case 2:06-cv-00349-rtr filed 03/21/2007 page 1 of 131...

Case 2:06-cv-00349-RTR Filed 03/21/2007 of 131 Document 44

UNITED STATES DISTRICT COURT

EASTERN DISTRICT OF WISCONSIN

MILWAUKEE DIVISION

ROSALIND MAIDEN, On Behalf of Herself and Others Similarly Situated,

Plaintiff,

Civil No. 06-CV-349 kiffil

MERGE TECHNOLOGIES, INC., (d.b.a. MERGE HEALTHCARE), RICHARD A LINDEN, and SCOTT T. VEECH,

Defendants.

CONSOLIDATED CLASS ACTION COMPLAINT


Lead Plaintiff Southwest Carpenters Pension Trust ("Plaintiff or "Lead Plaintiff ) alleges

the following against Defendants upon personal knowledge as to those allegations concerning

Plaintiff and, as to all other matters, upon the investigation of counsel, which included, without

limitation: review and analysis of public filings made by Merge Technologies and other related

parties and non-parties with the Securities and Exchange Commission ("SEC ); review and analysis

of press releases and other publications disseminated by Defendants and other related non-parties;

review of news articles, shareholder communications, and postings on Merge Technologies' website

concerning the Company's public statements; review of other publicly available information

concerning Merge Technologies, the other Defendants and related non-parties; consultation with

experts; and interviews with numerous former employees of Merge Technologies and former

employees of Merge Technologies' customers.

NATURE OF THE ACTION

1. This a securities class action brought on behalf of all purchasers of the publicly traded

securities of Merge Technologies, Inc. ("Merge Technologies or the "Company ) between April 25,

2002 and July 3, 2006, inclusive (the "Class Period ), seeking to pursue remedies under the

Securities Exchange Act of 1934 (the "Exchange Act ).

2. This case concerns a brazen accounting fraud scheme orchestrated by the senior

management of Merge Technologies. The Company, operating through its various subsidiaries,

engages in the development and delivery of medical imaging and information management

software and services. As set forth in painstaking detail herein, Defendants employed a wide range

of manipulative practices which were designed to enable Merge Technologies to improperly

recognize revenues in connection with the sale of its products and report artificially inflated financial

results. These practices included:

• Defendants entered into secret "side agreements in order to prematurely recognize revenue;


• Defendants recognized revenue on products that were shipped to customers who did not order the products;

• Defendants improperly recognized revenue for products that did not meet customers' specifications;

• Defendants improperly recognized revenue prior to shipping all products that were included in the customer's contract; and

. Defendants recognized revenue on "free products provided to customers.

3. During the Class Period, Merge Technologies reported increasing financial results

and growth, which caused the price of Merge Technologies' stock to increase as a result. In April

2002, the start of the Class Period, Merge Technologies common stock traded in a range of between

$7-8 per share. By February 2006, the price of Merge Technologies common stock had surged to

more than $27 share - an increase of 285% from the inception of the Class Period. Before the true

facts about the Company were revealed, Defendants and other Company insiders sold their

personally-held Merge Technologies common stock, generating proceeds of $24 million. In

addition, the Company completed a private placement, raising more than $8 million, and used its

artificially inflated common stock to complete a major corporate acquisition - the purchase of

Cedara Software Corp. ("Cedara ) for $393 million. In sum, Defendants' fraudulent scheme paid off

for them.

4. In January 2006, unbeknownst to investors, Merge Technologies received an

anonymous letter claiming that the Company was engaged in improper accounting and disclosure

practices. Over the following months, ten additional letters making similar claims would be received

by the Company.

5. Then, on February 24, 2006, the cracks in the dam started to appear. On that date,

Merge Technologies issued a press release announcing, among other things, that it would delay the

issuance of its financial results for the fourth quarter 2005 "in order to allow additional time to

complete the audit of the Company's financial statements. In response to this announcement, the

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price of Merge Technologies stock declined, falling from $24.50 per share to $20.50 per share.

Defendants, however, assured the market that there were no significant accounting issues lurking at

the Company and that Merge Technologies' business was performing well - all of which was not

true.

6. Then, March 17, 2006, Merge Technologies issued a press release announcing,

among other things, that it would be delayed in filing its Form 10-K for fiscal year 2005, that it

would be conducting an internal investigation into its accounting, and that its financial statements for

the quarters ended June 20, 2005, and September 30, 2005, should no longer be relied upon. In

response to the announcement that the Company had overstated its financial results for two quarters

and that it was launching an internal investigation into its accounting based on anonymous letters,

the price of Merge Technologies common stock declined from $17.91 per share to $15.85 per share.

Yet, Defendants continued to conceal the full scope of the accounting fraud at the Company, which

was not confined just to two quarters in 2005, but spanned all the way back to 2002.

7. On May 16, 2006, Defendant Richard A. Linden, the Company's CEO, "resigned.

8. A mere seven weeks later, on July 3, 2006, Merge Technologies issued a press release

admitting that it had been materially overstating its financial results since 2002. Further, the

Company reported that the Company's financial statements for fiscal years 2002 through 2005

should no longer be relied upon. In response to this announcement, the price of Merge Technologies

common stock dropped from $12.31 per share to $7.30 per share on extremely heavy trading

volume.

9. Also, on July 3, 2006, Defendant Scott Veech, the Company's Chief Financial

Officer, Secretary and Treasurer, and Defendant David Noshay, the Company's Senior Vice

President, Strategic Development, "resigned.


10. Finally, on August 29, 2006, Merge Technologies filed its Annual Report on Form

10-K for the year ended December 31, 2005 with the SEC (the "2005 Form 10-K). The 2005 Form

10-K contained the Company's restatement of its financial statements for fiscal years 2002-2004 and

the first three quarters of 2005 (the "Restatement ). The scope and breadth of the Restatement is

shocking. In the restatement, the Company admitted that it overstated net sales for 2002, 2003,

2004, and the first nine months of 2005 due to the following fraudulent practices:

Delivery of certain software products to end-user customers that did not fully meet the functionality that we believe our customers expected based on express representations we made to our customers or implied representations that arose from our demonstrations of the software products during the sales process. We have deferred such revenue until the delivery of the expected product functionality, the majority of which occurred in the third and fourth quarters of 2005 and the second quarter of 2006.

Collectibility was not reasonably assured at the time certain revenue was recognized. Some of our contracts failed to reflect contingencies expressly demanded by the customer. We have not recognized revenue until collectibility became reasonably assured, generally as cash was collected from the respective customer.

Recording revenue prior to shipment of the correct products included in a customer's contract. We have deferred revenue until shipment of the appropriate products occurred.

Recording of revenue prior to shipment of all software products included in a customer's contract. Since we did not have vendor specific objective evidence of fair value for the undelivered software element of certain of our contracts, we were required to defer all revenue for certain customer orders with partial software product shipment until delivery of all software products occurred.

For certain customers' contracts, we were unable to establish vendor specific objective evidence of fair value of maintenance. We have deferred the related contract value and are recognizing revenue ratably over the related maintenance period.

The 2005 Form 10-K also admitted that the Company's management was "directly involved in

circumventing our accounting controls and that the Company did not have adequate internal

controls to prevent accounting fraud.

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11. Now, Merge Technologies common stock trades in a range of $3-4 per share.

Through this action, Plaintiff seeks to hold Defendants accountable for their violations of the federal

securities law.

JURISDICTION AND VENUE

12. This Court has jurisdiction over the subject matter of this action pursuant to Section

27 of the Exchange Act, 15 U.S.C. §78aa, and pursuant to 28 U.S.C. §§1331 and 1337. The claims

asserted herein arise under Sections 10(b) and 20(a) of the Exchange Act and Rule lOb-S

promulgated thereunder.

13. Venue is proper in this District pursuant to Section 27 of the Exchange Act. Many of

the false and misleading statements were made in or issued from this District and Merge

Technologies maintains its principal executive offices in this District.

14. In connection with the acts, conduct, and other wrongs alleged in this Complaint,

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

including, but not limited to, the United States mails, interstate telephone communications, and the

facilities of the national securities markets, such as NASDAQ.

PARTIES

15. Plaintiff purchased Merge Technologies common stock during the Class Period, as set

forth in the certification previously filed with the Court and incorporated herein by reference.

16. Defendant Merge Technologies engages in the development and delivery of medical

imaging and information management software and services. The Company is headquartered in

Milwaukee, Wisconsin. As of August 22,2006, Merge Technologies had over 29 million shares issued

and outstanding and trades on NASDAQ under the ticker symbol "MRGE.

17. Defendant Richard A. Linden ("Linden ) served as Chief Executive Officer,

President, Director and Chairman of the Executive Committee of Merge Technologies from

September 2000 until he resigned in May 2006. 5


18. Defendant Scott T. Veech ("Veech ) served as Chief Financial Officer, Secretary and

Treasurer of Merge Technologies from July 2002 until "resigning in July 2006.

19. Defendant David M. Noshay ("Noshay ) was employed by Merge Technologies

from September 1995 until "resigning on July 2, 2006. While at the Company, Defendant Noshay

served as Senior Vice President of Strategic Business Development, Senior Vice President of

Product Innovation and Operations, Vice President of Business Development, and President of

Merge eMed.

20. Defendants Linden, Veech and Noshay are sometimes referred to herein as the

"Individual Defendants.

21. Defendant KPMG LLP ("KPMG) is a worldwide firm of Certified Public

Accountants, auditors and consultants. Through its Chicago office, KPMG served as Merge

Technologies auditor since at least 1995. The term "Defendant does not refer to KPMG unless

KPMG is specifically referenced.

CONFIDENTIAL SOURCES

22. The allegations made herein are based upon information and belief and are supported

by the first-hand knowledge of twenty-one confidential witnesses ("CWs ). These informants are

former Merge Technologies employees, each of whom was employed during the Class Period and

provided facts from various departments of the Company.

23. Confidential Witness 1 ("CW1 ) is a former Benefits, Compensation, and Human

Resources Information Systems Manager who was employed by the Company in 2006. CW1

reported to Vice President of Human Resources Susan Barkach ("Barkach ) who, in turn, reported to

Defendant Linden.

24. Confidential Witness 2 ("CW2 ) is a former Vice President of Direct Sales who was

employed by the Company from 1999 until May 2005. CW2 reported directly to Defendant Linden


from 2000 through 2005. As Vice President of Direct Sales, CW2 managed the efforts of the

Company's direct sales team.

25. Confidential Witness 3 ("CW3 ) is a former Vice President for Implementation who

was employed by the Company from July 2003 through January 2005. CW3 was originally

employed by RIS Logic beginning in January 2000 and joined Merge Technologies at the time the

Company acquired RIS Logic. For the majority of the witness' tenure with Merge Technologies,

CW3 reported directly to Defendant Linden.

26. Confidential Witness 4 ("CW4 ) is a former Regional Sales Manager who was

employed by the Company from January 2006 through November 2006. CW4 reported directly to

Defendant Noshay.

27. Confidential Witness 5 ("CW5 ) is a former Regional Sales Representative who was

employed by the Company from 2003 through November 2004. CW5 reported to CW2 who, in

turn, reported directly to Defendant Linden.

28. Confidential Witness 6 ("CW6 ) is a former Regional Sales Representative who was

employed by the Company from June 2004 through January 2005. CW6 reported to CW21 who

reported to CW2.

29. Confidential Witness 7 ("CW7 ) is a former Director of Business Development who

was employed by the Company from 2004 through 2006.

30. Confidential Witness 8 ("CW8 ) is a former Direct Sales Representative who was

employed by the Company from 2000 through 2003. CW8 reported to CW2 who, in turn, reported

directly to Defendant Linden. CW8 was responsible for procuring new sales prospects. CW8 was

also responsible for updating sales forecasts in the Company's database, which was used by all direct

sales representatives at Merge Technologies and reviewed by Defendants Linden and Veech on a

daily basis.

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31. Confidential Witness 9 ("CW9 ) is a former Director of Zones Sales who was

employed by the Company from July 2004 through September 2005. CW9 reported directly to

Defendant Noshay. As Zone Sales Director, CW9 was responsible for managing direct sales

representatives and assisting them to achieve sales goals for their region.

32. Confidential Witness 10 ("CW10 ) was employed by the Company from 1995

through June 2006. CW10 held various senior level accounting positions at the Company including

Controller, Financial Analyst, Accounting Team Leader, and Accounting Manager. CW10 reported

directly to Defendant Veech. CW1 0 discussed revenue recognition issues directly with Defendants

Linden and Veech.

33. Confidential Witness 11 ("CW1 1) is a former Senior Accountant who was employed

by the Company from 2004 until 2006. Beginning in 2005, CW1 1 reported to Assistant Controller

Kathy Sadler who reported to Controller and current Chief Accounting Officer Steve Oreskovich

who, in turn, reported to Defendant Veech. CW1 1 was responsible for cash reconciliation,

managing the Company's banking relationships and manually consolidating the Company's

financials. CW1 1 also prepared the consolidated financial statements that were reported in the

Company's SEC filings.

34. Confidential Witness 12 ("CW1 2 ) is a former accountant who was employed by the

Company from September 2005 until January 2006. CW12 reported to Assistant Controller Kathy

Sadler who reported to Controller and current Chief Accounting Officer Steve Oreskovich who, in

turn, reported to Defendant Veech.

35. Confidential Witness 13 ("CW13 ) is a former Sales Specialist who was employed by

the Company in 2006. CW13 was responsible for selling software upgrades.

36. Confidential Witness 14 ("CW14 ) was employed at the Company from May 2002

through July 2004 as a Territory Sales Manager.


37. Confidential Witness 15 ("CW1 5 ) is a former Vice President of Sales and Vice

President of Business Development who was employed by the Company from July 2003 through

July 2005. Among other things, CW15 was responsible for "partnership development, including

handling customer referrals, vendor referrals, developing reseller relationships and the cultivation of

national accounts. CW1 5 reported directly to Defendant Linden.

38. Confidential Witness 16 ("CW16 ) is a former contract administrator and executive

assistant who was employed by the Company from November 2001 through January 2007. CW1 6

was responsible for preparing contracts and generating software licensing agreements.

39. Confidential Witness 17 ("CW17 ) is a former Implementation Manager who was

employed by the Company from July 2003 through September 2005. CW17 was responsible for

tracking the amount of time spent on software implementation projects for revenue recognition

purposes.

40. Confidential Witness 18 ("CW1 8 ) is a former Vice President of Professional

Services who worked for the Company from March 2005 through March 2007. CW1 8 was

responsible for both implementation and customer service. CW1 8 tracked the percentage of

completion for each software implementation project in an Excel spreadsheet. CW1 8 reported

directly to Defendant Noshay.

41. Confidential Witness 19 ("CW1 9 ) is a former Regional Sales Manager who worked

for the Company from January 2004 through August 2005.

42. Confidential Witness 20 ("CW20 ), at various times, served as a shipping and

receiving clerk, configuration control employee and service administrator. CW20 was employed by

the Company from 1995 through June 30, 2006.

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43. Confidential Witness 21 ("CW21 ) is a former Director of National Accounts who

was employed by the Company from June 2000 through early 2007. CW21 reported directly to

Defendant Noshay.

SUBSTANTIVE ALLEGATIONS

The Company and Its Business

44. Defendant Merge Technologies, doing business as Merge Technologies Healthcare,

engages in the development and delivery of medical imaging and information management software

and services. The Company provides solutions for both original equipment manufacturer ("OEM )

and the end-user healthcare markets.

45. Merge Technologies offers its products in three categories, i.e., diagnostic imaging

workflow software applications, connectivity and component solutions, and professional services.

The Company's software purportedly supports end-to-end business and clinical workflow for

radiology department and specialty practices, imaging centers, and hospitals. The Company also

provides picture archiving and communications systems, radiology information systems, and

clinical medical imaging software applications and develops engineered software applications

and development tools for the medical imaging OEM and international markets.

