthur Andersen primarily relied upon the work

performed by Mayer Rispler. Although Arthur Andersen noted that there were material

differences in the costing of the same products, it failed to obtain any support to explain these

differences, in violation of GAAP.

144. Some of these costing discrepancies involved purchases purportedly made from

A&M, such that the same product purchased by Allou from A&M cost more than the same


50

product purchased from other suppliers. A&M was a related party and, as such, Mayer Rispler

and Arthur Andersen should have scrutinized these transactions more closely and performed

additional procedures to explain these discrepancies.

145. Impax Trading Company (“Impax”), another related entity, was also charging

Allou more for the same products. Impax was a related party used by the Jacobs to record

millions of dollars of fictitious inventory. If Mayer Rispler and Arthur Andersen had performed

additional procedures, as they were required to, they would have discovered this fact, or at the

very least, have confirmed that the costing reported by Allou could not be relied upon.

146. Arthur Andersen’s failure to detect these inventory irregularities and accounts

receivable discrepancies demonstrates an extreme departure from the standards of ordinary care

common to auditors, presenting an obvious danger of misleading investors that was known to

Arthur Andersen or was so obvious that the inference that it knew of the danger is inescapable.

147. Arthur Andersen also failed to discover that Allou transacted with numerous

entities owned and/or controlled by the Jacobs and members of their families and that these

entities were involved in various aspects of the fraud, including the bogus invoices and third-

party payments. For instance, instead of following the proper GAAP procedures, Arthur

Andersen merely asked the Jacobs if Allou was dealing with any related parties.

148. Ever Ready and A&M were vendors to Allou and the 2001 consolidated

financial statements disclose approximately $3 million of related party purchases during the year

ended March 31, 2001. Arthur Andersen failed to consider A-1 Medical even though it was also

identified as a related party in prior audits. During 2001, Ever Ready, A&M and A-1 Medical

“advanced” $26 million to Allou, which was not disclosed in the consolidated financial

statements. This amount was use to cover fraudulent accounts receivable. Had Arthur Andersen


51

properly performed required related party procedures and verified subsequent cash receipts

transactions, it would have discovered Allou’s accounts receivable fraud.

Arthur Andersen Failed to Perform Its Audit In Accordance With Professional Standards

149. Arthur Andersen acted with knowledge or reckless disregard as to (a) the false

and misleading nature of the certifications they provided, (b) the false and misleading nature of

the financial statements and their failure to conduct proper audit tests and examinations of the

books, records and financial statements of the Company, and (c) the false representations that the


150. In accordance with GAAS, Arthur Andersen was required to consider whether

Allou’s disclosures accompanying its financial statements were adequate. SAS No. 32, as set

forth in AU §431.02-03.


1997) Arthur Andersen had, but failed to fulfill, “a responsibility to plan and perform the audit to

obtain reasonable assurance about whether the financial statements are free of material

misstatement, whether caused by error or fraud.” If there is a material misstatement, whether by

fraud or mistake, the auditors’ procedures need to be designed and performed to detect it.

Further, the auditor is required to view the audit evidence with professional skepticism, a

standard that is particularly important when, as here, the Company in question is controlled by a

family group such as the Jacobs.

152. Arthur Andersen knowingly or recklessly failed to obtain reasonable assurances

as to whether the Company’s financial statements were free of material misstatements caused by

fraud. In fact, Arthur Andersen closed its eyes to the massive fraud detailed above. Instead, the

massive fraud was detected by a lender’s routine inspection of the Company’s books and


52

records.

153. Another of Arthur Andersen’s responsibilities as Allou’s independent auditor, was

to obtain “[s]ufficient competent evidential matter . . . to afford a reasonable basis for an opinion

regarding the financial statements under audit” as to the fairness with which they present, in all

material respects, financial position, results of operations, and its cash flows in conformity with

generally accepted accounting principles.” AU §§ 150,110.

154. SAS No. 85, Client Representations, and AU § 333, Client Representations, state

that representations from management are not a substitute for the application of these auditing

procedures necessary to afford a reasonable basis for an opinion regarding the financial


155. In violation of GAAS, and contrary to the representations in its report on Allou’s

financial statements, Arthur Andersen did not obtain sufficient, competent, evidential matter to

support Allou’s assertions regarding its inventory and accounts receivable. Moreover, the

auditors deliberately or recklessly ignored information indicating that Allou’s financial

statements did not “present fairly” the Allou’s financial position.

156. In carrying out its engagement to audit the financial statements of Allou and in

issuing its unqualified report on those financial statements, Andersen violated, among others, the

following GAAS standards:

a) The second general standard that the auditors should maintain an


b) The third general standard that due professional care is to be

exercised in the performance of the audit and preparation of the report;

c) The first standard of field work that the audit is to be adequately


53

planned and that assistants should be properly supervised;

d) The second standard of field work that the auditor should obtain a



e) The third standard of field work that sufficient, competent,

evidential matter is to be obtained to afford a reasonable basis for an opinion on the

financial statements under audit.

157. In an extreme departure from professional standards, Arthur Andersen failed to

audit the financial statements of the Company as of and for the fiscal year ended March 31, 2001

in conformity with GAAS.

158. In 2002, Arthur Andersen lost its auditing license in the United States as a result

of its involvement in the Enron collapse and, as mentioned above, was replaced by outside

auditor for Allou by KPMG on or about June 10, 2002.

The Wrongful Conduct of Defendant KPMG

159. Although KPMG ultimately issued the 2002 Audit Report, each of Mayer Rispler,

Arthur Andersen and KPMG were involved in performing and disseminating the 2002 Audit,

which was begun in January 2002 by Arthur Andersen and completed by KPMG who signed the

2002 Audit Report on July 3, 2002.

160. As a result of the demise of Arthur Andersen, three of the principal members of

the Allou audit team that had been employed by Arthur Andersen and that had performed the

2001 Audit, including the audit partner in charge of the audit, were hired by KPMG and

performed the 2002 Audit. Thus, many of the same individuals from Mayer Rispler, Arthur

Andersen and KPMG were involved in both the 2001 and 2002 Audits.


