Bally Fitness settles with shareholders over inflated profit statements

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October 5, 2010

Bally Fitness settles with shareholders over inflated profit statements 

The plaintiffs alleged that the fitness club chain, several of its executives, and its auditor reported artificially inflated profits and disseminated false information to defraud investors in violation of the Securities Exchange Act of 1934. The parties reached a $2 million settlement. In re Bally Total Fitness Secs. Litig.

In 1999, fitness club chain Bally Total Fitness Holding Corp. began declaring in its financial statements that it was profitable, and shareholders relied on those assertions. But in 2004, the company announced that the Securities and Exchange Commission was investigating it for accounting improprieties and that it would have to restate previous financial statements.

Bally’s stock dropped by 16.6 percent that day. Eventually, the company restated its previous reported net income of $126 million to a loss of more than $427 million from 1999 through 2004.

An internal investigation revealed that Bally’s CEOs, Lee Hillman and Paul Toback, and its chief financial officer, John Dwyer, had created an “aggressive accounting” system that had inadequate controls, no clear policies on financial reporting, and no training for staff on accounting issues.

Among other things, Bally falsely credited its profit margin with membership accruals but omitted the expenditures required to obtain and keep members. Any costs that were declared—for instance, fees for maintenance, advertising, inventory, and insurance claims—were deferred over a long period rather than claimed at once, as required by Generally Accepted Accounting Principles.

The investigation found that Hillman, Toback, and Dwyer encouraged the inaccuracies and directed Bally accountants to prepare two sets of statements—one with the accurate information for internal use only and one with false information for public distribution.

Bally’s auditor, Ernst & Young, didn’t notice the falsifications, and Bally employees who questioned the statements were sometimes told the strategies were approved by the outside auditor.

A class of shareholders who purchased stock between August 1999 and April 2004 sued Bally, the individual executives, and Ernst & Young, claiming the defendants reported artificially inflated profits and disseminated false information to defraud investors in violation of the Securities Exchange Act of 1934.

The defendants contended that the drop in stock price was a result of market conditions and that any false representations in the financial statements were unintentional.

Bally filed for bankruptcy during litigation.

The trial court twice dismissed the plaintiffs’ complaints for failure to sufficiently plead scienter. While the plaintiffs’ appeal was pending in the Seventh Circuit, the parties reached a $2 million settlement. The apportionment of liability among the defendants is unspecified. The court has preliminarily approved the settlement.

Citation: In re Bally Total Fitness Secs. Litig., No. 1:04-cv-03530 (N.D. Ill. Aug. 23, 2010).

Plaintiff counsel: Sherrie R. Savett, Glen L. Abramson, Douglas M. Risen, and Jon J. Lambiras, all of Philadelphia; and Carol V. Gilden and Katrina Blumenkrants, both of Chicago.


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