46. Merge Technologies' software technologies span various digital imaging

modalities, including computed tomography, magnetic resonance imaging, digital X-ray,

mammography, ultrasound, echo-cardiology, angiography, nuclear medicine, positron emission

tomography, and fluoroscopy. Its medical imaging offerings are used in various aspects of clinical

imaging workflow, including: the capture of a patient's digital image; the archiving,

communication, and manipulation of digital images; clinical applications to analyze digital

images; and the use of imaging in minimally-invasive surgery.

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47 The Company claims to have over 20 years of leadership in the medical imaging and

healthcare information technology markets, and claims to have consistently expanded its suite of

product and service offerings.

Defendants Issued Forecasts, Projections and Earnings Guidance that They Knew Could Not Be Met

48. Defendants Linden and Veech were responsible for setting the Company's sales

forecasts. However, CW2, a former Vice President of Direct Sales, explained that Defendants

Linden and Veech decided on the sales forecasts at the beginning of each fiscal year in order to meet

guidance given to "the Street. According to CW2, Defendants Linden and Veech reported these

forecasts and instructed CW2 to provide the forecasts to the members of the sales division, who were

required to meet the forecasts by any means necessary.

49. However, according to CW5, CW14 and CW19, Merge Technologies' future

prospects were bleak. For example, CW5 explained how each year, s/he would sell approximately

50% fewer products than s/he had sold in the previous year. CW14 also noted a significant decrease

in sales in 2004.

50. According to CW5 and CW1 4, the sales downturn was caused by heavy competition

between Merge Technologies and large companies such as General Electric, Siemens, Kodak, Fugi

and Phillips, which at or about that time, all had started offering products similar to those for which

Merge Technologies had not previously faced any competition.

51. Defendants Linden and Veech knew full that the Company's sales prospects were

dwindling. CW2 explained that Merge Technologies used a database called salesforce.com that

listed sales data by sales representative, region, product, or pipeline. According to CW2, Linden and

Veech routinely reviewed data in salesforce.com to track orders.

52. CW5, CW8 and CW1 9 all confirmed the fact that sales representatives were required

to enter all pertinent information concerning actual and prospective contracts into the Company's

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database. CW5 further corroborated the fact that Defendant Linden reviewed the information in the

salesforce.com database on a daily basis.

53. In addition, according to CW7, CW1 5, CW1 6 and CW1 9, Defendants Linden, Veech

and Noshay would participate in quarterly sales meetings and on monthly conference calls where

they would discuss sales and contracts.

54. CW9 explained that there were weekly conference calls with the direct sales

representatives and Defendant Linden to discuss forecasts and pending sales deals. At the end of

quarters, the calls increased to everyday. According to CW9, CW16, CW18 and CW19, Linden

implored sales representatives during these calls to close deals at the end of quarters in order to

recognize revenue.

55. In addition, according to CW2, Defendants Linden, Veech and Noshay were

intimately involved in the actual sales process. In fact, Defendant Noshay would finalize the

contracts and provide them to Defendants Linden and Veech, one of whom would sign every sales

contract.

56. According to CW4, following the Company's acquisition of Cedara Software, the

sales slowdown became even worse. Yet, CW4 reported that, although the sales had slowed

dramatically, Defendants continued to set sales forecasts that were still incredibly aggressive. In

fact, the sales forecasts were not revised despite the fact that sales representatives and Defendants

knew the forecasts could not be achieved.

Merge Technologies Engaged in a Massive "Cooking of the Books"

57. Throughout the Class Period, Defendants were focused on meeting or exceeding

analysts' earnings estimates and their internal sales forecasts.

58. In order to do so, Merge Technologies engaged in a host of improper accounting

practices which violated Generally Accepted Accounting Practices ("GAAP ) and which were

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designed to artificially inflate the Company's reported revenues, earnings and other financial results

in order to meet Defendants' unrealistic sales forecasts and projections and to make it appear that the

Company was performing better than it actually was.

59. In fact, having set the unrealistic forecasts, Defendants Linden, Veech and Noshay,

all of whom were directly involved in revenue recognition at the Company, used any means

necessary to meet those forecasts.

Defendants Entered into "Secret Side Agreements" in Order to Prematurely Recognize Revenue

60. Defendants routinely utilized "secret side agreements with Merge Technologies'

customers in order to conceal contract terms that would delay the Company's recognition of revenue.

In order to control this practice, Defendants Linden, Veech and Noshay required the strict use of

standardized contracts and refused to permit the Company's sales force to alter any contract terms on

the actual contract. Instead, Defendants instructed sales people to memorialize any change in terms

in "secret side agreements between Merge Technologies and the customer.

61. This practice was confirmed by CW2, former Vice President of Direct Sales, who

indicated that sales representatives were required to use the Company's standardized form contract.

However, in connection with the majority of the agreements entered into by the Company, the

customer would request terms different from those set forth in the standardized contract. In those

situations, according to CW2, Defendants Linden and Veech would personally modify the form

contract. CW2 explained that Defendants Linden and Veech carefully chose the language they used

in order to maximize revenue recognition for each contract. In the event that a customer insisted

upon certain terms that would somehow delay the recognition of revenue, CW2 stated that

Defendants Linden and Veech would negotiate side agreements with the customer and continue to

recognize revenue as if the side agreement did not exist.

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According to CW2, Defendant Linden informed sales representatives on a quarterly

basis of the types of representations they could and could not make to customers in order to

maximize revenue recognition. In fact, CW2 reported that sales representatives were told that they

could be terminated if they edited template contracts, discussed future products or made specific

recommendations for future orders, due to the potential impact on revenue recognition.

63. CW1 0, who held various senior level accounting positions at the Company including

Controller, also stated that the Linden and Veech entered into "secret side agreements with

customers. CW1 0 described these side deals as "improper agreements designed to make promises

to a customer that, if properly recorded, would jeopardize the timing of revenue recognition.

64. CW4, a former Regional Sales Manager at the Company, further corroborated the fact

that, up until 2006, Defendants routinely entered into "secret side agreements with customers in

order to recognize revenue improperly.

65. CW2 1, a former Director of National Accounts, provided additional details about the

Company's use of side agreements. Specifically, CW21 noted that Defendants Linden and Veech

directed sales representatives not to include certain items in contracts that would affect the

Company's ability to recognize revenue during the quarter when the contract was signed. For

example, in 2004, Radiology Associates of Venice Florida ("RAy ) began negotiations with Merge

Technologies to purchase one of the Company's products. Defendants Linden and Veech wanted the

contract signed during the third quarter. But, as the end of the third quarter approached, Defendants

were advised that RAV needed approval of its Board of Directors before it could complete the

purchase. As a result, any contract with the Company would have to be contingent upon Board

approval, which RAV would not be able to get until the fourth quarter. Defendant Linden insisted

that the contingency not be placed in the contract. Rather, Defendant Linden caused a side letter to

be drafted reflecting the contingent nature of the contract. However, Defendant Linden had the

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customer fax the side agreement to the home fax machine of the sales representative and not to the

Company's headquarters.

66. Similarly, CW21 reported that two other customers, Out-Patient Imaging and

Specialty Imaging, each entered into $200,000 contracts with the Company. Like the agreement

with RAy, both of these contracts were contingent upon approval by the customers' Board of

Directors. But, once again, Defendants would not allow that contingency to be placed in the actual

contract. Rather, side agreements were entered into with the customers. Specialty Imaging's Board

did not ultimately approve the contract, but Merge Technologies had already recognized the

contract's revenue.

67. CW21 also noted that Defendants used side letters in instances in which sales

representatives promised functionality that was not currently available in the Company's software.

Once again, these side letters were kept separate from the actual contract and not faxed to the

Company's offices. According to CW2 1, this improper procedure was followed in connection with

a $230,000 contract entered in 2005 by a customer from Tampa, Florida named Excel as well as in

connection with a $1.5 million contract entered into during the Class Period by Shands HealthCare.

68. As detailed below in the Restatement, Merge Technologies admitted to these

improper practices by stating that "some of our contracts failed to reflect contingencies expressly

demanded by the customer.

Defendants Engage in a Host of Other Improper Practices to Recognize Revenue Prematurely

69. Defendants also routinely shipped products to customers who did not order them in

order to recognize revenues.

70. CW2, a former Vice President of Direct Sales, explained that, in order to prematurely

recognize revenue, Defendant Linden instructed sales representatives to ship software before the end

of a quarter, even if the customer had not signed an agreement to purchase the product.

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71

For example, according to CW8, a former Direct Sales Representative, in fiscal 2002

CW8 identified St. John's Hospital in Springfield, Missouri as a prospective customer and began

speaking with a hospital representative about purchasing products from the Company. After

multiple conversations concerning a potential sale, CW8 informed the hospital's representative that

it was important to Merge Technologies that any sale be completed at the end of the second quarter

of 2002 (June 2002) for revenue recognition purposes. The St. John's representative explained that

the person authorized to order products was on vacation and would not be back until after July 1,

2002. As a result, the hospital would be unable to submit an order during the second quarter. CW8

explained the situation to CW2, who informed Defendant Linden that St. John's Hospital was unable

to purchase products prior to the end of the second quarter. CW8 was then "shocked to later learn

from CW2 that Defendant Linden shipped between $100,000 and $150,000 worth of products to St.

John's Hospital without a purchase order. This insider learned that Defendant Linden shipped these

products at the end of June 2002 in order to record additional revenue during the second quarter.

72. Similarly, CW8 recalled that, on several occasions, s/he and CW2 were required,

based on directions from Defendant Linden, to pressure customers to take early shipment of Merge

Technologies products in order for Merge Technologies to recognize additional revenues in a

particular quarter. For example, CW8 recalled that one customer was required to take shipment two

months prior to their requested shipment date and that the customer ended up having to put the

product in storage because it did not have room at the office site.

73. In addition, during the Class Period, Merge Technologies improperly recognized

revenues on products that did not meet customers' specifications. In other words, Defendants

recognized revenue on a sale that had not been completed because the customer had not been

provided with the product they had agreed to purchase.

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74. CW2, a former Vice President of Direct Sales, described how, on many occasions,

Defendants recognized revenue despite the fact that software did not meet a client's specifications.

For example, according to CW2, Defendants improperly recognized revenue associated with a 1.5

million sales contract with Shands HealthCare. CW2 confirmed that the software shipped to Shands

HealthCare did not have the functionality promised by the Company, but Defendants nonetheless

recognized the revenue associated with that contract.

75. Similarly, CW2 stated that, upon shipping software to Radiology Associates in

Chicago, Illinois, Defendants recognized all of the revenue with the contract, even though it took

more than six months to implement the software. In fact, CW2 explained that Defendants

prematurely recognized revenue associated with virtually every one of Merge Technologies'

contracts, notwithstanding long delays in the implementation of the software.

76. The Company also improperly recognized revenue by shipping damaged, used or

incorrect products to customers. For example, CW20 recalled a situation with Beverly Hospital in

Massachusetts. Rather than ship Beverly Hospital the products that it ordered, the Company sent a

used print server. When CW20 investigated why Beverly Hospital did not receive what it had

ordered, the Company's employee involved told CW20 that she was "only doing what she was told

and that when Defendant Linden learned that they did not have the proper products in stock, he

instructed her to "ship whatever they had in stock, as they needed to make their numbers. CW20

confirmed that from 2000 through 2006, Company would engage in the practice of shipping the

wrong products when they did not have the proper products in stock.

77. CW10, who held various senior level accounting positions at the Company,

confirmed that the Defendants were "frantic to meet revenue projections at the end of a quarter.

CW10 explained that, toward the end of a quarter, the shipping department often was instructed to

ship boxes to customers on the very day that a contract was purportedly signed. However, according

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to CW1O, those boxes did not always contain the products ordered by the customer and, in some

instances, did not contain any products at all. Rather, if the proper products were not ready to be

shipped, the shipping department was instructed to ship empty boxes and damaged products to

customers at quarter-end in order to make revenue numbers for the quarter.

78. CW15, a former Vice President of Sales and Vice President of Business

Development, confirmed instances where Merge Technologies shipped empty boxes to customers at

the end of quarters, as well as a situation where the Company shipped damaged goods to a customer,

all in an effort to artificially boost quarter-end numbers. Defendant Linden eventually asked CW1 5

to leave the Company because CW1 5 expressed dissenting opinions and would not agree with any

improper business activities.

79. At other times, Defendants would recognize revenue even though the Company did

not ship anything at all to the customer. For example, according to CW1 3, a former Sales Specialist,

the Company maintained an Excel spreadsheet which listed the customers who had the Company's

products. CW13 would attempt to sell additional "add-on products to those customers. However,

at least two of the customers listed on the Excel spreadsheet informed CW1 3 that they had not

received Merge Technologies' products.

80. CW17, a former Implementation Manager, described a troubling situation at the end

of fiscal year 2004, where Merge Technologies recognized revenue for installations that were not

shipped to the customer. In December 2004, CW17 was directed to cancel a personal vacation

during the week of Christmas to travel to Merge Technologies' offices in Milwaukee and install four

Fusion RIS/PACS systems for four separate customers in order to recognize revenue before the end

of the fiscal year. CW17 understood that these four installations represented approximately $1.4

million in revenue that Merge Technologies recognized before the end of fiscal year 2004.

However, after installing these four systems, CW17 packed the hardware in boxes labeled with the

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customer names, but none of the four systems were shipped to the customers before the end of 2004.

In fact, CW17 stated that none of the systems shipped for several months and one system, for a

customer in Texas, did not ship until the end of 2005.

81. CW2 1, a former Director of National Accounts, recounted additional instances of the

Defendants causing the Company to ship products not ordered by customers. For example, when

Martin Memorial in Florida entered into a contract to purchase products that the Company did not

have in stock, the Company shipped whatever they had at the time to the customer in order to

recognize revenue.

82. CW20 further reported that Defendant Linden would pressure the service department

to increase revenues. In that regard, Linden would come to CW20 directly and provide a sheet

listing the revenue that he wanted to be able to recognize. CW20 explained to Defendant Linden on

numerous occasions that the number he provided was "ridiculous and did not reflect the true

percentage of the installation that had been completed. During 2003 and 2004, CW20 learned the

amount of revenue that was recognized for certain contracts from accounting employees. However,

those amounts did not correspond with the actual percentage of completion, but rather were picked

by Defendant Linden based upon the amount of revenue that he wanted to recognize.

83. In addition, in contracts with customers, Defendants purposefully mis-described items

required to be delivered in order to prematurely recognize revenue. For example, CW2, a former

Vice President, stated that Defendant Linden was particular about the words that sales

representatives could and could not use when speaking with customers. For instance, although

pursuant to a sales contract, Merge was required to provide customers with "upgrades to the

software at a later date, sales representatives were instructed to improperly refer to those upgrades as

"updates. According to CW2, Defendant Linden explained that the term "upgrades indicates

future deliverables, which would prohibit the Company from recognizing all of the revenue

19


associated with a contract. However, by improperly referring to "upgrades as "updates,

Defendants improperly recognized all of the contract's revenue upon execution. Thus,

notwithstanding the fact that Merge was required to provide customers with upgrades that required

the Company to defer the recognition of revenue, Defendants still recognized all of the revenue

associated with a contract by improperly using the term "updates in their form contract.

84. According to CW4, CW6 and CW19, Defendants Linden and Veech directly

pressured sales representatives to close deals at the end of a quarter and instructed them to offer

"deep discounts to do so. CW8 also was instructed to offer prospective customers large discounts

to meet sales goals at the end of a quarter.

85. As detailed further below, in the Restatement, the Company has now admitted that it

improperly recognized revenue for products that were not delivered as promised. In particular, the

Company determined that it overstated its net sales throughout the Class Period as a result of the

"[d]elivery of certain software products to end-user customers that did not fully meet the

functionality that we believe our customers expected based on express representations we made to

our customers or implied representations that arose from our demonstrations of the software products

during the sales process.

86. In addition, as detailed below, the Company has now admitted that Defendants

engaged in the improper "[r]ecording of revenue prior to shipment of all software products included

in a customer's contract.