54

161. According to Allou’s Form 14A filed with the SEC on July 30, 2002, KPMG

provided auditing and accounting services for the Company beginning in June 2002, several

weeks after the end of Allou’s fiscal year.

162. KPMG audited and, on July 3, 2002, certified the Company’s financial statements

for fiscal year ended March 31, 2002, as set forth below. KPMG presumably was able to

complete its audit and issue its unqualified report less than one month after it was engaged, by

compressing the time frame of its audit procedures and/or utilizing work done by Andersen prior

to its ceasing its engagement by Allou. For the reasons set forth herein, KPMG is liable in whole

or in part for the damages suffered by plaintiffs and class members as a result of purchases of

Allou Class A common stock from July 1, 2002, the date that the audited financial results of

Allou for fiscal year 2002 were announced, through the end of the Class Period.

KPMG’s Misconduct in Connection With the 2002 Audit

163. KPMG’s report on the 2002 Allou financial statements was false and misleading

due to its failure to conduct its audits in compliance with GAAS and because Allou’s financial

statements were not prepared in conformity with GAAP. KPMG knew its report would be relied

upon by present and potential investors in Allou securities.

164. According to the Bankruptcy Trustee’s Complaint against Allou’s auditors, during

the 2002 Audit, KPMG ultimately determined that Mayer Rispler should be considered the

client. In fact, many audit areas of the 2002 Audit identify Mayer Rispler as Allou’s internal

auditors. Work product prepared by Mayer Rispler relating to the 2002 consolidated financial

statements is clearly marked with the designation “PBIA” (i.e., prepared by internal audit).

KPMG allowed Mayer Rispler to determine the nature, timing and extent of critical audit

procedures and Mayer Rispler was allowed to determine the sufficiency and adequacy of


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evidential matter related to those procedures. Moreover, Mayer Rispler made representations

that KPMG relied upon without independent verification and KPMG did not appropriately

modify its audit scope.

165. Out of $109.7 million of reported accounts receivable of Allou at March 31, 2002,

at least $60 million, or 55% were, fictitious. The Allou accounts receivable balance at March 31,

2002 was comprised of approximately 55,000 invoices, of which approximately 28,000 or 51%

were fictitious. Defendants’ accounts receivable procedures collectively were deficient on their

face because their procedures did not identify a fraud of this magnitude. Therefore, the sheer

size of the accounting fraud at Allou during the fiscal year 2002 demonstrates the inadequacy of

KPMG’s audit of Allou’s financial results, and that the audit represented an extreme deviation

from acceptable auditing standards.

166. Mayer Rispler initially tested for the existence of accounts receivable by sending

out written confirmations to 103 of Allou’s customers asking that the receivables be confirmed in

writing by the customers. This method of verifying receivables is considered reliable because

the information comes from the customers themselves not from the client whose records may be

incorrect or fraudulent. However, since most of the customers apparently did not respond to the

confirmation requests, defendants were required under GAAS to perform alternative procedures

that would not rely solely on Allou’s internal records.

167. Mayer Rispler devised a confirmation test of accounts receivable pertaining to

103 customers. This sampling included the two largest customers, Sears and Wal-Mart (the “103

Customer Test”). The 103 Customer Test, if properly performed, would have represented a

sample that aggregated $67.3 million of the total outstanding of $109.7 million of Allou’s

accounts receivable. The customers of Allou, represented $86.1 million or 79% of the $109.7


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million. Fifty-one of these 103 accounts were Allou customers aggregating $48.1 million or

72% of the 67.3 million. Two of these 51 customers were Sears and Wal-Mart, representing

$17.5 million and $16.6 million or 26% and 25%, respectively, of the total sample of $67.3

million. $16.0 million, or 92%, of the Sears of subsequent cash receipts came from third parties

and were fraudulent. More than $17.4 million, or 25%, of the sample of $67.3 million was

unpaid by the time KPMG signed its Audit Report on July 3, 2002. A large part of that $17.4

million, i.e., $15.8 million, consisted of fraudulent Wal-Mart accounts receivable. Thus, as

further discussed below, if the 103 Customer Test had been completed and performed properly,

the fraud would have been discovered.

168. The 103 Customer Test, as designed by Mayer Rispler, required full and complete

verification of the entire $67.3 included in the sample of 103 customers or consideration of the

unverified amount as an accounting error. Under this test, subsequent cash collections (i.e.,

March 31, 2002 balances that were collected through the end of audit fieldwork) were to be used

as the primary source of evidential matter for verifying the existence of accounts receivable at

March 31, 2002. Mayer Rispler was required to establish these payments by examining copies

of electronic payment receipts or other actual checks received in the lockbox maintained by

Allou’s bank. Since these copies were not prepared by, or under the control of, Allou, they are

not considered more reliable than Allou’s internal cash receipts journals. If Mayer Rispler had

performed that procedure, it would have discovered the fraud. In this regard, there were

subsequent collections with respect to Tereza Merchandising Inc. (“Tereza”) in the amount of

approximately $2.9 million. However, an examination of the lockbox checks reveals that

approximately $1.0 million of this amount did not come from Tereza but came from a third party

known as HIL Associates which, upon information and belief, was a sham entity owned or


57

controlled by the Jacobs. If defendants had examined the checks, they would have seen this

obvious discrepancy and would have been required to investigate it further. In fact, the entire

$2.9 million of accounts receivable with respect to Tereza were fraudulent.

169. Similarly, Mayer Rispler’s test sample included subsequent collections in the

amount of approximately $1.5 million with respect to Ipex Trading (“Ipex”). More than $1

million of this amount came from other Allou entities, i.e., Allou Distributors, Inc. and Roan, and

not from Ipex. If defendants would have traced these payments to the lockbox checks, they

would have discovered the fraud.