The Restatement

87. Merge Technologies' admission that its financial reporting during the Class Period

was materially misstated came in a series of announcements beginning on February 24, 2006, when

Defendant Linden announced that "as a result of the complexities associated with accounting for

20


sales transactions in the fourth quarter, our year-end audit has not been sufficiently completed and,

accordingly, we are not publishing complete financial results at this time.

88. On August 29, 2006, Merge Technologies filed the 2005 10-K with the SEC. The

Company identified the following improper accounting practices:

Revenue Recognition

We determined that we overstated net sales for 2002, 2003, 2004 and the first nine months of 2005 due to the following:





For certain customers' contracts, we were unable to establish vendor specific objective evidence offair value of maintenance. We have deferred the related contract value and are recognizing revenue ratably over the related maintenance period.

We determined that we failed to reduce net sales attributable to a contract although we had agreed to provide the customer with additional software at no additional cost to the customer.

Income Tax Expense

We determined that we understated income tax expense, income tax payable and goodwill for the quarter ended, and as of, June 30, 2005, due to a failure to record

21


additional tax liability and income tax expense in connection with our June 2005 business combination with Cedara Software Corp.

In addition, we adjusted the provisions for income tax and related tax accounts at the applicable statutory rates to account for the effects of the restatement adjustments described herein.

Other Adjustments

As a result of the revenue adjustments, certain revenue-related accounts were impacted and also restated. These included cost of goods sold related to contracts impacted, deferred revenue (net of the costs of goods), bad debt expense, and the related accounts receivable allowance, accounts receivable and commission expense. [Emphasis added.]

89. In the 2005 Form 10-K Merge Technologies admitted that "certain former members

of management were directly involved in circumventing the Company's "accounting controls.

The 2005 Form 10-K stated in pertinent part as follows:

certain former members of senior management did not set a proper ethical tone within our organization and instill an attitude of control compliance. Certain former members of our management were directly involved in circumventing our accounting controls, and other form er members of our management were aware, or should have been aware, that such controls were being circumvented. This deficiency contributed to material misstatements in our interim consolidated financial statements as of, and for the interim periods ended, September 30, 2005, June 30, 2005 and March 31, 2005 and our annual consolidated financial statements as of, and for the years ended, December 31, 2004, 2003 and 2002, as well as our consolidated financial statements for interim periods within those years. [Emphasis added.]

90. As a result of the foregoing improprieties, Merge Technologies has now restated its

annual 2004, 2003 and 2002 financial statements. In addition, Merge Technologies has confirmed

that its interim financial statements during the Class Period were also presented in violation of

GAAP and the SEC's accounting rules and regulations. In failing to file financial statements with

the SEC which conformed to GAAP, Defendants repeatedly disseminated financial statements of

Merge Technologies during the Class Period that materially inflated the Company's operating

performance.

91. By restating its previously issued financial statements from 2002 through 2005,

Merge Technologies has made the determination that such financial statements were material

22


because GAAP, in FASB's Statement of Financial Accounting Standards "SFAS No. 154, provides

that only materially misstated financial statements need be retroactively restated. In addition, Merge

Technologies has indicated that its financial reporting prior to 2002 was also materially misstated.

In fact, Merge Technologies has now admitted that its accumulated deficit, that is, the cumulative

amount of its loss from its formation through December 31, 2002, was understated by more than

12%.

92. In particular, concerning its Annual Class Period financial statements, Merge

Technologies has now admitted that:

S

its fiscal 2002 pre-tax and net income were overstated by more than 30%;

S

its fiscal 2003 pre-tax and net income were overstated by more than 115% and 40%, respectively; and

S

its fiscal 2004 pre-tax and net income were overstated by more than 912% and 240%, respectively.

93. Concerning its interim Class Period financial statements, Merge Technologies has

now admitted that:

. its pre-tax and net income for the quarter ended March 31, 2004 were overstated by more than 1142%;

. its pre-tax and net income for the quarter ended June 30, 2004 were overstated by more than 446%;

. its pre-tax and net income for the quarter ended September 30, 2004 were overstated by more than 321% and 141%, respectively;

. its net income for the quarter ended December 31, 2004 was overstated by more than 170%;

. its pre-tax and net income for the quarter ended March 31, 2005 were overstated by more than 1169%;

. its pre-tax and net loss for the quarter ended June 30, 2005 were understated by approximately 22%; and

. its pre-tax and net income for the quarter ended September 30, 2005 was understated by more than 15%.

23


its net income for the quarter ended December 31, 2004 was overstated by more than 170%;

Additionally, Merge Technologies admitted that these material misstatements were

the result of former management's "direct participation in the circumvention of the Company's

accounting controls. As noted in the SEC's Staff Accounting Bulletin "SAB No. 99:

The staff believes that a registrant and the auditors of its financial statements should not assume that even small intentional misstatements in financial statements, for example those pursuant to actions to "manage earnings, are immaterial. While the intent of management does not render a misstatement material, it may provide significant evidence of materiality. The evidence may be particularly compelling where management has intentionally misstated items in thefinancial statements to "manage reported earnings. In that instance, it presumably has done so believing that the resulting amounts and trends would be significant to users of the registrant's financial statements. The staffbelieves that investors generally would regard as significant a managementpractice to over- or under-state earnings up to an amount just short of a percentage threshold in order to "manage earnings. Investors presumably also would regard as significant an accounting practice that, in essence, rendered all earnings figures subject to a management-directed margin of misstatement. [Footnotes deleted, emphasis added.]

Materially False and Misleading Statements Issued During the Class Period

95. The Class Period commences on April 25, 2002. On that date, Merge Technologies

issued a press release announcing its financial results for the first quarter of 2002, the period

ending March 31, 2002. For the quarter, the Company reported revenues of $4,535,000 and

net income of $704,000, or $0.09 per share. Defendant Linden commented on the positive

financial results stating in pertinent part as follows:

I am pleased to report we have started 2002 by achieving our first quarter financial targets and posting our sixth consecutive quarters of improved operating results . . . These positive results reflect a continued focus on operational excellence, accelerated product innovation and increased investments in sales, marketing and professional service.

*

We continue to deliver on our product innovation model designed to launch new component software products every three to four months and fully expect to maintain that level of new product introduction going forward. [Emphasis added.]

24


The press release also contained "Guidance and represented that the "Company expects to continue

its original revenue growth trajectory of year-over-year quarterly growth of 30% and expected to

have $21-22 million in revenue for fiscal 2002.

96. The statements referenced above in 195 were materially false and misleading because

they failed to disclose and misrepresented the following facts:

(a) that the Company was engaged in a host of improper accounting practices, as

detailed herein at 1148-86, which were artificially inflating the Company's reported financial results.

Accordingly, the Company did not have revenues of $4,535,000 or net income of $704,000, and

those figures were materially overstated. Merge Technologies has now admitted that its

interim financial results were materially overstated throughout the Class Period;

(b) that the Company had only met its "first quarter financial targets by

engaging in accounting fraud; and

(c) based on the foregoing, it was not true that "[t]hese positive results

reflect a continued focus on operational excellence, accelerated product innovation and

increased investments in sales, marketing and professional service as the "positive results

were the product of accounting fraud, and not "a continued focus on operational excellence,

accelerated product innovation and increased investments in sales, marketing and professional

service.

97. On May, 15, 2002, Merge Technologies filed its Form 10-Q for the period ending

March 31, 2002, with the SEC which was signed by Defendant Linden and confirmed the previously

announced financial results. With respect to the financial statements contained therein, the Form 10-

Q represented as follows:

The accompanying unaudited consolidated financial statements of the Company reflect all adjustments of a normal recurring nature, which are, in the opinion of management, necessary to present a fair statement of its financial position and results of operations.

25


The statements referenced above in 197 were materially false and misleading because




Accordingly, the financial results contained in the Form 10-Q materially overstated the Company's

financial performance;

(b) that the financial statements contained in the Form 10-Q were not prepared in

accordance with GAAP and, therefore, were materially false and misleading. Merge Technologies

has admitted that its interim financial statements were not prepared in accordance with GAAP; and

(c) based on the foregoing, it was not true that the financial statements contained

in the Form 10-Q "reflect all adjustments of a normal recurring nature, which are, in the opinion of

management, necessary to present a fair statement of its financial position and results of operations.

99. On July 31, 2002, Merge Technologies issued a press release announcing its financial

results for the second quarter of 2002, the period ending June 30, 2003. For the quarter, the

Company reported revenues of $4,183,000 and net income of $598,000, or $0.07 per share.

Defendant Linden commented on the results stating in pertinent part as follows:

I am pleased to report that we successfully completed several financial, operational and strategic objectives during the second quarter. Our performance continues to demonstrate a strong customer interest in our products and services, an ability to effectively manage operating expenses while simultaneously increasing our investment in sales, and an ability to maintain strong gross margins as the mix of our business shifts to software and professional services. [Emphasis added.]

100. The statements referenced above in 199 were materially false and misleading because




Accordingly, the Company did not have revenues of $4,183,000 and net income of $598,000, and

26



interim financial results were materially overstated; and

(b) based on the foregoing, it was not true that the Company's "performance

continues to demonstrate a strong customer interest in our products and services, an ability to

effectively manage operating expenses while simultaneously increasing our investment in sales, and

an ability to maintain strong gross margins as the mix of our business shifts to software and

professional services as the "performance was the product of accounting fraud, and did not

"demonstrate a strong customer interest in the Company's products.

101. On August 14, 2002, Merge Technologies filed its Form 10-Q for the period ending

June 30, 2002, with the SEC which was signed by Defendant Linden and confirmed the previously

announced financial results. With respect to the financial statements contained therein, the Form 10-

Q represented as follows:


102. The statements referenced above in ¶101 were materially false and misleading for the

reasons set forth in ¶100.

103. On October 31, 2002, Merge Technologies issued a press release announcing its

financial results for the third quarter of 2002, the period ending September 30, 2002. For , the quarter,

the Company reported revenues of $5,322,000 and net income of $1,046,000, or $0.09 per share.


Finally, we are encouraged by market conditions and independent healthcare IT studies suggesting continued growth in capital spending to digitize patient care operations, with particular emphasis on clinical specialties such as radiology information systems and PACS. In alignment with these market conditions, we continue to evolve from a technology components company to a software solutions organization. We have solidly demonstrated that evolution by the strength of our financial results, and the reception of our target market to the

27


expanded capabilities of the Merge Technologies eFilm organization. [Emphasis added.]

The Company reiterated the financial "Guidance that it had previously given to the market in April

2002.

104. The statements referenced above in 1103 were materially false and misleading

because they failed to disclose and misrepresented the following facts:

(a) that the Company was engaged in a host of improper accounting practices as


Accordingly, the Company did not have revenues of $5,322,000 and net income of $1,046,000, and



(b) based on the foregoing, the statement that "[i]n alignment with these market

conditions, we continue to evolve from a technology components company to a software solutions

organization. We have solidly demonstrated that evolution by the strength of our financial results

was materially false and misleading because it attributed the Company's financial performance to the

Company's ability to successfully sell software products when, in truth and in fact, the purported

success was based, in material part, on the Company's improper and fraudulent accounting practices.

105. On November 19, 2002, Merge Technologies filed its Form 10-Q for the period

ending September 30, 2002, with the SEC which was signed by Defendant Linden and confirmed the

previously announced financial results. With respect to the financial statements contained therein,

the Form 10-Q represented as follows:


106. The statements referenced above in 1105 were materially false and misleading for the

reasons set forth in 1104. 28


107 On February 27, 2003, Merge Technologies issued a press release announcing its

financial results for the fourth quarter of 2002 and fiscal year 2002, the period ending December 31,

2002. For the quarter, the Company reported revenues of $6,746,000 and net income of $1,279,000,

or $0.11 per share. For fiscal year 2002, the Company reported that net income was $3,629,000 or

$0.33 per share. Defendant Linden commented on the results stating in pertinent part as follows:

Consolidation in the marketplace continues to provide us with opportunities for strategic partnerships. In anticipation of those opportunities, we have established a strong financial position for strategic growth in 2003 with our enhanced $5 million line of credit and our growing positive cash flow. We will maintain the operational and financial discipline that has contributed to our positive financial performance in 2002, and will remain steadfast in our customer-focused model of integrating clinical and operational insights in the development of our solutions. [Emphasis added.]





Accordingly, for the fourth quarter, the Company did not have revenues of $6,746,000 and net

income of $1,279,000 and those figures were materially overstated. Merge Technologies has

now admitted that its fourth quarter of 2002 and fiscal year 2002 financial results were

materially overstated; and

(b) based on the foregoing, the statement "[w]e will maintain the operational and

financial discipline that has contributed to our positive financial performance in 2002 was

materially false and misleading because it falsely attributed the Company's positive financial results

to "operational and financial discipline when, in truth and in fact, it was the result of accounting

fraud.

109. On March 31, 2003, Merge Technologies filed its Annual Report on Form 10-K for

the year ended December 31, 2002 ("2002 Form 10-K ), with the SEC which was signed by

29


Defendants Linden and Veech and confirmed the previously announced financial results. The 2002

Form 10-K contained audited financial statements. The 2002 Form 10-K reported the following

financial results; net sales of $20,786,000; operating income of $3,644,000; net income $3,629,000;

earnings per share $0.38; and working capital of $7,872,000.

110. The statements referenced above in 1109 from the 2002 Form 10-K were materially

false and misleading because they failed to disclose Merge Technologies' accounting fraud. In

addition, the 2002 Form 10-K contained materially false and misleading financial statements which

were prepared in violation of GAAP as detailed herein in 11186-203. Indeed, the Company has

admitted that the financial statements contained in the 2002 Form 10-K were materially false and

misleading when issued and has restated those financial results. In particular, the Company has

admitted that its net sales were not $20,786,000 as reported but were $19,147,000, that its net

income was not $3,629,000 but was $2,767,000, and that its earnings per share were not $0.33 per

share but rather were $0.29 per share.

111. On April 30, 2003, Merge Technologies issued a press release announcing its

financial results for the first quarter of 2003, the period ending March 31, 2003. For the quarter, the

Company reported revenues of $6,117,000 and net income of $1,316,000 or $0.07 per share.


Our strong financial start to 2003 is a reflection of our continued focus on targeting our FUSION Server products and services to small and medium sized hospitals and imaging centers, and leveraging the global brand and installed base of the historical Merge Technologies eFilm product lines.

* * *

Furthermore, our continued growth and strong financial performance has led to a steady increase in investor relations activities and financial market exposure. [Emphasis added.]


The press release also reported "Guidance. The Company reaffirmed its guidance for 2003

revenues in the range $27 million to $28 million with year-over-year growth of approximately 30%

to 35% and an earnings per share range of $0.47 per share to $0.52 per share.

112. The statements referenced above in ¶111 were materially false and misleading




Accordingly, the Company did not have revenues of $6,117,000 and net income of $1,316,000 and



(b) based on the foregoing, it was materially false and misleading to attribute the

Company's financial performance to "a reflection of our continued focus on targeting our FUSION

Server products and services to small and medium sized hospitals and imaging centers, and

leveraging the global brand and installed base of the historical Merge Technologies eFilm product

lines when it was the product of accounting fraud.

113. On or about May 15, 2003, Merge Technologies filed its Form 10-Q for the period

ending March 31, 2003, with the SEC which was signed by Defendants Linden and Veech and

confirmed the previously announced financial results. With respect to the financial statements

contained therein, the Form 10-Q represented as follows:



reasons set forth in 1112.

31


115 On July 30, 2003, Merge Technologies issued a press release announcing its financial




I am pleased to report that we successfully completed several strategic, financial and operational objectives during the second quarter. Our performance continues to demonstrate the market's acceptance of our product and service offering and our ability to successfully execute our strategy. We demonstrated a strong focus on operational execution and a continued alignment of our strategy within our target market, where the value of our expanded RIS/PACS product and service offering is evident. [Emphasis added.]

The press release also contained updated "Guidance from the Company. The Company increased

its guidance for 2003 revenues to the range of $29 million to $30 million with year-over-year growth

of approximately 38% to 40%.








(b) based on the foregoing, it was materially false and misleading to claim that the

Company's financial performance "continues to demonstrate the market's acceptance of our product

and service offering and our ability to successfully execute our strategy when, in truth and in fact,

the Company's financial performance was the product of accounting fraud.


June 30, 2003, with the SEC which was signed by Defendants Linden and Veech and confirmed the

32




Our accompanying unaudited consolidated financial statements of the Company reflect all adjustments of a normal recurring nature, which are, in the opinion of management, necessary to present a fair statement of its financial position and results of operations.





the Company reported revenues of $7,619,000 and net income of $1,625,000 or $0.12 per share.


I am pleased to report that the strategic initiatives we launched in the third quarter have delivered on expectations. Specifically, the RIS Logic acquisition has strengthened our product portfolio to include a full RIS/PACS solution, enhanced our target market positioning and accelerated the effectiveness of our operations. The results are positive financial performance, confirmed alignment with market trends, growing market share, expanding sales pipeline and demonstrable RIS/PACS product innovation, all of which further reinforced our belief that we are well positioned for continued growth and financial success.

* * *

Finally, the continued strengthening of our balance sheet supports both our operating plans and strategic growth initiatives. Specifically, we successfully raised $8 million in cash through a private placement, generated record positive operating cash flow for the quarter, significantly increased our aggregate deferred revenue balances representing future revenues to the Company and remain debt-free. [Emphasis added.]

The Company also reaffirmed its previously issued financial guidance





33





(b) based on the foregoing, it was materially false and misleading to represent

that the Company's "strategic initiatives have resulted in "positive financial performance when the

Company's financial performance was based, in material part, on accounting fraud.

121. On November 14, 2003, Merge Technologies filed its Form 10-Q for the period

ending September 30, 2003, with the SEC which was signed by Defendants Linden and Veech and



Our accompanying unaudited consolidated financial statements reflect all adjustments of a normal recurring nature, which are, in the opinion of management, necessary to present a fair statement of our financial position and results of operations.



123. On February 19, 2004, Merge Technologies issued a press release announcing its

financial results for the fourth quarter of 2003 and fiscal year 2003, the periods ending December 31,

2003. For the quarter, the Company reported revenues of $8,507,000 and net income of $1,897,000

or $0.15 per share. For fiscal year 2003, the Company reported revenues of $28,677,000 and net

income of $6,239,000 or $.053 per share. Defendant Linden commented on the results stating in

pertinent part as follows:

During 2003, Merge Technologies eFilm focused on five initiatives: expand our product line to become a leading provider ofRIS/PACS software solutions; provide our target market customers with a single source for clinical and business workflow solutions; expand our direct sales and marketing activities in North America; develop new OEM/VAR partnerships in the U.S., Europe and Japan; and strengthen our financial position to support continued growth and strategic initiatives. I'm very pleased to report we have accomplished these initiatives, resulting in exceptional

34


financial performance and long-term value creation for our key stakeholders: customers, shareholders and employees.

*

Our financial strength continues to support both strategic and operational business growth initiatives. We established a $15 million unsecured line of credit, increased from $5 million in 2002, and increased our cash position to $16.9 million. Our institutional ownership increased to more than 40%, up from 12% at the beginning of 2003, due in part to the July private placement and the move to the NASDAQ National Market. [Emphasis added.]





Accordingly, for the fourth quarter the Company did not have revenues of $8,507,000 and net

income of $1,897,000 and those figures were materially overstated. In addition, for fiscal year

2003, the Company did not have revenues of $28,677,000 and net income of $6,239,000 but

rather had revenues of $24,560,000 and net income of $4,434,000. Merge Technologies has

now admitted that its 2003 financial results were materially overstated; and

(b) based on the foregoing, it was materially false and misleading to attribute the

Company's "exceptional financial performance to the completion of corporate "initiatives when

the Company's financial performance was based, in material part, on accounting fraud.

125. On March 15, 2004, Merge Technologies filed its Annual Report on Form 10-K for

the year ended December 31, 2003 ("2003 Form 10-K ), with the SEC which was signed by

Defendants Linden and Veech and confirmed the previously announced financial results. The 2003

Form 10-K contained audited financial statements. In addition, the 2003 Form 10-K reported the

following financial results: net sales of $28,677,000; operating income of $7,001,000; net income of

$6,239,000; earnings per share of $0.49; working capital of $21,723,000; shareholders equity of

$53,523,000; and cash flow of $6,239,000.

35


126. The statements referenced above in ¶125 from the 2003 Form 10-K were materially

false and misleading because they failed to disclose Merge Technologies accounting fraud. In

addition, the 2003 Form 10-K contained materially false and misleading financial statements which

were prepared in violation of GAAP as detailed herein 11186-203. Indeed, the Company has

admitted that the financial statements contained in the 2003 Form 10-K were materially false and

misleading when issued and has restated those financial results. In particular, the Company has

admitted that: net sales were not $28,677,000 as reported but rather were $24,560,000; operating

income was not $7,001,000 but rather was $3,208,000; net income was not $6,239,000 but rather

was $4,434,000; earnings per share was not $0.49 but rather was $0.35 per share; working capital

was not $21,723,000 but rather was $18,187,000; and cash flow was not $6,239,000 but rather was

$4,434,000. Furthermore, and as admitted on page 34 of the Restatement, the Company's balance

sheet data from 2003 was false when issued. Moreover, and as admitted on page 65 of the

Restatement, the Company's cash flow data from operating activities in 2003 was false when issued.


financial results for the first quarter of 2004, the period ending March 31, 2004. For the quarter, the



Our financial and operational performance this quarter is a reflection of our strategy to position Merge Technologies eFilm as a leader in RIS/PACS software and professional services for our target market. The rapid and successful integration of RIS Logic®, the market adoption of our FUSION RIS/PACSTM solutions and corresponding emphasis on North American direct sales, the design and development of our next generation RIS/PACS in close collaboration with our customers, and the strengthening of our professional services organization all contributed to delivering a strong first quarter. These enacted strategies, along with our operational discipline, form the foundation for reaffirming our 2004 guidance. [Emphasis added.]

The press release also provided "Guidance. The Company stated that it reaffirmed its full 2004

guidance with revenues growing 30% to 35% year-over-year to a range of $37.5 to $39.5 million.

im


128 The statements referenced above in 1127 were materially false and misleading





those figures were materially overstated. In fact, revenues were $6,002,000 and net income

was $109,000. Merge Technologies has now admitted that its interim financial results were

materially overstated; and


that the Company's "financial and operational performance was a "a reflection of our strategy to

position Merge Technologies eFilm as a leader in RIS/PACS software and professional services for

our target market when it was based, in material part, on accounting fraud.

129. On May 10, 2004, Merge Technologies filed its Form 10-Q for the period ending

March 31, 2004, with the SEC which was signed by Defendants Linden and Veech and confirmed

the previously announced financial results. With respect to the financial statements contained

therein, the Form 10-Q represented as follows:




131. On July 28, 2004, Merge Technologies issued a press release announcing its financial




37


Our financial and operational performance this quarter is a direct result of our strategy to position Merge Technologies eFilm as a leader in RIS, PACS and RIS/PACS software and professional services for our target market - imaging centers, small to medium sized hospitals and specialty clinics. Second quarter highlights include: exceptional performance by our North American Direct Sales and Services division which delivered record year-over-year growth; accelerated product innovation in collaboration with our customers that resulted in new releases of FUSIONrM RIS, PACS, RISLPACS and OEM products; and recognition of our products' quality by objective third party certification organizations. These accomplishments, the trends towards paperless and filmless workflow within our target market, our products' alignment with those trends and the execution of a national distribution agreement in July 2004 with SourceOne Healthcare Technologies form the foundation for reaffirming our 2004 guidance. [Emphasis added.]

The Company also reaffirmed its guidance.






those figures were materially overstated. In fact, revenues were $6,332,000 and operating

income was $274,000. Merge Technologies has now admitted that its interim financial results

were materially overstated; and


that the Company's financial performance was "direct result of certain corporate developments

when it was based, in material part, on accounting fraud.





im







the Company reported revenues of $9,307,000 and net income of $2,237,000, or $0.16 per share.

Defendant Linden commented on the announcement stating in pertinent part as follows:

We continue to advance our market-leading position in clinical and business workflow systems, specifically RIS, PACS and RIS/PACS software and professional services, for our target market - imaging centers, small to medium sized hospitals and specialty clinics. Third quarter highlights include: new and expanded relationships with imaging centers and national chains, strengthening our product innovation model through customer relationship initiatives, improving our OEM and international VAR business and continuing our investments in quality processes throughout Merge Technologies eFilm to provide a foundation for growth. Our success this quarter combined with our growing strength in the imaging center market and a lower effective tax rate forms the foundation for increasing our guidance for earnings per share. [Emphasis added.]

136. In the press release the Company also increased its earnings per share guidance to a

range of $0.50 to $0.53 per share.


because they failed to disclose and misrepresented the following facts that the Company was

engaged in a host of improper accounting practices, as detailed herein at 1148-86, which were

artificially inflating the Company's reported financial results. Accordingly, the Company did not

have revenues of $9,307,000 and net income of $2,237,000, and those figures were materially

overstated. In fact, revenues were $7,144,000 and net income was $928,000. Merge

Technologies has now admitted that its interim financial results were materially overstated.

im


138 On November 8, 2004, Merge Technologies filed its Form 10-Q for the period ending

September 30, 2004, with the SEC which was signed by Defendants Linden and Veech and




139. The statements referenced above in ¶138 were materially false and misleading for the


140. On January 18, 2005, Merge Technologies issued a press release announcing that it

had entered into an agreement to purchase Cedara in an all-stock transaction. According to the press

release, pursuant to the terms of the merger, Merge Technologies would issue either 0.587

Merge Technologies common shares, or 0.587 shares of a newly-created class of Canadian

exchangeable shares for each Cedara common share. Based on the 20-day volume weighted

average price of Merge Technologies stock for the period ending January 14, 2005, the

transaction was valued at $12.37 (or, approximately $15.10 in Canadian currency) for each

common share of Cedara, representing a 17.5% premium to Cedara's 20-day volume weighted

average price.

141. On February 15, 2005, Merge Technologies issued a press release announcing its

financial results for the fourth quarter of 2004 and fiscal year 2004, the period ending December 31,

2004. For the quarter, the Company reported revenues of $10,154,000 and net income of $2,379,000

or $0.18 per share. For fiscal year 2004, the Company reported revenues of $37,005,000 and net

income of $7,467,000 or $0.54 per share. Defendant Linden commented on the announcement

stating in pertinent part as follows:

40


I'm pleased to report to our shareholders that we have successfully balanced our efforts to deliver strong financial performance this quarter while simultaneously planning the integration of our pending merger with Cedara Software Corp. and its subsidiary, eMed Technologies Corporation. In the first quarter, we added to our direct sales capabilities and expanded our relationship with large national imaging center chains, increased our eCommerce strategies and strengthened our FUSION RIS/PACSTM product portfolio by offering enhanced financial and clinical applications. Simultaneously, we began the important process of merger integration, and strengthened our capabilities to scale with our future growth as we prepare the new company for post-merger success. These efforts, along with our operational discipline, form the foundation for reaffirming our pre-merger 2005 guidance. [Emphasis added.]

The press release also contained financial "Guidance. The Company reported that it "anticipates

2005 revenues to grow 30% to 35% year-over-year to a range of $48 million to $50 million and

earnings per share of $0.68 to $0.75.


because they failed to disclose and misrepresented that the Company was engaged in a host of

improper accounting practices as detailed herein at 1148-86, which were artificially inflating the

Company's reported financial results. Accordingly, for the fourth quarter the Company did not have

revenues of $10,154,000 and net income of $2,379,000 but rather had revenues of $6,868,000 and

net income of $878,000. For fiscal year 2004, the Company did not have revenue of

$37,005,000 and net income of $7,467,000 or $0.54 per share but rather had revenue of

$26,347,000 and net income of $2,190,000 or $0.16 per share. Merge Technologies has now

admitted that its 2004 financial results were materially overstated.

143. On March 7, 2005, Merge Technologies filed its Annual Report on Form 10-K for the

year ended December 31, 2004 ("2004 Form 10-K ), with the SEC which was signed by Defendants

Linden and Veech and confirmed the previously announced financial results. The 2004 Form 10-K

contained audited financial statements.


reasons set forth in 1142 above. Merge Technologies has admitted that the financial statements

41


contained in the 2004 Form 10-K were materially false and misleading when issued and has restated

those financial results. In addition, the 2004 10-K contained materially false and misleading

financial statements which were prepared in violation of GAAP as detailed herein 11186-203.


financial results for the first quarter of 2005, the period ending March 31, 2005. The Company

reported revenues of $10,501,000 and net income of $2,096,000 or $0.20 per share. Defendant

Linden commented on the results stating in pertinent part as follows:

I'm pleased to report to our shareholders that we have delivered strong financial performance this quarter while simultaneously merging with Cedara Software Corp., and its subsidiary, eMed Technologies Corporation. I am exceedingly proud of the contributions of our employees who have put forth the extra effort and focus required to continue our business growth and service our customers, while concurrently integrating our operations. The talent and dedication of our employees yielded this quarter's success, and represents a strong foundation for our future.

Consistent with our strategic growth initiatives over the last five years, we moved quickly to implement our near-term merger integration plans with a focus on becoming one company, unifying our leadership, realizing tangible product and revenue synergies and assuring our customers of the benefits of this merger. Our single company, multiple distribution channel model is best measured on a go-forward basis by focusing on total revenues and pre-tax cash earnings, which will form the foundation for our guidance going forward. We are especially pleased with revenues for the quarter and the pre-tax cash earnings we generated for our shareholders. [Emphasis added.]

The Company reaffirmed its guidance.






those figures were materially overstated. The true results were revenues of $6,937,000 and net

income of $165,000. Merge Technologies has now admitted that its interim financial results

were materially overstated; and 42


(b) based on the foregoing, it was materially false and misleading to claim that

the Company had "delivered strong financial performance this quarter while simultaneously merging

with Cedara Software when the Company was engaged in an accounting fraud.

147. On May 5, 2005, Merge Technologies filed its Form 10-Q for the period ending

March 31, 2005, with the SEC which was signed by Defendants Linden and Veech and confirmed

the previously announced financial results. With respect to the financial statements contained

therein, the Form 10-Q represented as follows:




149. On May 24, 2005, Merge Technologies issued a press release announcing that its

shareholders overwhelmingly approved its merger with Cedara at a special shareholder meeting held

that same day in Milwaukee, Wisconsin. The merger was expected to close June 1, 2005, following

court approval in Canada.

150. On June 1, 2005, Merge Technologies and Cedara issued a press release announcing

that they successfully completed the merger of the two companies. Under the terms of the

transaction, shareholders of Cedara were to receive either 0.587 shares of Merge Technologies

common stock or 0.587 exchangeable shares for each common Cedara share held.

151. On June 9, 2005, Merge Technologies issued a press release announcing that it had

changed its corporate name to Merge Technologies Healthcare, following its recent merger with

Cedara and its subsidiary eMed Technologies. The stock would continue to trade on

NASDAQ under the "MRGE symbol, and also would trade on the Toronto Stock

Exchange under the ticker symbol "MRG. Following the merger, the Company had two

43


operating divisions: Merge Technologies eFilm, which developed, marketed, and serviced

RIS/PACS products for hospitals, imaging centers and specialty clinics; and Cedara, which

focused on developing innovative medical imaging software for the OEM and international

markets.

152. In connection with the Cedara acquisition, on July 8, 2005, Defendants filed

Amendment No. 1 to Form S-3 (the "Amended Registration Statement ) with the SEC. The

Amended Registration Statement incorporated by reference the 2004 Form 10-K and numerous other

SEC filings which included the Company's earnings releases for 2005.