170. Mayer Rispler’s confirmation procedures for Allou’s accounts receivable appear

to have been categorized into two groups. The first group included accounts under $10 million

and the second included accounts over $10 million (i.e., Sears and Wal-Mart). As of May 28,

2002, the test sample of the first group had a total unpaid balance of $1.3 million that was not

verified in accordance with GAAS. Under AU § 330, the auditors were required to complete the

work and verify the unpaid balance using other sources of competent evidential matter. If the

work was not completed, KPMG was required to treat the entire $1.3 million as a misstatement

and project the misstatement to the entire balance of the first group of Allou Distributors, Inc

(“ADI”), a subsidiary of Allou, accounts receivable. The projected misstatement for the group of

Allou accounts receivable is approximately $4.7 million, which is material to Allou’s March 31,

2002 consolidated financial statements.

171. KPMG had examined the Mayer Rispler work papers containing the result of 103

Customer Test. Thus, KPMG knew, or should have known, that Mayer Rispler never completed

that test and that approximately nine percent (9%) of the first group of Allou’s receivables

remained unverified and required further investigation. Upon information and belief, no such


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further investigation or the unresolved balance was conducted by KPMG.

172. As mentioned above, the second group of Allou receivables included Sears and

Wal-Mart, which were the two largest accounts debtors to Allou. As of March 31, 2002, Sears

had a reported account balance of $17,461,631, and Wal-Mart had a reported account balance of

$14,624,794 or a combined amount of $34,096,425. In an attempt to authenticate the accounts

receivable balance, Mayer Rispler compared Allou’s March 31, 2002 aging report with its May

31, 2002 aging report, which indicated that the entire Sears balance had been paid, but that most

of the Wal-Mart balance, i.e., $15,749,555 was still outstanding. Defendants did nothing to

investigate the unpaid Wal-Mart balance other than to discuss it with Shamilzadeh, who claimed

the reason why the Wal-Mart balance was past due by more than 60 days was that special terms

were given to these two customers because of Mother’s Day and Father’s Day promotions, and

because Wal-Mart and Sears allegedly “asked that special courtesy be given them in light of the

post-9/11 economical situation, which affected retailers severely.” This explanation is

nonsensical because it fails to explain why Sears was apparently able to timely satisfy its

outstanding balance, while Wal-Mart did not. As was later discovered, substantially all of the

Sears payments originated from third parties and were fraudulent. Similarly, all of the

outstanding Wal-Mart invoices were fraudulent.

173. KMPG itself designed a test that, if implemented, would have uncovered the fraud

as it related to accounts receivable. However, instead of performing the test that it initially

planned, KPMG dramatically modified the planned procedure. Based on KPMG’s own work

papers, the modified test was biased and did not provide for KPMG to review any of the

customers’ supporting cash receipts documentation and did not include any testing whatsoever of

the receivables due from Sears and Wal-Mart.


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174. The modified test that KPMG ultimately used for its audit was deficient because it

was heavily biased towards significantly smaller entities (i.e., Sobol) and therefore was an

inherently unreliable test of the total reported accounts receivable.

175. KPMG also purportedly employed a test to obtain sufficient evidence that sales

revenue and cost of goods sold were accurate and properly recorded. In fact, the sample that

KPMG tested included fictitious invoices, with payments from third party entities such as,

“Capital Sales Corp.,” “SE-Roebuck, Ltd.” and “Omni Development and Marketing Ltd.,” all of

which were sham entities controlled by the Jacobs. Actually, some of these checks were signed

by Ari Jacobs, the son of Victor and brother of Herman and Jacob Jacobs, and by Jacob

Schwartz, a longtime employee of Allou who was Victor Jacobs’ nephew and Herman and Jacob

Jacobs’ cousin. KPMG either never performed the test it said it had performed, or performed the

test and disregarded this clear evidence of fraud that was right in front of its face.

176. KPMG purportedly tested Allou invoice no. 1270786 dated September 28, 2001

in connection with a purported sale to a customer in the amount of $22.75. The invoice amount

per Allou’s computer system and the subsequent payment were in the amount of $1,031.52, not

$22.75. The cancelled check supporting the subsequent payment that paid this invoice was not

from the identified customer, but from a third party, which happened to be a sham entity

controlled by the Jacobs. Moreover, the check was handwritten and drawn on a local Brooklyn

bank and signed by an Allou employee, Jacob Schwartz. It appears that KPMG never inspected

the original invoice and the supporting customer payment documentation. In addition, KPMG

purportedly tested ADI invoice no. 1218637, dated July 8, 2001 in connection with another

invoice in the amount of $310.40. The invoice amount per Allou’s computer system and the

subsequent payment were in the amount of $4,369.68, not $310.40. The electronic payment


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supporting the subsequent payment that paid this invoice was not from the expected customer,

but rather was from another third party, which was a sham entity controlled by the Jacobs.

Again, it appears that KPMG never inspected the original invoice and the supporting customer

payment documentation. KPMG either ignored these obvious red flags or never performed the

test in the first place. Under either of these scenarios, KPMG was reckless.

177. KPMG’s also gathered industry statistics relative to accounts receivable,

including statistics showing industry performance with respect to days sales in accounts

receivable, accounts receivable turnover and comparative agings of accounts receivable at

various points in time. This information revealed that the performance of these assets had

substantially deteriorated and was substantially below industry standards. In addition, the year-

to-year comparative information showed a consistently downward trend in Allou’s accounts

receivable turnover and comparative aging statistics. These findings were additional red flags

that required KPMG to perform heightened test procedures. Instead, KMPG did just the opposite

and even the limited tests it purportedly performed were recklessly mishandled, to the extent

they were performed at all.

178. When the level of risk assessment is high, as it was in the case of Allou, because,

inter alia, the Company reported large amounts of accounts receivable and financial controls

were dominated by members of a single family, GAAS requires that accounts receivable

confirmations be obtained and evaluated by “a direct communication from a third-party in

response to a request for information about a particular item affecting financial statement

assertions.” AU § 330. Had such tests been properly planned and performed by KPMG,

notwithstanding the restricted time frame in which KPMG completed the audit, then some of the

fraudulent receivables would have been detected.


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179. Had KPMG not violated GAAS and performed other required tests of, inter alia,

accounts receivable and subsequent receipts, KPMG would have detected the bogus Salesman

No. 2 invoices to such customers as Eckerd, Wal-Mart and J.C. Penney. As previously alleged,

the Company created phony invoices that amounted to approximately $220 million in sales from

January 2000 to March 2003.

180. Defendants also failed to properly plan the procedures to examine the observation

and testing of Allou’s inventory. Among other things, upon information and belief, they failed to

obtain Allou’s entire perpetual inventory record for all the inventory at all locations. Instead,

they were furnished with portions of the perpetual inventory of approximately $185.5 million.

Moreover, the portions of the perpetual inventory records that were given to Arthur Andersen

and KMPG were selected by the client, Allou, and/or Mayer Rispler, which KMPG was

allegedly treating as the equivalent of the client. The proper procedure would have been for the

auditor to obtain the entire perpetual inventory for all locations, and then for the auditor, not the

client, to select the portions of the perpetual inventory from which sample items would be tested.

Letting the client select the portions of the perpetual that would be subjected to the auditor’s

testing amounts to a client imposed scope limitation that should have prevented KPMG from

issuing an unqualified Audit Report.

181. None of the physical inventory observations were performed on the actual date

that the inventory count was taken by Allou. Moreover, the inventory observation at the

Brooklyn and Brentwood, New York warehouses took place on different days. Thus in the

absence of additional measures, which were not employed, Allou had the opportunity to move

inventory between warehouses. Defendants failed to guard against this classic technique used in

inventory fraud.


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182. The fraud was so massive that even the flawed physical observation procedures

performed by defendants revealed glaring discrepancies in the perpetual inventory records. For

example, in early January 2002, as part of its inventory observation procedures at the Brooklyn

warehouse, Arthur Andersen selected 40 items for verification by test counts and discovered that

there were discrepancies between the test counts made by Arthur Andersen and Allou’s perpetual

inventory records for nine of these items, or 22.5% of the sample. Arthur Andersen discovered

that these same nine items were not recorded on the warehouse’s records. As a result, Arthur

Andersen determined that it could not conclude on the inventory count. Arthur Andersen then

advised Herman Jacobs of the discrepancies and asked him for an explanation. Herman never

responded to that inquiry.

183. Arthur Andersen also asked Nachman Lichter, the operator of the Brooklyn

warehouse, for records that would reconcile the discrepancies. However, upon information and

belief, the discrepancies were never reconciled by the time KPMG executed its Audit Report in

connection with the 2002 Audit. Under Section AU 350.25 of GAAS, all of the missing items

required full and complete resolution.

184. In connection with the inventory observation procedures performed at Stanford,

Arthur Andersen (and later KPMG which relied upon Arthur Andersen’s tests) also determined

that there were “eight true exceptions which may indicate ineffective internal controls related to

inventory.” Additional discrepancies were noted with respect to the inventory observations

procedures performed at Direct, where 57 out of 75 items test counted by Arthur Andersen

showed discrepancies. These were further red flags that indicated that Allou’s internal controls

of inventory were suspect.

185. In the physical observation procedures performed, KPMG did not modify the


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nature, timing and extent of their audit work as a result of the inventory control weaknesses that

were noted during their observation procedures. Instead, they disregarded their own conclusions

that had shown there were serious problems with Allou’s inventory control system.

186. In order to test the integrity of Allou’s inventory controls and information

technology, KPMG’s “Information Risk Management” group was engaged to perform certain

procedures, including testwork over the input, electronic processes, and outputs of Allou’s

inventory subledger and Allou’s general ledger as it relates to inventory. However, KPMG

assigned only one person to perform the procedures and he only spent two days in performing

them. KPMG’s own internal documents concede the work could not have been done properly in

such a short span of time. Thus, KPMG knew or should have known that it could not rely upon

Allou’s inventory controls and information technology, but it did so anyway.

187. Except for the inventories at Stanford and Direct, the inventories were conducted

on dates other than Allou’s year end (i.e., March 31, 2002). Defendants did not obtain competent

evidential matter to support the rollforward and rollback of the inventory, as it should have, and

the related balances for all locations, for the period between the physical inventory observation

dates and the balance sheet date of March 31, 2002. In addition, there were material

discrepancies between the balances noted in the inventory observation work papers and the

balances presented in Allou’s general ledger. Defendants ignored and/or failed to investigate

these serious discrepancies.

188. KPMG purportedly obtained rollforwards as to all four inventory locations

observed by Arthur Andersen in January and February 2002 and a rollback as to the inventory

location observed by KPMG in 2002. However, even if the rollforwards and rollbacks for all

locations were obtained, the procedures performed by KPMG to test them were fundamentally


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flawed.

189. In order to determine whether the reported inventory was properly valued,

“costing” tests were performed. Costing tests are procedures whereby vendor invoice data is

gathered as evidence in support of unit costs reflected on the client’s inventory records.

However, among other things, KPMG failed to quantify the actual amount of verification work

performed during its inventory test and, upon information and belief, only a portion of the

inventory was verified with supporting documentation.

190. KPMG failed to use the most exhaustive test, which should have been used for

critical audit decisions, particularly decisions regarding material misstatements to Allou’s $152.1

million inventory as required by GAAS. Under GAAS, the projected misstatements were

approximately $70 million and $33.6 million, using two inventory tests, which required

additional work, which KPMG never performed.

191. KPMG also ignored the deterioration of year-over-year performance of Allou and

the industry statistics it had obtained when comparing these statistics to Allou’s inventory

performance. For example, these industry statistics indicated an average inventory turnover of

7.47 times per year, while Allou was not even managing to achieve two times per year. This is

yet another red flag that required KPMG to perform heightened testing procedures that KMPG

chose to ignore.

192. If KPMG had performed the tests required by GAAS for confirmation of

inventory balances, it would have discovered inconsistencies that would have led to the

disclosure of the fraud. GAAS states that “[w]hen [inventory] quantities are determined solely

on physical count and all counts are made as of the balance sheet date or within a reasonable

time before or after the balance sheet date, the auditor should ordinarily be present when


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inventory is counted.” AU § 331. If there is a perpetual inventory system, GAAS suggests that

“[i]f these records are well kept and checked by the client periodically by comparisons with


under audit.” Id. KPMG utterly failed to properly observe inventory counts and/or test

inventory values. Had Arthur Andersen performed the required tests of inventory Arthur

Andersen would have detected that substantial amounts of inventory reported on the trial balance

of Allou were non-existent or materially overvalued.