153. On August 2, 2005, Merge Technologies issued a press release announcing its

financial results for the second quarter of 2005, the period ending June 30, 2005. For the quarter,

the Company reported revenue of $18,773,000. The Company also announced that it was updating

its financial guidance as a result of merging with Cedara stating in pertinent part as follows:

reported revenues for 2005 are expected to be in the range of $90 million to $95 million. This translates into organic growth greater than 25% for the second half of 2005. The Company believes that pre-tax cash earnings guidance, removing the differences between effective and cash tax rates and the various transaction-related expenses, is the best way to measure the operating performance of the combined company. The Company currently expects pre-tax cash earnings per share of $1.30 - $1.45. The Company reaffirms its belief that the merger will deliver accretive pre-tax cash earnings to shareholders within the first year post-merger closing. [Emphasis added.]

154. The statements referenced above in 11152-153 were materially false and misleading


(a) that the Company was engaged in a host of improper accounting practices as


Accordingly, the Company did not have revenues of$1 8.8 million and this figure was materially

overstated. In truth, the Company had revenues of $15,161,000. Merge Technologies has now

admitted that its interim financial results were materially overstated; and

44


(b) based on the foregoing, and given the problems with the Cedara merger, it

was materially false and misleading to claim that "the merger will deliver accretive pre-tax cash

earnings to shareholders within the first year post-merger closing."










the Company reported revenues of $32,723,000 and pre-tax cash earnings of $12,713,000 or $0.47

per share. Defendant Linden commented on the results stating in pertinent part as follows:

I am pleased to report that we delivered strong financial, operational and organizational performance in our first full quarter subsequent to merging with Cedara Software Corp.... These results represent the remarkable teamwork, effort, and dedication of our employees who have put forth the extra effort to Merge Technologies and integrate our organizations while continuing to serve our customers, create innovative medical imaging software solutions, and sell our solutions to our target markets. We have been especially pleased with customer response to this merger, which has been overwhelmingly positive.

* * *

Our strong results during the third quarter provide initial evidence of the operational and strategic benefits made possible by our recent merger with Cedara Software. We continue to be encouraged by key market trends that align with our initiatives to expand our portfolio of products to include clinical applications, and to pursue new healthcare markets beyond the traditional radiology setting. While important integration initiatives continue, and new challenges and opportunities lie ahead of us, we are confident that our strategy, market position and

45


focus on operations will enable us to continue delivering value to our stakeholders: customers, employees and shareholders. [Emphasis added.]

158. The Company also increased its guidance for "2005 due to strong financial and

operational performance in the quarter ended September 30, 2005. The Company increased its

2005 revenue guidance from $95 million to $98 million.





Accordingly, the Company did not have revenues of $32,723,000 and pre-tax cash earnings of

$12,713,000 per share of $0.47 and these figures was materially incorrect. Merge Technologies

has now admitted that its interim financial results were materially incorrect; and

(b) based on the foregoing, it was materially false and misleading to characterize

the Company's financial performance as "strong without disclosing that it was based, in material

part, on accounting fraud.

160. On November 3, 2005, Merge Technologies filed its Form 10-Q for the period ending

September 30, 2005, with the SEC which was signed by Defendants Linden and Veech and






162. On January 24, 2006, the Company issued a press release (the "January 24, 2006)

press release announcing a user group meeting for its RIS, PACS and clinical application customers. 46


According to Defendant Noshay, "Our users have a continual need to learn new ways to accelerate

productivity, grow their revenues and expand their reach and services to referring physicians. The

user group meeting provides an opportunity for radiologists, imaging center managers, PACS and

RIS administrators, radiology managers, IT staff, billing managers and others to learn new ways to

improve workflow, speed productivity and improve profitability within their organizations. Our last

User Group Meeting was rated very highly by the participants, and we look forward to meeting the

many new customers that have joined us this past year.

163. Noshay's statement in the January 24, 2006 press release was materially false and

misleading because the user group meeting was not designed to provide an opportunity for

customers to learn news was to improve workflow, speed productivity and improve profitability

within their organizations. Rather, the user group meeting was set up as a vehicle for customers to

express their complete and utter dissatisfaction with Merge Technologies, its software and its

customer service.

164. The Company issued a press release on February 8, 2006 (the "February 8, 2006

Press Release ) announcing that its imaging center customers increase revenues and referring

physician satisfaction by delivering data, images and information via the Company's web-based

portal. In the February 8, 2006 Press Release, Noshay represented that: "Our customers' business

needs are driving the evolution of a new age of medical imaging. The Referring Practice Portal is

aligned with those business needs, along with the comprehensive solutions that bring together RIS,

PACS, clinical applications and solid expertise in integration.

165. Noshay's statement in the February 8, 2006 Press Release was materially false and

misleading because the Company did not have solid expertise in integration. Rather, as explained

above, the Company was unable to integrate and implement its products in a timely fashion.

47


The Truth Begins to Slowly Emerge

166 On February 24, 2006, Merge Technologies issued a press release announcing that it

would delay the issuance of its financial results for the fourth quarter 2005 results "in order to allow

additional time to complete the audit of the Company's financial statements Defendant Linden

commented on the announcement stating in pertinent part as follows:

2005 was a year of significant change and growth for Merge Technologies Healthcare, including a strategic business combination with Cedara Software. As a result of the complexities associated with accounting for sales transactions in the fourth quarter, our year-end audit has not been sufficiently completed and, accordingly, we are not publishing complete financial results at this time. However, during the quarter we strengthened our core operations, further broadened our product portfolio for our customers, and improved our competitive positioning.

The press release also reported that "Certain large sales contracts entered into during the fourth

quarter will be recorded as deferred revenue and, therefore, the Company would only realize

revenues of "between $23 million and $26 million for the fourth quarter.

167. That same day, Merge Technologies held a conference call to discuss the Company's

announcement. During the call, Defendants Linden and Veech attempted to bolster the Company's

outlook and highlight positive developments, while concealing the full extent of the accounting fraud

at Merge Technologies. Defendant Linden stated in pertinent part as follows:

Thank you, Scott, and good morning, everyone. 2005 represented a year of significant change for Merge Technologies Healthcare as we positioned ourselves for further growth and business development in the coming years as a result of our strategic merger with Cedara Software.

While we are pleased with the many operational and strategic initiatives we accomplished during the fourth quarter and throughout the year, we regret to report to our shareholders that the complexities of accounting for certain large sales contracts signed in the fourth quarter have delayed our ability to complete the audit.

* * *

While reported earned revenues are expected to be significantly below our guidance, and we regret to have to report this news to you, there are other metrics representing our business that reflect the overall strength of our strategy, the strength of our core business, our performance in the quarter and our positioning for the coming years.

48


For example, the total dollar value of signed sales contracts - bookings, if you will - in the fourth quarter exceeded the totals for the third quarter representing sequential growth in the total book of business we closed.

168. At the same time, Defendant Veech stated his confidence that the Company's audit

process would not result in any "change stating in pertinent part as follows:

First and foremost, there is nothing in the audit process to date or any of the open items that lead us to leave that any of the prior quarterly contracts are going to change. The audit is not complete. We feel comfortable with the accounting that has occurred.

169. Finally, in response to an analyst question, Defendant Linden put positive spin on the

Company's merger with Cedara:

Lawrence Rhee - Genuily Capital markets - Analyst

-- is there still longer than expected integration issues between the two companies? Or is that just a stretch?

Linden

I would say that is a stretch in general. Again, while we will go through more specific examples and accomplishments from a Merger integration perspective at the subsequent earnings call, we are pleased with the progress we're making in realizing synergies from the Merger integration. So I don't think you should make a connection there. [Emphasis added.]

170. In response to the announcements about the delay in the release of earnings, the price

of Merge Technologies common stock declined from $24.50 per share to $20.50 -- a one-day drop of

16.3 percent - on extremely heavy trading volume.

171. The statements in 11166-169 only partially disclosed the problems at Merge

Technologies and, accordingly, the price of Merge securities continued to be artificially inflated

following the February 24 th announcements.

172. On March 1, 2006, Merge Technologies issued a press release announcing that its

Board of Directors had authorized the Company to expand the Company's stock repurchase program

to $20 million from $10 million. Defendant Linden commented on the announcement stating in

pertinent part as follows:

49


This expanded stock repurchase program will enhance our ability to maximize shareholder value . . . . As of December 31, 2005 we had a cash balance of approximately $64 million. Additionally, we have no outstanding debt, access to a $35 million line of credit, and we continue to produce positive cash flow. Given our strong financial position, we believe that this expanded stock repurchase plan contributes to our ability to build shareholder value, while maintaining sufficient resources to continue investing in our growth strategies. [Emphasis added.]


because Defendant Linden knew that he and others at the Company had engaged in a massive

accounting fraud and that the Company's financial position was materially overstated. Accordingly,

the Company would not be in a position to complete the share re-purchase it had just announced.

174. On March 17, 2006, Merge Technologies issued a press release announcing that it

would be delayed in filing its Annual Report on Form 10-K for the year ended December 31, 2005.

The Company reported that the delay "relates to revenue recognition and tax accounting matters

relating to the merger of the Company and Cedara Software Corp. in June 2005. In addition, the

Company reported that it was initiating an internal investigation into anonymous complaints

received by the Board of Directors relating to the Company's accounting. Furthermore, the

Company reported that its management and Audit Committee has concluded that its previously

issued financial statements for the quarters ended June 30,2005, and September 30, 2005, should no

longer be relied upon.

175. In response to this announcement, the price of Merge Technologies stock declined

from $17.97 to $15.85 per share on extremely heavy trading volume. Defendants, however,

continued to conceal the true nature and extent of the accounting fraud at Merge Technologies.

176. On May 16, 2006, Merge Technologies issued a press release announcing changes to

its senior management team and providing an update to its regulatory and accounting matters. The

Company reported that it had accepted the "resignation of Defendant Linden. Furthermore, the

Company reported that its Audit Committee was continuing its investigation and it expected to be

50


finished within the next few weeks. Finally, the Company reported that it had found another error in

its second quarter 2005 financial results stating in pertinent part as follows:

In addition to those errors previously disclosed, the Company has determined that an error was made with respect to the recognition of revenue associated with a sales contract entered into in the second quarter of 2005. Specifically, the $1 million in revenue recognized on that contract in the second quarter of 2005 should not have been recognized in such quarter because collectibility was not reasonably assured. This was an error in the timing of recognition, as the Company ultimately collected $150,000 in the fourth quarter of 2005 and $850,000 in the first quarter of 2006 on the sales contract, and the revenue will be recognized in those periods.

177. The Class Period ends on July 3, 2006. On that date, Merge Technologies issued a

press release announcing an "update on regulatory and accounting matters. The Company reported

that since January 10, 2006, it had received a number of anonymous letters alleging improper

accounting and disclosure practices, among other things. The press release described the

investigation of the Audit Committee stating in pertinent part as follows:

The Audit Committee retained the independent national law firm of Sidley Austin LLP and Alvarez & Marsal, LLC, a nationally-recognized forensic accounting firm, to conduct an independent investigation of the allegations contained in the anonymous letters. Sidley Austin LLP and Alvarez & Marsal have conducted a comprehensive investigation of the Company's accounting and financial reporting practices, which has included, among other things, a review of relevant documents and interviews of current and former employees of the Company and former employees of Cedara Software Corp., which the Company acquired in June 2005. Throughout the investigation, the Audit Committee's independent advisors have provided the Audit Committee and the remainder of the Company's Board of Directors with periodic updates with respect to their findings. In the course of the investigation, Sidley Austin LLP and Alvarez & Marsal have regularly consulted with KPMG LLP, the Company's independent registered public accountants.

178. The Company also provided an update on its restatement of financial results and, for

the first time, stated that the Audit Committee had determined that the accounting problems spanned

back to 2002 stating in pertinent part as follows:

The Audit Committee has since determined that, because of improper accounting and financial reporting practices with respect to reporting periods in the fiscal years 2002 through 2005, the previously issued financial statements for each of the reporting periods in 2002 through 2005 should no longer be relied upon. Furthermore, the audit reports of KPMG LLP with respect to those financial statements should no longer be relied upon. Accordingly, it will be necessary to restate previously issued

51


financial statements for such periods. The Company currently anticipates that the restatements will primarily relate to the timing of revenue recognition, with a significant amount of revenue recognized in 2002 through early 2005 expected to be instead recognized in late 2005 and 2006. At this time, however, the Company cannot provide a precise estimate of the impact of these non-cash adjustments to the financial statements.

179. Finally, the Company reported that it had accepted the "resignations of William C.

Mortimore, the Company's interim Chief Executive Officer, as well as Defendants Veech and

Noshay.

180. In response to this announcement, the price of Merge Technologies stock declined

from $12.31 to $7.30 per share on extremely heavy trading volume.

181. On August 29, 2006, Merge Technologies filed its Form 10-K for the year ended

December 31, 2005 with the SEC (the "2005 Form 10-K ). The 2005 Form 10-K described

Defendants' accounting fraud and admitted that Merge Technologies and its senior management had

been improperly recognizing revenue through the following numerous fraudulent and manipulative

devices:

Revenue Recognition

We determined that we overstated net sales for 2002, 2003, 2004 and the first nine months of 2005 due to the following:




52




182 Merge Technologies also acknowledged failures in its recording of tax liabilities:

Income Tax Expense

We determined that we understated income tax expense, income tax payable and goodwill for the quarter ended, and as of, June 30, 2005, due to a failure to record additional tax liability and income tax expense in connection with our June 2005 business combination with Cedara Software Corp.

In addition, we adjusted the provisions for income tax and related tax accounts at the applicable statutory rates to account for the effects of the restatement adjustments described herein.

183. With respect to disclosure controls and reporting, Merge Technologies announced in

pertinent part:

Disclosure controls and procedures are controls and other procedures of a registrant designed to ensure that information required to be disclosed by the registrant in the reports that it files or submits under the Securities Exchange Act of 1934 (the "Exchange Act ) is properly recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's ("SEC ) rules and forms. Disclosure controls and procedures include processes to accumulate and evaluate relevant information and communicate such information to a registrant's management, including its principal executive and financial officers, as appropriate, to allow for timely decisions regarding required disclosures.

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2005, as required by Rule 13a-15 of the Exchange Act. This evaluation was carried out under the supervision and with the participation of our management, including our principal executive officer and principal financial officer. As described below, under "Management's Report on Internal Control Over Financial Reporting, material weaknesses were identified in our internal control over financial reporting as of December 31, 2005 relating to our control environment, revenue recognition, accounting for income taxes and accounting for business combinations. Based on the evaluation described above, our principal executive officer and principal financial officer have concluded that, as of December 31, 2005, our disclosure controls and procedures were not effective to

53


ensure (1) that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms, and (2) information required to be disclosed by us in our reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

(c) Management's Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with GAAP.

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

A material weakness in internal control over financial reporting (as defined in Auditing Standard No. 2 of the Public Company Accounting Oversight Board) is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects a company's ability to initiate, authorize, record, process or report external financial data reliably in accordance with GAAP such that there is more than a remote likelihood that a misstatement of the company's annual or interim financial statements that is more than inconsequential will not be prevented or detected.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO ) in Internal Control-Integrated Framework. In assessing the effectiveness of our internal control over financial reporting, management identified the following material weaknesses in internal control over financial reporting as of December 31, 2005:

1. Our control environment was not adequate because certain former members of senior management did not set a proper ethical tone within our organization and instill an attitude of control compliance. Certain former members of our

54


management were directly involved in circumventing our accounting controls, and other former members of our management were aware, or should have been aware, that such controls were being circumvented. This deficiency contributed to material misstatements in our interim consolidated financial statements as of, and for the interim periods ended, September 30, 2005, June 30, 2005 and March 31, 2005 and our annual consolidated financial statements as of, and for the years ended, December 31, 2004, 2003 and 2002, as well as our consolidated financial statements for interim periods within those years.

2. We did not maintain effective policies and procedures relating to revenue recognition associated with our sales contracts. This lack of effective policies and procedures contributed to our premature recognition of revenue related to components of our software contracts that were undelivered as of a reporting date, for which we were unable to establish fair value, or to contracts for which collectibility was not reasonably assured. These deficiencies resulted in material misstatements in our interim consolidated financial statements as of, and for the interim periods ended, September 30, 2005, June 30, 2005 and March 31, 2005 and our annual consolidated financial statements as of, and for the years ended, December 31, 2004, 2003 and 2002, as well as our consolidated financial statements for interim periods within those years.

3. We did not maintain effective policies and procedures over the accounting for income taxes. Specifically, our policies and procedures did not provide for obtaining third party technical assistance in connection with our accounting for the income tax consequences of complex transactions. This deficiency resulted in material misstatements in our interim consolidated financial statements as of and for the interim periods ended September 30, 2005 and June 30, 2005.

4. We did not maintain effective controls over the accounting for business combinations. Specifically, we did not have formal policies and procedures to provide for a sufficient analysis to identify all assets acquired in business combinations to appropriately allocate the purchase price. This deficiency resulted in material misstatements in our interim consolidated financial statements as of, and for the interim periods ended, September 30, 2005 and June 30, 2005.

As a result of the material weaknesses described above, our management concluded that we did not maintain effective internal control over financial reporting as of December 31, 2005, based on the criteria established by CO SO.

We acquired Cedara Software Corp. during 2005. The acquired assets represented $57,422,000 of our total consolidated assets as of December 31, 2005 and $43,770,000 of our 2005 consolidated net sales. We did not conduct an assessment of the effectiveness of internal control over financial reporting associated with Cedara Software Corp., as permitted by the implementation guidance set forth by the SEC in June 2004 (and revised on October 6, 2004) to issuers relating to the SEC's final rules on internal control over financial reporting.

55


184. Finally, Merge Technologies announced changes in internal control over financial

reporting:

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Based on the recommendations of Sidley Austin LLP, Alvarez & Marsal and our Chief Accounting Officer, the Audit Committee of our Board has approved and adopted the following remediation plan to address the issues raised in the independent investigation conducted by Sidley Austin LLP, the deficiencies in our disclosure controls and procedures and the material weaknesses in our internal control over financial reporting described above under "Management's Report on Internal Control Over Financial Reporting

1. On May 15, 2006, our Board accepted Mr. Linden's resignation from all positions with us and our subsidiaries, including as an officer, employee and director, effective immediately.

2. We strengthened the oversight role of our independent directors by determining that one of our non-employee directors will serve as Chairman of our Board of Directors. Accordingly, on May 15, 2006, Michael D. Dunham, who had been serving as our lead independent director, was named Chairman of our Board of Directors.

3. On July 2, 2006, our Board of Directors accepted the resignations of Messrs. Mortimore, Noshay and Veech from all positions with the Company, effective immediately. At the same time, our Board appointed Michael D. Dunham, the Chairman of our Board of Directors, as our principal executive officer on an interim basis. Our Board is searching for a new Chief Executive Officer.

4. On July 2, 2006, our Board of Directors also appointed Steven M. Oreskovich, who had been serving as our Vice President and Corporate Controller, as our Chief Accounting Officer and interim Treasurer and Secretary. Mr. Ore skovich will serve as our principal accounting officer and interim principal financial officer. Our Board is searching for a Chief Financial Officer.

5. We will create an internal audit function and appoint a Director of Internal Audit, who will report directly to the Audit Committee of our Board of Directors, to oversee the internal audit function for us. This internal audit function will include the review of each of our sales contracts under which we expect to receive revenue in excess of $100,000. We have retained Alvarez & Marsal, the forensic accounting firm retained by Sidley Austin in connection with its investigation, to consult on a variety of accounting and financial reporting matters, at least until such time as we appoint a Director of Internal Audit.

56


6. On August 28, 2006, our Board of Directors approved a revised Audit Committee Charter. See Part III, Item 10, "Directors and Executive Officers of the Registrant--Audit Committee; Audit Committee Financial Expert in this Annual Report on Form 10-K for more information.

7. At least until a new Chief Executive Officer is retained, our principal financial officer will report directly to the Audit Committee of our Board.

8. We will further standardize our OEM contracts to provide additional clarity on issues related to revenue recognition.

9. Our product documentation and marketing materials will clearly present product functionality available for sale.

10. We will enhance our contract review process to include a cross functional group that is responsible for reviewing contracts and providing information required to assist us in our determination of revenue recognition.

11. We will formalize our procedures for project status determination and customer acceptance sign-off.

12. We will establish formal policies and procedures for the customer audit confirmation process.

13. We will enhance our continuing education program for our sales and service organization to educate them regarding our revenue recognition policies and we will require sales personnel to verify their compliance with these policies.

14. We will work with KPMG LLP, our independent registered public accounting firm, to institute a formal disclosure review procedure between the Audit Committee of our Board and our management.

15. We will establish an ongoing contract review process, related to contracts with non-standard or complex terms, with a goal of determining appropriate accounting treatment prior to quarter-end.

16. In connection with complex transactions, we will seek expert outside advice on tax issues.

17. We will establish formal policies and procedures to identify all assets we acquire in business combination transactions.

18. We have established a disclosure committee to, among other things, assist our principal executive officer and principal financial officer in fulfilling their responsibilities with respect to Sections 3 02, 404 and 906 of the Sarbanes-Oxley Act of 2002 and the rules of the SEC.

19. We intend to hire a General Counsel to, among other things, work with our principal executive officer, principal financial officer, principal accounting officer and Director of Internal Audit to further improve our control environment.

57


We have already begun instituting this remediation plan. The Audit Committee is committed to further refinement and improvement of this plan.

185. Thereafter, during a November 17, 2006, conference call with investors, with respect

to the Company's prior positive statements concerning the merger between Merge Technologies,

eMed and Cedara, current CEO Ken Rardin stated in response to a question from Jeffries & Co.

analyst Richard Close:

Richard Close: Okay. With respect to the $14 million in revenue for the third quarter, what was the biggest thing in contributing would you say to the year-over-year decrease? Is it more your internal situation, or is there anything on the macro-environment, and maybe if you could talk a little but about pricing as well?

Ken Rardin: Well, obviously there are really three things in my opinion. I think there was a lot of discussion that was just the restatement process we were going through, and once we got through that, things would recover quickly. I don't think it was just the restatement, I think it was as much a problem with the integration as the restatement itself. I don't think we did proper integration with our businesses, especially in the area of Merge Technologies eMed

On the Cedara side, it's not a competitive business. Cedara is in the OEM space. On the direct selling side, we basically integrated two competitive companies, and I think that caused a lot of confusion in the marketplace, and a lot of confusion internally. And I think that contributed significantly to the reduction in sales year-over-year. That is and has been fully integrated now. We have a single organization, we have a single product strategy, and we expect that to improve as we go forward. [Emphasis added.]

Merge Technologies' False Financial Statements

186. At all relevant times during the Class Period as set forth herein, Merge Technologies

represented that its financial results were reported in accordance with GAAP. 1 These representations

were materially false and misleading because, as it has now admitted, Merge Technologies' financial

GAAP are those principles recognized by the accounting profession as the conventions, rules and procedures necessary to define accepted accounting practices at a particular time. Generally Accepted Auditing Standard ("GAAS ) §AU 411.02. Regulation S-X [17 C.F.R. §210.4-01 (a)( 1)] states that financial statements filed with the SEC that are not prepared in conformity with GAAP are presumed to be misleading and inaccurate. Additionally, Regulation S-X requires that interim financial statements must also comply with GAAP. [17 C.F.R. 210.01-01.]

58


reporting was materially misstated and violated numerous provisions of GAAP during the Class

Period.

187. During the Class Period, Defendants caused or allowed Merge Technologies to issue

statements that failed to disclose or misstated the fact that: (i) the Company's financial statements

violated GAAP in numerous respects; (ii) the Company's management was "directly involved in

circumventing its accounting controls and procedures; (iii) the disclosed policies of accounting in the

Company's interim and annual reports filed with the SEC were materially false and misleading; (iv)

the Company's reported financial results were grossly overstated; and (v) despite representations to

the contrary in its interim and annual reports filed with the SEC, the Company's internal and

disclosure controls were materially deficit and ineffective.

Merge Technologies' Violations of GAAP

188. Defendants had the responsibility to present Merge Technologies' business activities

in accordance with Section 13 of the Exchange Act of 1934, which provides:

Every issuer which has a class of securities registered pursuant to Section 12 of this title and every issuer which is required to file reports pursuant to Section 15(d) of this title shall - -

A. make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; and

B. devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that - -

i. transactions are executed in accordance with management's general or specific authorization;

ii. transactions are recorded as necessary (a) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (b) to maintain accountability for assets;

59


iii. access to assets is permitted only in accordance with management's general or specific authorization; and

iv. the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

189. As set forth in Financial Accounting Standards Board ("FASB ) Statement of

Concepts ("Concepts Statement ) No. 1, a fundamental objective of financial reporting is to provide

useful information about an entity's financial performance. In addition, GAAP, in Concepts

Statement No. 2, provides that financial reporting should be reliable in that it represents what it

purports to represent with reliable financial information.

190. As it has now admitted, Merge Technologies' financial reporting violated these and

numerous other provisions of GAAP, which materially inflated its true financial results during the

Class Period.

Merge Technologies' Improper Recognition of Revenue Violated GAAP

191. GAAP provides that revenue should not be recognized until it is realized or realizable

and earned. Concepts Statement No. 5, 183. The conditions for revenue recognition ordinarily are

met when persuasive evidence of an arrangement exists, delivery has occurred or services have been

rendered, the seller's price is fixed or determinable, collectibility of the sales price is reasonably

assured, and when the entity has substantially performed the obligations which entitle it to the

benefits represented by the revenue. Generally, revenue should not be recognized until an exchange

has occurred and the earnings process is complete. SEC SAB Nos. 101 and 1042; FASB Concept

2 In December 2003, SAB No. 101 was superseded by SAB No. 104, which updated portions of SAB No. 101 to make it consistent with then current authoritative accounting guidance. The principal revisions to SAB No. 101 included the deletion of certain interpretive guidance because of the issuance of private sector GAAP and the incorporation of certain sections of the staffs "Revenue Recognition in Financial Statements Frequently Asked Questions and Answers into SAB No. 104.

M.


Statement Nos. 2 and 5; FASB SFAS No. 48; Accounting Research Bulletin ("ARB ) No. 43;

Accounting Principles Board ("APB ) Opinion No. 10; and American Institute of Certified Public

Accountants ("AICPA ) Statement of Position ("SOP ) 97-2.

192. During the Class Period, Merge Technologies falsely represented that it complied

with these accounting rules. In its financial statements for the year ended December 31, 2002, filed

with the SEC on Forms 10-KSB, 3 Merge Technologies disclosed the following with respect to its

policy of revenue recognition:

Revenues are derived primarily from the sublicensing and licensing of computer software, installations, training, consulting, software maintenance, and sales ofPACS solutions. Inherent in the revenue recognition process, are significant management estimates and judgements, [Sic] which influence the timing and amount of revenue recognition.

For sales of software arrangements, the Company recognizes revenue according to the American Institute of Certified Public Accountants Statement of Position 97-2 (SOP 97-2), Software Revenue Recognition, and related amendments. SOP 97-2, as amended, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. Revenue from multiple-element software arrangements is recognized using the residual method. Under the residual method, revenue is recognized in a multiple element arrangement when Company-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. The Company allocates revenue to each undelivered element in a multiple element arrangement based on its respective fair value, with the fair value determined by the price charged when that element is sold separately.

Specifically, the Company determines the fair value of the maintenance portion of the arrangement based on the renewal price of the maintenance offered to clients, which is stated in the contract and fair value of the installation based upon the price charged when the services are sold separately. If evidence of the fair value cannot be establishedfor an undelivered element of a software sale, the entire amount of revenue under the arrangement is deferred until these elements have been delivered or vendor-specific objective evidence offair value can be established

Revenue from the sale of sublicenses sold on an individual basis and computer software licenses is recognized upon shipment provided that evidence of an

Merge Technologies filed two amendments to its 2002 Form 10-KSB.

61


arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable and collection of the related receivable is reasonably assured.

Revenue from software usage sublicenses sold through annual contracts and software maintenance is deferred and recognized ratably over the contract period. Revenue from installation, training, and consulting services is recognized as services are performed.

Revenue from sales ofPACS solutions sold directly to healthcare institutions where installation services are considered essential to the functionality of the solution sold is recognized on a percentage-of-completion method, as prescribed by the American Institute of Certified Public Accountants Statement of Position 81-1, Accounting for Performance on Construction-Type and Certain Production-Type Contracts. Percentage-of-completion is determined by the output method based upon the achievement of delivery milestones.

The Company's policy is to allow returns when the Company has preauthorized the return. Based on the Company's historical experience of very limited returns and the Company's expectation that returns, if any, will be insignificant, the Company has not provided for an allowance for potential items to be returned. [Emphasis added.]

193. In its financial statements for the year ended December 31, 2003, filed with the SEC

on Form 10-K, Merge Technologies disclosed the following with respect to its policy of revenue

recognition:

Revenues are derived primarily from the sublicensing and licensing of computer software, installations, training, consulting, software maintenance and sales ofPACS, RIS and RIS/PACS solutions. Inherent in the revenue recognition process are significant management estimates and judgments, which influence the timing and amount of revenue recognized.

For software arrangements, we recognize revenue according to the AICPA SOP 97-2, Software Revenue Recognition, and related amendments. SOP No. 97-2, as amended, generally requires revenue earned on software arrangements involving multiple elements to be allocated to each element based on the relative fair values of those elements. Revenue from multiple-element software arrangements is recognized using the residual method, pursuant to SOP No. 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Under the residual method, revenue is recognized in a multiple element arrangement when vendor-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. We allocate revenue to each undelivered element in a multiple element arrangement based on its respective fair value, with the fair value determined by the price charged when that element is sold separately. Specifically, we determine the fair value of the maintenance portion of the arrangement based on the renewal price of the maintenance offered to customers, which is stated in the contract, and fair value of the installation based upon the price charged when the

62


services are sold separately. If evidence of the fair value cannot be establishedfor undelivered elements of a software sale, the entire amount of revenue under the arrangement is deferred until these elements have been delivered or vendor-specific objective evidence offair value can be established

Revenue from sublicenses sold on an individual basis and computer software licenses is recognized upon shipment provided that evidence of an arrangement exists, delivery has occurred and risk of loss has passed to the customer, fees are fixed or determinable and collection of the related receivable is reasonably assured.

Revenue from software usage sublicenses sold through annual contracts and software maintenance is deferred and recognized ratably over the contract period. Revenue from installation, training, and consulting services is recognized as services are performed.

Revenue from sales of RIS and from RIS/PACS solutions sold directly to customers, where professional services are considered essential to the functionality of the solution sold, is recognized on a percentage-of-completion method, as prescribed by AICPA SOP 8 1-1, Accounting for Performance on Construction-Type and Certain Production-Type Contracts. Percentage-of-completion is determined by the input method based upon the amount of labor hours expended compared to the total estimated amount of labor hours to complete the project. Total estimated labor hours is [Sic] based on management's best estimate of the total amount of time it takes to complete a project.

These estimates require the use ofjudgment. A significant change in one or more of these estimates could affect the profitability of one or more of our contracts. We review our contract estimates periodically to assess revisions in contract values and estimated labor hours expended and reflect changes in estimates in the period that such estimates are revised under the cumulative catch-up method.

Our policy is to allow returns when we have preauthorized the return. Based on our historical experience of a limited number of returns and our expectation that returns, if any, will be insignificant, we have provided for an allowance for specific potential items only. [Emphasis added.]

194. These representations were repeated in all material respects in Merge Technologies'

financial statements for the year ended December 31, 2004, filed with the SEC on Forms 10-K.