193. KPMG’s failure to detect these accounts receivable discrepancies and inventory

irregularities demonstrates an extreme departure from the standards of ordinary care common to

auditors, presenting an obvious danger of misleading investors that was known to KPMG or was

so obvious that the inference that KPMG knew of the danger is inescapable.

194. Although Allou had disclosed to KPMG purported dealings with only one related

entity, i.e., Ever Ready, which also did business with A&M, KPMG failed to make sufficient

inquiries concerning the nature of the relationships. It appears that the only procedure applied by

KPMG was to ask the Jacobs if Allou was dealing with any related parties. Once a relationship

is identified, the auditor is guided by AU §§ 334.09 and 334.10 to examine identified

relationships with related parties. After identifying related party transactions, the auditor should

apply additional procedures to obtain satisfaction concerning the purpose, nature, and extent of

these transaction and their effect on the financial statements. The procedures should be directed

toward obtaining and evaluating sufficient competent evidential matter and should extend

beyond inquiry of management. KPMG failed to perform these procedures and never even

obtained an understanding of the nature and magnitude of the relationship between Allou and the

related parties that KPMG did identify (i.e., Ever Ready and A&M).


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195. Allou’s 2002 consolidated financial statement disclosed approximately $21

million of related party purchases during the year ended March 31, 2002. KPMG failed to

scrutinize transaction between Allou and Ever Ready and A&M, who were vendors to Allou and

related parties. KPMG also failed to consider A-1 Medical even though it was also identified as

a related party in prior audits. During 2002, Ever Ready, A&M and A-1 Medical "advanced"

$46 million to Allou which was not disclosed in the consolidated financial statements and was

used to mask fraudulent accounts receivable. Had KPMG properly performed required related

party procedures and verified subsequent cash receipts transactions, it would have detected

Allou's accounts receivable fraud.

196. KPMG did not consider many indicators of the fraud that it came across during

the conduct of its audit in developing an audit scope or plan. In fact, KPMG noted several

indicators listed in its own internal checklist that, if properly evaluated, would have alerted it to

the risk of the fraud at Allou, such as declining margins and the inability to generate cash flow

from operations while reporting earnings. In planning the procedures to be implemented in

conducting the audit, KPMG failed to take into account these known risks. Ultimately, the 2002

Audit was grossly flawed in its planning and execution.

197. KPMG staffed the Allou audit with auditors (including the audit partner) who had

migrated to it from Arthur Andersen after Arthur Andersen’s collapse. KPMG's professional

skepticism and independence were severely compromised because the former Arthur Andersen

partners and staff (a) had a personal incentive to minimize Arthur Andersen’s prior audit failures

and their own potential liability therefore by failing to "discover" audit issues and irregularities

that could expose Arthur Andersen’s prior audit to scrutiny and liability, and (b) did not have a

full and complete understanding of KPMG’s audit procedures and policies which, despite the use


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of other KPMG personnel and audit documentation were not followed.

KPMG’s Failed to Perform Its Audit in Accordance With Professional Standards

198. KPMG acted with knowledge or reckless disregard as to (a) the false and

misleading nature of the certifications they provided, (b) the false and misleading nature of the

financial statements and their failure to conduct proper audit tests and examinations of the books,

records and financial statements of the Company, and (c) the false representations that the



were woefully inadequate. In violation of GAAS, KPMG failed to expand the scope of its audit

in light of the fact that it actually knew about many of these issues or recklessly ignored the

many inconsistencies, lack of documentation and red flags that would have put it on notice of the

massive overstatements of inventory and receivables.

200. In accordance with GAAS, KPMG was required to consider whether Allou’s

disclosures accompanying its financial statements were adequate. SAS No. 32, as set forth in AU

§431.02-03.


1997) KPMG had “a responsibility to plan and perform the audit to obtain reasonable assurance

about whether the financial statements are free of material misstatement, whether caused by error

or fraud.” If there is a material misstatement, whether by fraud or mistake, the auditors’

procedures need to be designed and performed to detect it. Further, the auditor is required to

view the audit evidence with professional skepticism, a standard which is particularly important

when, as here, the Company in question is controlled by a family group such as the Jacobs.

202. KPMG knowingly or recklessly failed to obtain reasonable assurances about


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whether the Company’s financial statements were free of material misstatements caused by

fraud. KPMG closed its eyes to the massive fraud detailed above. Instead, the massive fraud

was detected by a lender’s routine inspection of the Company’s books and records.

203. One of KPMG’s responsibilities as Allou’s independent auditor, was to obtain

“[s]ufficient competent evidential matter ... to afford a reasonable basis for an opinion regarding

the financial statements under audit” as to the fairness with which they present, in all material

respects, financial position, results of operations, and its cash flows in conformity with generally

accepted accounting principles.” AU §§ 150,110.

204. SAS No. 85, Client Representations, and AU § 333, Client Representations, state

that representations from management are not a substitute for the application of these auditing

procedures necessary to afford a reasonable basis for an opinion regarding the financial


205. In violation of GAAS, and contrary to the representations in its report on Allou’s

financial statements, KPMG did not obtain sufficient, competent, evidential matter to support

Allou’s assertions regarding its inventory and accounts receivable. Moreover, the auditors

deliberately or recklessly ignored information indicating that Allou’s financial statements did not

“present fairly” the Company’s financial position.

206. In carrying out its engagement to audit the financial statements of Allou and in

rendering its unqualified report on those financial statements for fiscal year 2002, KPMG

violated, among others, the following GAAS standards:

i. The second general standard that the auditors should maintain an


ii. The third general standard that due professional care is to be exercised in


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the performance of the audit and preparation of the report;

iii. The first standard of field work that the audit is to be adequately planned

and that assistants should be properly supervised;

iv. The second standard of field work that the auditor should obtain a



v. The third standard of field work that sufficient, competent, evidential

matter is to be obtained to afford a reasonable basis for an opinion on the financial


vi. In substantial departure from professional standards, KPMG failed to audit

the financial statements of the company as of and for the fiscal year ended March 31,

2002 in conformity with GAAS.

The Wrongful Conduct of the Additional Director Defendants

207. The Additional Director Defendants served as members of the Audit Committee.

Pursuant to the Charter of the Audit Committee of the Board of Directors of Allou, which was

attached as an appendix to the Company’s Proxy Statement dated August 5, 2000, the Audit

Committee had a duty to, among other things, review, prior to their filing or prior to their release,

the Company’s Form 10-Ks, Form 10-Qs and other financial information submitted to the SEC.

The Audit Committee was also required to review and appraise the audit efforts of the

Company’s independent auditors and to periodically consult with the independent auditors out of

the presence of management about internal controls and completeness and accuracy of the

Company’s financial statements.

208. The Company had only three independent directors, defendants Naimark, Berg


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and Glasser. The four remaining directors were the key operational executives of Allou, and

three of them were close relatives. This gave rise to the serious risk of the internal controls of

the Company being manipulated by top management. Defendants Naimark, Berg and Glasser

were aware of the serious risk and therefore, as the Audit Committee, had reason to exercise

greater diligence in carrying out their duties to satisfy themselves that the financial reporting of

Allou was accurate.

209. The Audit Committee utterly failed to carry out its responsibilities under the

standards detailed in its Charter. Instead the Additional Director Defendants appear to have

rubber-stamped the acts of management. Indeed, even after learning that the Brooklyn

warehouse fire in September 2002 was of a suspicious nature and that the Jacobs had concealed

the fact that the warehouse was an entity owned by Victor Jacobs’ wife and son, defendant

Naimark continued to blind himself to the fraud at Allou. He is reported in a Newsday article of

November 22, 2003 to have stated, “[t]he Company itself is a very strong company and very well

run.” Such a reaction to the events then coming to light create a strong presumption that

defendant Naimark either knew of the fraudulent scheme or recklessly blinded himself to the

wrongdoing of the Individual Defendants.

210. As detailed in the Complaint filed by the Bankruptcy Trustee against the

Additional Director Defendants, the Bankruptcy Trustee requested all minutes from Allou’s

Board of Directors’ meetings and audit committee meetings.

211. In response, the Bankruptcy Trustee received only two file folders that contained

copies of the following documents: unanimous consent resolutions of the board, minutes from

shareholders meetings, “scripts” for shareholders meetings, company annual reports, SEC Forms

10-K and 10-Q, outside auditor reports, press releases, news clippings, handwritten notes,


71

internal business proposals, compensation agreements and correspondence.

212. However, Allou’s counsel did not produce any minutes from any recent meetings

of either the Board or the Audit Committee meetings except for the following items: (a) agenda

and minutes from telephonic board meeting of June 6, 2002; (b) agenda for annual board meeting

of September 12, 2002; and (c) agenda for special board meeting of April 1, 2003. No minutes

or agendas reflecting Audit Committee meetings were produced, despite the fact that the

Company traded on a national stock exchange and was subject to extensive federal reporting

requirements.

213. Either the Additional Director Defendants did not hold Audit Committee

meetings, or the meetings were so lacking in substance that the Additional Director Defendants

did not bother memorializing them. As such, the Additional Director Defendants failed to

comply with their duties as Audit Committee members.

214. The Additional Director Defendants, as members of the Audit Committee, signed

Allou’s SEC filings that contained material misrepresentations about Allou’s financial condition

and are, therefore, responsible for the accuracy of the contents of those filings.

215. The degree of fraud was so immense that it is reasonable to infer that the Audit

Committee either knew of or blinded themselves to the true financial condition of the Company

and the manipulation of its accounts by the Individual Defendants. The Additional Director

Defendants knowingly or recklessly failed to carry out their responsibilities and therefore

knowingly or recklessly caused to be disseminated to the public information that was materially

false and misleading.

NO SAFE HARBOR

216. The statutory safe harbor provided for forward-looking statements under certain


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circumstances does not apply to any of the allegedly false statements pleaded in this complaint.

Many of the specific statements pleaded herein were not identified as “forward-looking

statements” when made. To the extent there were any forward-looking statements, there were no

meaningful cautionary statements identifying important factors that could cause actual results to

differ materially from those in the purportedly forward-looking statements. Alternatively, to the

extent that the statutory safe harbor does apply to any forward-looking statements pleaded

herein, defendants are liable for those false forward-looking statements because at the time each

of those forward-looking statements was made, the particular speaker knew that the particular

forward-looking statement was false, and/or the forward-looking statement was authorized

and/or approved by an executive officer of Allou who knew that those statements were false

when made.

ADDITIONAL SCIENTER ALLEGATIONS

217. As alleged herein, each defendant acted with scienter in that defendants knew or

acted with reckless disregard for the fact that the public documents and statements issued or

disseminated in the name of the Company were materially false and misleading, and reflected

fictitious and phony bookkeeping entries which defendants personally created, and/or falsehoods

of which defendants had first-hand knowledge; knew or recklessly disregarded that such

statements or documents would be issued or disseminated to the investing public; and knowingly

or recklessly, materially participated or acquiesced in the issuance or dissemination of such

statements or documents as primary violations of the federal securities laws.

218. As set forth elsewhere herein in detail, the Individual Defendants, by virtue of

their receipt of information reflecting the true facts regarding Allou, their control over, and/or

receipt and/or modification of the Company’s alleged materially misleading misstatements


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and/or their associations with the Company which made them privy to confidential proprietary

information concerning Allou, participated in the fraudulent scheme alleged herein. To date, this

conduct has led to the indictment of three of the Individual Defendants.