Then, in its financial statements for the year ended December 31, 2005, Merge Technologies

disclosed:

Based upon the results of the investigation, the Audit Committee determined that, because of improper accounting and financial reporting practices with respect to reporting periods in the fiscal years 2002 through 2005, the previously issued financial statements for each of the reporting periods in 2002 through 2005 should no

63


longer be relied upon. The errors identified in previously issued financial statements are described below.

Revenue Recognition

We determined that we overstated net sales during 2002, 2003, 2004 and the first three quarters of 2005 due to the following:

Delivery of certain software products to end-user customers that did not fully meet the functionality that we believe our customers expected based on express representations we made to our customers or implied representations, made to our customers that arose from our demonstrations of the software products during the sales process. We have deferred such revenue until the delivery of the expected product functionality, the majority of which occurred in the third and fourth quarters of 2005 and the second quarter of 2006.



Recording of revenue prior to shipment of all software products included in a customer's contract. Since we did not have vendor specific objective evidence of fair value for the software element of certain of our contracts, we were required to defer all revenue for certain customer orders with partial software product shipment until delivery of all software products occurred.


We determined that we failed to reduce net sales attributable to a contract although we had agreed to provide the customer with $200 in additional software at no additional cost to the customer.

195. The above admissions make clear that Merge Technologies violated numerous

provisions of its publicly stated policy of accounting for revenue, as well as GAAP's criteria for

64


revenue recognition. 4 In so doing, Merge Technologies, as it has now admitted, materially

overstated its assets, shareholders' equity and earnings during the Class Period. Nonetheless, Merge

Technologies' Class Period financial statements were falsely represented to have been prepared in

conformity with GAAP.

Merge Technologies' Reporting of Expense Violated GAAP

196. GAAP, in SFAS No. 5, requires financial statements to recognize and report a charge

to income when information existing at the date of the financial statements indicates that it is

probable (e.g., likely) that an asset has been impaired or a liability has been incurred; and the amount

of such loss can be reasonably estimated. In addition, Chapter 3 of ARB No. 43, states that the

objective of providing for reserves against receivables is to assure that, "[a]ccounts receivable net of

allowances for uncollectible accounts.. . are effectively stated as the amount of cash estimated as

realizable.

197. In its financial statements for the year ended December 31, 2003 filed with the SEC

on Form 10-K, Merge Technologies disclosed:

Substantially all receivables are derived from sales and related support and maintenance of our products to healthcare providers located throughout the United States and in certain foreign countries.

Our accounts receivable balance is reported net of an allowance for bad debt. We provide for an allowance for estimated uncollectible accounts based upon historical experience and management's judgment.

GAAP, in APB Opinion No. 22, 17, provides that the usefulness of financial statements in making economic decisions depends significantly upon the user's understanding of the accounting policies followed by a company. In fact, GAAP states that information about the accounting policies adopted by a reporting company is "essential for financial statement users. (APB Opinion No. 22, 8)

65


198 These representations were repeated in all material respects in Merge Technologies'

financial statements for the year ended December 31, 2004, filed with the SEC on Forms 10-K. In

its financial statements for the year ended December 31, 2005, Merge Technologies disclosed:

As a result of the revenue adjustments, certain revenue-related accounts were impacted and also restated. These included cost of goods sold related to contracts impacted, deferred revenue (net of the costs of goods), bad debt expense, and the related accounts receivable allowance, accounts receivable and commission expense.

199. In fact, former Merge Technologies employees stated that Company customers

routinely withheld payment due to non-functional systems it "purchased from Merge Technologies.

For example, CW3 stated that customers typically demanded additional system functionality before

making payments.

200. In addition, GAAP, in SFAS No. 109, provides that in accounting for income taxes,

financial statements recognize the amount of taxes payable or refundable in a given year, as well as

to recognize the amount of deferred tax liabilities and assets for future tax consequences.

201. In its financial statements for the year ended December 31, 2005, Merge

Technologies disclosed:

We determined that we understated income tax expense, income tax payable and goodwill in the amounts of $1,308, $3,854 and $2,546, respectively, for the quarter ended, and as of, June 30, 2005, due to a failure to record additional tax liability and income tax expense in connection with our June 2005 business combination with Cedara Software. In addition, we adjusted the provisions for income tax and related tax accounts at the applicable statutory rates to account for the effects of the restatement adjustments described herein.

202. These admissions and factual representations make clear that Merge Technologies

violated GAAP and its publicly stated policies of accounting for accounts receivable and income

taxes during the Class Period.

M.


Merge Technologies' Other Violations of GAAP

203. In addition to the accounting improprieties set forth above, Merge Technologies

presented its financial statements during the Class Period in a manner which also violated, at

minimum, the following provisions of GAAP:

The principle that interim financial reporting should be based upon the same accounting principles and practices used to prepare annual financial statements (APB No. 28, 110);

The concept that financial reporting should provide information about the economic resources of an enterprise, the claims to those resources, and the effects of transactions, events and circumstances that change resources and claims to those resources (Concepts Statement No. 1, 140);

The concept that financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it. To the extent that management offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospective investors and to the public in general (Concepts Statement No. 1, 150);

The concept that financial reporting should be reliable in that it represents what it purports to represent. That information should be reliable as well as relevant is a notion that is central to accounting (Concepts Statement No. 2, 1158-59);

The concept of completeness, which means that nothing is left out of the information that may be necessary to ensure that it validly represents underlying events and conditions (Concepts Statement No. 2, 179); and

The concept that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent (Concepts Statement No. 2, 1195, 97).

In failing to file financial statements with the SEC which conformed to the requirements of GAAP,

Merge Technologies disseminated financial statements that were presumptively misleading and

inaccurate. The Company's Class Period Forms 10-K and 10-Q filed with the SEC were also

materially false and misleading in that they failed to disclose known trends, demands, commitments,

events, and uncertainties that were reasonably likely to have a material adverse effect on the

67


Company's liquidity, net sales, revenues and income from continuing operations, as required by Item

303 of Regulation S-K.

Merge Technologies' False and Misleading Reporting on and Certifications of Disclosure and Internal Controls

204. As a result of the rash of recent corporate accounting scandals, Congress enacted the

Sarbanes-Oxley Act ("Sarbanes-Oxley ) in 2002, in part, to heighten the responsibility of public

company directors and senior managers associated with the quality of financial reporting and

disclosures made by their companies. The SEC revised Item 307 and added Item 308 of Regulation

S-K [17 C.F.R. 229.307 and 308] to require companies to disclose the conclusions of its principal

executive and principal financial officers on the effectiveness of the Company's disclosure controls

and procedures and disclose a report by management on its internal control over its financial

reporting. 5

205. Accordingly, Merge Technologies' fiscal 2002, 2003, 2004 and 2005 Forms 10-K

disclosed: 6

2002 10-KSB

Our Chief Executive Officer [Defendant Linden] and Chief Financial Officer [Defendant Veech] have concluded, based on their evaluation as of a date within 90 days prior to the filing date of this report, that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Exchange Act. There have been no significant changes in our internal controls or in other factors that could

The Securities Exchange Act Rules and Regulations defines disclosure controls as: (1) controls and other procedures designed to ensure that the information required to be disclosed to investors under The Securities Exchange Act is recorded, processed, summarized and reported; and (2) internal control over financial reporting as a process designed by, or under the supervision of, the issuer's principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.

6 As set forth above, Merge Technologies made similar false representations in its interim filings made with the SEC on Form 10-Q during the Class Period.

M.


significantly affect these controls subsequent to the date of the previously mentioned evaluation. [Emphasis added.]

2003 10-K

Our Chief Executive Officer [Defendant Linden] and Chief Financial Officer [Defendant Veech] have concluded, based on their evaluation as of a date within 90 days prior to the filing date of this report, that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Exchange Act. There have been no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the previously mentioned evaluation.

Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. [Emphasis added.]

2004 10-K

Our Chief Executive Officer [Defendant Linden] and Chief Financial Officer [Defendant Veech] have concluded, based on their evaluation as of December 31, 2004, that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d- 15(e) under the Exchange Act) are effective for gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Exchange Act, There have been no significant changes in our internal controls or in otherfactors that could significantly affect these controls subsequent to the date of the previously mentioned evaluation.

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. [Emphasis added.]

Report of Management on Internal Control Over Financial Reporting

Our Chief Executive Officer [Defendant Linden] and Chief Financial Officer [Defendant Veech], together with other members of management of Merge Technologies Technologies Incorporated, are responsible for establishing and maintaining adequate internal control over financial reporting.

Internal control over financial reporting is the process designed under our supervision, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and


the preparation of our financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.

There are inherent limitations in the effectiveness of internal control over financial reporting, including the possibility that misstatements may not be prevented or detected. Accordingly, even effective internal controls over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Furthermore, the effectiveness of internal controls can change with circumstances.

Management has evaluated the effectiveness of internal control over financial reporting as of December 31, 2004, in relation to criteria described in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations Commission of the Treadway Commission (COSO). Based on that assessment, management concluded that, as of December 31, 2004, our internal control over financial reporting is effective based on the criteria established in Internal Control-Integrated Framework. [Emphasis added.]

206. Then, at the end of the Class Period, Merge Technologies admitted that the above

representations about its internal and disclosure controls, and the similar representations Defendants

included in the Company's interim filings made with the SEC on Form 10-Q during the Class

Period, were materially false and misleading when made.

207. Concerning its internal controls representations during the Class Period, Merge

Technologies has now admitted:

From January 10, 2006 through May 26, 2006, we received 11 anonymous letters primarily alleging improprieties relating to our financial reporting, fulfillment of customer contracts and disclosure practices. More specifically, the letters contained allegations of improper revenue recognition practices. The Audit Committee of our Board of Directors took a leadership role in assessing these matters and determining appropriate corrective action with the assistance of outside counsel. The Audit Committee retained the independent national law firm of Sidley Austin LLP and Alvarez & Marsal, a nationally-recognized forensic accounting firm, to conduct an independent investigation of the allegations contained in the anonymous letters. Sidley Austin LLP and Alvarez & Marsal conducted a comprehensive investigation of our accounting and financial reporting practices, which included, among other things, a review of relevant documents and interviews of current and former employees of Merge Technologies Healthcare and former employees of Cedara Software Corp., which we acquired in June 2005. Throughout the investigation, the Audit Committee's independent advisors provided the Audit Committee and the remainder of our Board of Directors with periodic updates with respect to their findings. In the course of the investigation, Sidley Austin LLP and Alvarez & Marsal regularly consulted with KPMG LLP, our independent registered public accountants.

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Based upon the normal year end closing process and the preliminary findings of the investigation, we identified certain errors in our financial statements for the second and third quarters of 2005. On May 15, 2006, Richard A. Linden, our former President and Chief Executive Officer, submitted his resignation from all positions with us and our subsidiaries, including as an officer, employee and director, and our Board of Directors accepted Mr. Linden's resignation.

On June 29, 2006, soon after Sidley Austin LLP completed its investigation, Sidley Austin LLP reported its findings to the Audit Committee, and the Audit Committee determined that, because of improper accounting and financial reporting practices with respect to reporting periods in the fiscal years 2002 through 2005, the previously issued financial statements for each of the reporting periods in 2002 through 2005 should no longer be relied upon. Furthermore, the audit reports of KPMG LLP with respect to those financial statements should no longer be relied upon. On June 30, 2006, the Audit Committee presented its recommendations to all of our non-employee directors. On July 2, 2006, our Board of Directors held a meeting at which it accepted the resignations of each of William C. Mortimore, our former interim Chief Executive Officer, Scott T. Veech, our former Chief Financial Officer, Treasurer and Secretary, and David M. Noshay, our former Senior Vice President, Strategic Business Development, from all positions with us and our subsidiaries, including as officers, employees and directors.

208. In its 2005 Form 10-K, Merge Technologies also stated that:

Disclosure controls and procedures are controls and other procedures of a registrant designed to ensure that information required to be disclosed by the registrant in the reports that it files or submits under the Securities Exchange Act of 1934 (the "Exchange Act ) is properly recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's ("SEC ) rules and forms. Disclosure controls and procedures include processes to accumulate and evaluate relevant information and communicate such information to a registrant's management, including its principal executive and financial officers, as appropriate, to allow for timely decisions regarding required disclosures.

We evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2005, as required by Rule 13a-15 of the Exchange Act. This evaluation was carried out under the supervision and with the participation of our management, including our principal executive officer and principal financial officer. As described below, under "Management's Report on Internal Control Over Financial Reporting, material weaknesses were identified in our internal control over financial reporting as of December 31, 2005 relating to our control environment, revenue recognition, accounting for income taxes and accounting for business combinations. Based on the evaluation described above, our principal executive officer andprinc:palfinancial officer have concluded that, as offlecember 31, 2005, our disclosure controls andprocedures were not effective to ensure (1) that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms, and (2) information required to be disclosed by us in our reports that we file or submit

71


under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

* * *

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of our financial statements for external reporting purposes in accordance with GAAP.

Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.

A material weakness in internal control over financial reporting (as defined in Auditing Standard No. 2 of the Public Company Accounting Oversight Board) is a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. A significant deficiency is a control deficiency, or combination of control deficiencies, that adversely affects a company's ability to initiate, authorize, record, process or report external financial data reliably in accordance with GAAP such that there is more than a remote likelihood that a misstatement of the company's annual or interim financial statements that is more than inconsequential will not be prevented or detected.

Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2005, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO ) in Internal Control-Integrated Framework. In assessing the effectiveness of our internal control over financial reporting, management identified the following material weaknesses in internal control over financial reporting as of December 31, 2005:

Our control environment was not adequate because certain former members of senior management did not set a proper ethical tone within our organization and instill an attitude of control compliance. Certain former members of our management were directly involved in circumventing our accounting controls, and other form er members of our management were aware, or should have been aware, that such controls were being circumvented. This deficiency contributed to material misstatements in our

72


interim consolidatedfinancial statements as of andfor the interim periods ended, September 30, 2005, June 30, 2005 and March 31, 2005 and our annual consolidated financial statements as of and for the years ended, December 31, 2004, 2003 and 2002, as well as our consolidated financial statements for interim periods within those years.

2. We did not maintain effective policies and procedures relating to revenue recognition associated with our sales contracts. This lack of effective policies and procedures contributed to our premature recognition of revenue related to components of our software contracts that were undelivered as of a reporting date, for which we were unable to establish fair value, or to contracts for which collectibility was not reasonably assured. These deficiencies resulted in material misstatements in our interim consolidated financial statements as of andfor the interim periods ended, September 30, 2005, June 30, 2005 and March 31, 2005 and our annual consolidated financial statements as of; and for the years ended, December 31, 2004, 2003 and 2002, as well as our consolidatedfinancial statem ents for interim periods within those years.

3. We did not maintain effective policies andprocedures over the accounting for income taxes. Specifically, our policies and procedures did not provide for obtaining third party technical assistance in connection with our accounting for the income tax consequences of complex transactions. This deficiency resulted in material misstatements in our interim consolidated financial statements as of andfor the interim periods ended Septem ber 30, 2005 and June 30, 2005.

4. We did not maintain effective controls over the accounting for business combinations. Specifically, we did not have formal policies and procedures to provide for a sufficient analysis to identify all assets acquired in business combinations to appropriately allocate the purchase price. This deficiency resulted in material misstatements in our interim consolidated financial statements as of and for the interim periods ended, September 30, 2005 and June 30, 2005.

As a result of the material weaknesses described above, our management concluded that we did not maintain effective internal control over financial reporting as of December 31, 2005, based on the criteria established by CO SO.

We acquired Cedara Software Corp. during 2005. The acquired assets represented $57,422,000 of our total consolidated assets as of December 31, 2005 and $43,770,000 of our 2005 consolidated net sales. We did not conduct an assessment of the effectiveness of internal control over financial reporting associated with Cedara Software Corp., as permitted by the implementation guidance set forth by the SEC in June 2004 (and revised on October 6, 2004) to issuers relating to the SEC's final rules on internal control over financial reporting. (Emphasis in bold added.)