219. Mayer Rispler’s, Arthur Andersen’s and KPMG’s scienter is further demonstrated

by the fact that the accounting fraud at Allou was so widespread and touched such a large

proportion of the assets and revenues reported by the Company, yet went undetected by any of

these auditors. Instead, the falsified books and records were simple enough to be discovered by

one of the Company’s lenders performing a routine quarterly inspection of Allou’s inventory and

accounts receivable. Mayer Rispler’s, Arthur Andersen’s and KPMG’s conduct of the

Company’s audits represented an extreme departure from the professional standards that should

have been applied. SAS No. 80, Consideration of Fraud in a Financial Statement Audit,

declares that “[d]ue professional care requires the auditor to exercise professional skepticism –

that is, an attitude that includes a questioning mind and critical assessment of audit evidence.”

Had the auditors exercised due professional care and professional skepticism, they could have

determined that Salesman No. 2 did not actually exist, that the phony sales recorded on the

Company’s books lacked sufficient documentation, that many of the Company’s purported

transactions were a sham, that the books and records were consistently falsified and that

defendants had engaged in other fraudulent activities explained herein.

COUNT I

Violation of Section 10(b) of The Exchange Act and Rule 10b-5 Promulgated Thereunder Against All Defendants Other Than The Auditor Defendants

216. Plaintiffs repeat and reallege each and every allegation contained above as if fully

set forth herein.

217. During the Class Period, Allou, and the defendants carried out a plan, scheme and


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course of conduct which was intended to and, throughout the Class Period, did: (i) deceive the

investing public, including plaintiff and other Class members, as alleged herein; (ii) artificially

inflate the market price for Allou’s Class A common stock; and (iii) cause plaintiffs and other

Class members to purchase Allou’s Class A common stock at artificially inflated prices. In

furtherance of this unlawful scheme, plan and course of conduct, defendants, and each of them,

took the actions set forth herein above.

218. Defendants (a) employed devices, schemes, and artifices to defraud; (b) made

untrue statements of material fact and/or omitted to state material facts necessary to make the

statements not misleading; and (c) engaged in acts, practices, and a course of business which

operated as a fraud and deceit upon the purchasers of the Company’s Class A common stock in

an effort to maintain artificially high market prices for Allou’s Class A common stock in

violation of Section 10(b) of the Exchange Act and Rule 10b-5. All defendants are sued either as

primary participants in the wrongful and illegal conduct charged herein and/or as controlling

persons as alleged below.

219. Defendants individually and in concert, directly and indirectly, by the use, means

or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a

continuous course of conduct to fraudulently inflate the financial results of Allou and to conceal

adverse material information about the business, operations and future prospects of Allou as

specified herein above.

220. The Individual Defendants’ and the Additional Director Defendants’ liability

arises from the facts set forth above and the following additional facts: (i) the Individual

Defendants and Additional Director Defendants were high-level executives and/or directors at

the Company during the Class Period and participated directly in the fraudulent activities set


75

forth above; (ii) each of these defendants, because of his responsibilities as a senior officer

and/or director of the Company participated in the development of and reporting of the

Company’s public filings and reports; and (iii) each of the defendants knew or recklessly

disregarded that the Company disseminated false and misleading information to the public.

221. Defendants employed devices, schemes and artifices to defraud while in

possession of material adverse non-public information and engaged in acts, practices, and a

course of conduct as alleged herein in an effort to assure investors of Allou’s value and

performance and continued substantial growth. Defendants’ misconduct included the making of,

or the participation in the making of, untrue statements of material facts and omitting to state

material facts necessary in order to make the statements made about Allou and its business

operations in the light of the circumstances under which they were made, not misleading, as set

forth more particularly herein, and engaged in transactions, practices and a course of business

which operated as a fraud and deceit upon the purchasers of the Company’s Class A common

stock during the Class Period.

222. Defendants had actual knowledge of the misrepresentations and omissions of

material facts set forth herein, or acted with reckless disregard for the truth in that they failed to

ascertain and to disclose such facts, even though such facts were available to them.

223. As a result of the dissemination of the materially false and misleading information

and failure to disclose material facts, as set forth above, the market price of Allou’s securities

was artificially inflated during the Class Period. Plaintiffs and the other members of the Class

were ignorant of the fact that the market price of Allou’s publicly traded securities was

artificially inflated during the Class Period. They relied, directly or indirectly, on the false and

misleading statements made by defendants, or upon the integrity of the market in which the


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securities trade, and/or on the absence of material adverse information that was known to or

recklessly disregarded by defendants but not disclosed in public statements by defendants during

the Class Period. As a result, plaintiffs and the other members of the Class acquired Allou

securities during the Class Period at artificially high prices and were damaged thereby.

224. At the time of said misrepresentations and omissions made in defendants’ public

filings and press releases described herein, plaintiffs and the other members of the Class were

ignorant of their falsity, and believed them to be true. Had plaintiffs and the other members of

the Class and the marketplace known of the true financial condition of Allou, which was

misrepresented by defendants, plaintiffs and the other members of the Class would not have

purchased their Allou Class A common stock, or, if they had purchased such stock during the

Class Period, they would not have done so at the artificially inflated prices which they paid.

225. By virtue of the foregoing, defendants have violated Section 10(b) of the

Exchange Act, and Rule 10b-5 promulgated thereunder.

226. As a direct and proximate result of defendants’ wrongful conduct, Plaintiffs and

the other members of the Class suffered damages in connection with their purchases of the

Company’s Class A common stock during the Class Period.

COUNT II

Violation of Section 20(a) of the Exchange Act Against the Individual Defendants

227. Plaintiffs repeat and reallege each and every allegation contained above as if fully

set forth herein.

228. By reason of their status as officers, members of senior management and/or

directors of Allou, the Individual Defendants were “controlling persons” of the Company within

the meaning of Section 20 of the Exchange Act and had the power and influence to cause Allou


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to engage in the unlawful conduct complained of herein. Because of their positions of control,

the Individual Defendants were able to and did, directly or indirectly, control the conduct of

Allou’s business, the information contained in its filings with the SEC and public statements

about its business. The Individual Defendants were provided with or had unlimited access to

copies of the Company’s internal reports, and press releases and public filings alleged by

plaintiffs to be misleading prior to and/or shortly after these statements were issued and had the

ability to prevent the issuance of the statements or cause the statements to be corrected. The

Individual Defendants controlled Allou, the Board of Directors of Allou, and all of its

employees.

229. In particular, the Individual Defendants had direct involvement in the day-to-day

operations of the Company and therefore are presumed to have had the power to control or

influence the particular statements giving rise to the securities violations as alleged herein, and

exercised the same.

230. As set forth above in Count I, the Individual Defendants violated Section 10(b)

and Rule 10b-5 promulgated thereunder by its acts and omissions as alleged in this Complaint.

By virtue of their positions as controlling persons of Allou, the Individual Defendants are liable

for the Company’s violations of Section 10(b) of the Exchange Act and Rule l0b-5 promulgated

hereunder, as alleged in Count I, pursuant to Section 20(a) of the Exchange Act.

231. As a direct and proximate result of the Individual Defendants wrongful conduct,

plaintiffs and other members of the Class suffered damages in connection with their purchases of

Allou’s Class A common stock during the Class Period.


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COUNT III

Against Mayer Rispler & Company, PC, Arthur Andersen LLP and KPMG LLP for Violations of Section 10(b) of the Exchange Act and Rule 10b-5

232. Plaintiffs repeat and reallege each of the allegations set forth in the foregoing

paragraphs as if fully set forth herein.

233. This Count is asserted on behalf of purchasers of Allou common stock. This

Count is asserted against Mayer Rispler as a result of its unqualified audit reports rendered on

Allou’s financial statements with respect to Mayer Rispler’s audits for Allou’s 2000 fiscal year,

Mayer Rispler and Arthur Andersen as a result of Arthur Andersen’s unqualified audit reports

rendered on Allou’s financial statements with respect to Arthur Andersen’s audit for Allou’s

2001 fiscal year, and Mayer Rispler and Arthur Andersen and KPMG as a result of KPMG’s

unqualified audit reports rendered on Allou’s financial statements with respect to KPMG’s audit

for Allou’s 2002 fiscal year for violations of Section 10(b) of the Exchange Act, 15 U.S.C. §

78j(b)g and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.

234. Mayer Rispler, Arthur Andersen and KPMG, individually and in concert, directly

and indirectly, by the use and means of instrumentalities of interstate commerce and of the mails,

engaged and participated in a continuous course of conduct to conceal adverse material

information about Allou which resulted in misstatements and omissions of material facts in

Allou’s financial reporting. Mayer Rispler, Arthur Andersen and KPMG each employed

devices, schemes and artifices to defraud while in possession of material, adverse non-public

information and engaged in acts, practices and a course of conduct that included the making of,

or participation in the making of, untrue and misleading statements of material facts and omitting

to state material facts necessary in order to make the statements made about Allou not


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misleading. Specifically, Mayer Rispler, Arthur Andersen and KPMG each knew or were

reckless in not knowing that Allou’s reported annual financial results for fiscal years 2000, 2001

and 2002, which were disseminated to the investing public, were materially overstated and were

not presented in accordance with GAAP; and that the audits were not performed in accordance

with GAAS and, therefore, Mayer Rispler’s, Arthur Andersen’s and KPMG’s unqualified audit

reports were materially false and misleading.

235. As Mayer Rispler, Arthur Andersen and KPMG knew, or should have known,

Allou’s financial statements were all materially false and misleading. Mayer Rispler, Arthur

Andersen and KPMG failed to perform their audits and reviews in accordance with accepted

accounting principles and procedures. Mayer Rispler, Arthur Andersen and KPMG (i) failed to

meet their professional obligations to obtain sufficient competent evidential matter necessary to

satisfy an auditor that Allou’s financial statements fairly presented Allou’s financial condition in

all material respects; (ii) misrepresented that their audits were performed in accordance with

GAAS and were complete when they issued unqualified opinions on Allou’s financial statements

even though Mayer Rispler failed to exercise professional care and skepticism and knew, or were

reckless in not knowing, that Allou’s financial statements failed to comply with GAAP and were

otherwise misleading and misstated; and (iii) failed to properly investigate or test Allou’s

accounting practices, recorded transactions and controls and were easily satisfied and untested,

self-serving, management explanations and representations with respect thereto, turning a blind

eye to apparent discrepancies and deficiencies.

236. As a result of Mayer Rispler’s, Arthur Andersen’s and KPMG’s deceptive

practices and false and misleading statements and omissions in their unqualified audit reports,

the market price of Allou common stock was artificially inflated throughout the Class Period.


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Plaintiffs and other members of the Class were ignorant of the fact that the market price of

Allou’s publicly traded securities was artificially inflated during the Class Period. They relied,

directly or indirectly, on the false and misleading statements made by defendants, or upon the

integrity of the market in which the securities trade, and/or on the absence of material adverse

information that was known to or recklessly disregarded by defendants but not disclosed in

public statements by defendants during the Class Period. As a result, plaintiffs and other

members of the Class acquired Allou securities during the Class Period at artificially high prices

and were damaged thereby.

237. By virtue of the foregoing, Mayer Rispler, Arthur Andersen and KPMG violated

Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.

WHEREFORE, plaintiffs pray for relief and judgment, as follows:

A. Declaring this action to be a proper class action and certifying plaintiffs as class

representative under Rule 23 of the Federal Rules of Civil Procedure;

B. Awarding monetary damages against all defendants, in favor of plaintiffs and the

other members of the Class for all losses and damages suffered as a result of the wrongdoings

alleged herein, together with interest thereon;

C. Awarding plaintiffs the fees and expenses incurred in this action, including

reasonable allowance of fees for plaintiffs’ attorneys and experts; and

D. Granting plaintiffs and the other members of the Class such other and further

relief as the Court may deem just and proper.


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JURY DEMAND

Plaintiffs hereby demand a trial by jury.

Dated: September 18, 2006

Respectfully submitted,

ABBEY SPANIER RODD ABRAMS & PARADIS, LLP

By:_/s/ Stephen T. Rodd_______ Stephen T. Rodd (SR-8228) Nancy Kaboolian (NK-6346) 212 East 39th Street New York New York 10016 Tel: (212) 889-3700 Fax: (212) 684-5191 Lead Counsel for Plaintiffs and the Class


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