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209. Merge Technologies' false and misleading representations about its disclosure and

internal controls during the Class Period were then repeatedly certified by Defendants Linden and

Veech when they knew such certification was false and caused such certifications to be included in

Merge Technologies' Forms 10-K during Class Period: 7

2002 Form 10-KSB

I,. . . , certify that:

1. I have reviewed this annual report on Form 10-KSB of Merge Technologies Incorporated;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of and for, the periods presented in this annual report;

4. The Registrant's other certifying officer and I (herein, the "Certifying Officers ) are responsiblefor establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 1 3a- 14 and 1 5d- 14) for the Registrant and have:

a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries (collectively, the "Company ) is made known to the Certifying Officers by others within the Company, particularly during the period in which this annual report is being prepared;

b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date ); and

c) presented in this annual report the conclusions of the Certifying Officers about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date.

Defendants Linden and Veech signed similar false certifications that Merge Technologies included in its interim filings made with the SEC during the Class Period

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5. The Registrant's Certifying Officers have disclosed, based on the Certifying Officers' most recent evaluation, to the Registrant's auditors and the audit committee of the Registrant's board of directors:

a) all significant deficiencies, if any in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and

6. The Registrant's Certifying Officers have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. [Emphasis added.]

2003 Form 10-K


1. I have reviewed this annual report on Form 10—K of Merge Technologies Incorporated (the "Registrant );


3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;

4. The Registrant's other certifying officer and I (herein, the "Certifying Officers ) are responsiblefor establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13(a)-14 and 15(d)-14) for the Registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries (collectively, the "Company ), is made known to the Certifying Officers by others within the Company, particularly during the period in which this annual report is being prepared; and

b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date ); and

75


c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as the Evaluation Date; and

5. The Registrant's Certifying Officers have disclosed, based on the Certifying Officers' most recent evaluation, to the Registrant's auditors and the Audit Committee of the Registrant's Board of Directors:

a) all significant deficiencies in the design or operation of internal controls that would adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weakness in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and

6. The Certifying Officers have indicated in the annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. [Emphasis added.]

2004 Form 10-K


1. I have reviewed this annual report on Form 10—K of Merge Technologies Incorporated (the "Registrant );


3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;

4. The Registrant's other certifying officer and I (herein, the "Certifying Officers ) are responsiblefor establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries (collectively, the "Company ), is made known to the Certifying Officers

76


by others within the Company, particularly during the period in which this annual report is being prepared; and

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability offinancial reporting and the preparation offinancial statem ents for external purposes in accordance with generally accepted accounting principles; and

(c) Evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this annual report our conclusions about the effectiveness of the disclosure controls andprocedures, as of the end of the period covered by this annual report based on such evaluation; and

(d) Disclosed in this annual report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant's internal control over financial reporting; and

5. The Registrant's Certifying Officers have disclosed, based on the Certifying Officers' most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the Audit Committee of the Registrant's Board of Directors:

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant's ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. [Emphasis added.]

Additional Scienter Allegations

210. As set forth elsewhere throughout this Complaint, Defendants acted with scienter in

that they: knew or disregarded with severe recklessness that the public documents and statements,

issued or disseminated in the name of the Company, were materially false and misleading; knew that

such statements or documents would be issued or disseminated to the investing public; and

knowingly and substantially participated or acquiesced in the issuance or dissemination of such

statements or documents as primary violations of the federal securities laws. Defendants, by virtue

of their receipt of information reflecting the true facts regarding Merge Technologies, their control

77


over, and/or receipt and/or modification of Merge Technologies' materially misleading

misstatements and/or their associations with the Company which made them privy to confidential

proprietary information concerning Merge Technologies, participated in the fraudulent scheme

alleged herein.

211. Defendants knew and/or disregarded with severe recklessness the falsity and

misleading nature of the information that they caused to be disseminated to the investing public. The

ongoing fraudulent scheme described herein could not have been perpetrated over a substantial

period of time, as has occurred, without the knowledge and complicity of the personnel at the highest

level of the Company, including each of the Individual Defendants.

212. In fact, in the Restatement, the Company admitted Defendants' conscious

misbehavior and recklessness:

Certain former members of our management were directly involved in circumventing our accounting controls, and other former members of our management were aware of, or should have been aware, that such controls were being circumvented.

213. Lead Plaintiffs investigation confirmed the Company's conclusion that Defendants

acted with scienter.

214. For example, the fact that Defendants consciously misbehaved and were reckless is

demonstrated by the fact that, in order to recognize revenue improperly:

. Defendant Linden caused products to be shipped to customers before the customers entered into contracts. (CW2)

. Defendants Linden and Veech caused products not ordered by customers to be shipped in situations when the Company did not have the correct product in stock. (CW18, CW20, CW21)

. Defendant Linden caused products to be shipped to customers prior to the requested shipment date. (CW8)

. Defendants Linden and Veech caused used and damaged products to be shipped to customers when the customer ordered new products (CW10, CW15, CW20)

78


. Defendants Linden and Veech caused empty boxes to be shipped to customers. (CW1O, CW15)

Defendants Linden and Veech entered into "secret side agreements that were specifically designed to hide the fact that the underlying contract contained certain contingencies that would prohibit the immediate recognition of revenue; (CW2, CW4, CW1O, CW21)

. Defendants Linden, Veech and Noshay purposefully used incorrect terminology when describing products in sales contracts. (CW2)

. Defendants Linden and Veech required sales representatives to provide free products to customers but failed to account properly for the free products when recognizing revenue. (CW6)

. Defendants Linden and Veech caused the Company to recognize revenue equal to the full purchase price of software that did not meet the client's specifications. (CW2)

. Defendants Linden and Veech caused the Company to recognize revenue equal to the full purchase price of software prior to the software's implementation. (CW2)

. Defendants Linden and Veech required sales representatives to offer "deep discounts at the end of a quarter so that the Company could meet its projections. (CW4, CW6, CW8, CW19)

Defendants Linden and Veech were provided with spreadsheets indicating the proper amount of revenue that could be recognized but the amount of revenue that Defendants caused the Company to recognize did not correspond to amounts set forth on these spreadsheets. (CW3, CW1O, CW2O)

. Defendants threatened to terminate employees who failed to accede to Defendants' demands that they engage in activities designed to recognize revenue improperly. (CW2, CW1 5)

. Defendants Linden, Veech and Noshay all "resigned from the Company after the disclosure of their fraud.

215. In addition, Defendants' conscious misbehavior and recklessness is further evidenced

by the fact that Defendants made revenue and earnings projections that they knew could not be met,

as demonstrated by the following:

. Defendants Linden, Veech and Noshay all knew that the Company's sales had slowed dramatically. (CW5, CW19, CW14)

79


Defendants Linden, Veech and Noshay regularly reviewed information concerning the Company's current and future sales prospects by accessing the Company's sales database and participating in sales meeting and conference calls. (CW2, CW5, CW7, CW9, CW15, CW16, CW18, CW19)

S

Defendant Linden or Defendant Veech signed every sales contract entered into by the Company. (CW2)

S

Defendants Linden and Veech did not take the true future prospects of the Company when setting forecasts and issuing guidance. (CW2, CW20)

216. Moreover, Defendants were highly motivated to have Merge Technologies' common

shares trading at as high of a price as possible in order to maximize the capital raised through the

Company's private placements.

217. Toward that end, on July 8, 2003, Defendants announced that Company was able to

raise $8 million in cash from the sale of 667,000 shares of its common stock at the artificially

inflated price of $12 per share.

218. Defendants also were able to use the Company's artificially inflated stock price to

finance the merger with Cedara.

219. Specifically, on January 18, 2005, Defendants announced that the Company had

entered into definitive merger agreement with Cedara in an all stock transaction. Based upon the

Company's stock price, the merger, which closed on June 1, 2005, was valued at $393 million.

220. Additionally, prior to the belated disclosure of Merge Technologies' true operating

results and future prospects, the Individual Defendants sold their personally-held Merge

Technologies common stock to the unsuspecting public, reaping illicit proceeds of $5,199,451.

221. Defendants' insider sales were unusual and suspicious in timing and amount for the

following reasons, among others:

(a) as set forth in the chart below, Defendants Linden, Veech and Noshay sold

42%, 81% and 75%, respectively, of the Merge Technologies shares they directly owned during the

Class Period;

Last Name First Name LINDEN RICHARD

Date 5/13/2002 5/14/2002 5/15/2002 5/23/2003

6/7/2004 6/7/2004 6/7/2004 6/7/2004 6/8/2004

6/14/2004 6/16/2004 6/17/2004 11/1/2004 11/1/2004 11/1/2004 11/2/2004 11/2/2004

11/16/2005

VEECH SCOTT 5/22/2003 5/23/2003 11/1/2004 11/1/2004 11/1/2004 11/1/2004 11/2/2004

11/16/2005 11/17/2005 11/18/2005 11/18/2005 11/18/2005 11/18/2005


(b) no shares of Merge Technologies common stock were sold by any of these

Defendants at any time prior to the start of the Class Period; and

(c) in each instance, the timing of the Defendants' sales shortly followed a bullish

announcement by Defendants concerning the Company's current financial results and/or future

earnings prospects.

% Sold Shares Price Proceeds

4,000 $7.20 $28,800

29,000 $7.31 $211,990

17,000 $7.82 $132,940

25,000 $10.90 $272,500

4,000 $16.30 $65,200

2,000 $16.37 $32,740

500 $16.35 $8,175

500 $16.37 $8,185

1,500 $16.28 $24,420

6,500 $16.25 $105,625

500 $16.25 $8,125

1,000 $16.25 $16,250

11,250 $19.00 $213,750

5,000 $19.03 $95,150

2,000 $19.02 $38,040

8,500 $19.33 $164,305

6,750 $19.22 $129,735

30,000 $26.35 $790,500

155,000 $2,346,430

5,000 $10.24 $51,200

5,000 $10.95 $54,750

8,750 $19.00 $166,250

5,000 $19.03 $95,150

2,500 $19.00 $47,500

2,000 $19.02 $38,040

6,750 $19.22 $129,735

10,500 $26.50 $278,250

10,000 $26.65 $266,500

10,000 $26.65 $266,500

7,000 $26.80 $187,600

6,500 $26.95 $175,175

6,000 $26.92 $161,520

85,000 $1,918,170

42.25%

80.95%

81


Last Name First Name NOSHAY DAVID

Date 5/7/2002

12/4/2002 12/4/2002 12/4/2002 5/2/2003 5/2/2003 5/2/2003

9/15/2003 9/15/2003

11/10/2005

Shares Price Proceeds

8,500 $6.30 $53,550

3,830 $7.34 $28,112

3,600 $7.47 $26,892

1,000 $7.52 $7,520

20,000 $8.38 $167,600

15,000 $8.24 $123,600

1,945 $8.41 $16,357

10,000 $16.75 $167,500

3,846 $16.60 $63,844

10,806 $25.90 $279,875

78,527 $934,851

% Sold

75.31%

Total:

318,527 $5,199,451

222

Similarly, prior to the belated disclosure of Merge Technologies' true operating

results and future prospects, the Company's directors, officers and insiders (other than the Individual

Defendants) sold their personally-held Merge Technologies common stock to the unsuspecting

public, reaping illicit proceeds of $18,987,487. Each of these insiders' sales was unusual and

suspicious in timing and amount for the following reasons, among others:

(a) as set forth in the chart below, the Company's directors, officers and insiders

(other than the Individual Defendants) sold between 12% and 100% of the Merge Technologies

shares they directly owned during the Class Period;

(b) as a group, these individuals sold just $5,000 of Merge Technologies common

stock prior to the Class Period; and

(c) in each instance, the timing of the insiders' sales shortly followed a bullish

announcement by Defendants concerning the Company's current financial results and/or future

earnings prospects.

82

Last Name BARISH

First Name ROBERT

Date 11/7/2005 11/7/2005 11/7/2005 11/7/2005 11/7/2005 11/7/2005 11/7/2005

11/11/2005 11/11/2005 11/11/2005 11/29/2005 11/29/2005 11/29/2005 11/29/2005 11/29/2005 11/29/2005 11/29/2005 11/29/2005 11/29/2005 11/29/2005

12/2/2005

PATRICE 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003

8/11/2003 9/19/2003 9/19/2003 9/19/2003

•1I1 I i h


% Sold Shares Price Proceeds

3,600 $23.96 $86,256

1,090 $23.84 $25,986

600 $23.93 $14,358

400 $23.89 $9,556

400 $23.86 $9,544

200 $23.87 $4,774

110 $23.88 $2,627

2,600 $26.11 $67,886

2,300 $26.12 $60,076

100 $26.12 $2,612

7,500 $27.86 $208,950

2,500 $27.78 $69,450

2,000 $27.97 $55,940

1,219 $28.12 $34,278

902 $28.15 $25,391

279 $28.00 $7,812

200 $28.05 $5,610

200 $28.10 $5,620

100 $28.01 $2,801

100 $28.11 $2,811 35,000 $29.60 $1,036,000

61,400 $1,738,338

26,770 $13.05 $349,349

15,250 $13.02 $198,555

7,800 $13.04 $101,712

6,530 $13.05 $85,217

2,800 $13.08 $36,624

2,700 $13.15 $35,505

2,500 $13.20 $33,000

1,200 $13.07 $15,684

600 $13.18 $7,908

400 $13.03 $5,212

100 $13.18 $1,318

72,939 $13.00 $948,207

15,900 $18.50 $294,150

1,222 $18.51 $22,619

104 $18.50 $1,924

156,815 $2,136,983

49.44%

48.58%

COOPER PETER 6/20/2005 4,240 $19.62 $83,189 6/20/2005 2,500 $19.64 $49,100 6/20/2005 2,500 $19.67 $49,175 6/20/2005 2,500 $19.68 $49,200

11,740 $230,664 100.00%

83


Date 8/8/2003 8/8/2003 8/8/2003 8/8/2003 8/8/2003

8/11/2003 8/11/2003 8/11/2003 8/11/2003 8/11/2003 8/11/2003

9/18/2003 9/18/2003 9/18/2003 9/19/2003 9/19/2003 9/19/2003 9/19/2003 9/19/2003

10/31/2005 10/31/2005

11/3/2005 11/8/2005 11/8/2005 11/8/2005 11/8/2005 11/8/2005 11/8/2005 11/8/2005 11/8/2005


50,020 $13.00 $650,260

8,480 $13.00 $110,240

5,200 $13.01 $67,652

2,750 $13.02 $35,805

200 $12.97 $2,594

63,861 $13.00 $830,193

3,100 $13.03 $40,393

2,700 $13.01 $35,127

2,600 $13.02 $33,852

500 $13.04 $6,520

179 $13.05 $2,336 139,590 $1,814,972

36,000 $19.07 $686,520

30,000 $19.02 $570,600

5,000 $19.05 $95,250

19,000 $18.87 $358,530

3,000 $18.70 $56,100

3,000 $18.71 $56,130

3,000 $18.72 $56,160

1,000 $19.07 $19,070

36,100 $21.83 $788,063

13,900 $21.82 $303,298

25,424 $24.00 $610,176

7,500 $24.00 $180,000

5,000 $24.18 $120,900

5,000 $24.18 $120,900

5,000 $24.18 $120,900

5,000 $24.14 $120,700

5,000 $24.09 $120,450

5,000 $24.08 $120,400

5,000 $24.01 $120,050

Last Name

First Name COUCH

GREGORY % Sold

89.02%

GERAS

ROBERT

DOAN

GENTILE

COLLEEN

JOSEPH

9/24/2002 13,248 $4.12 $54,582

9/25/2002 25,400 $3.82 $97,028

10/22/2002 10,000 $4.49 $44,900

10/23/2002 20,000 $4.39 $87,800

10/24/2002 10,323 $4.31 $44,492

78,971 $328,802

5/20/2002 1,522 $8.99 $13,683

12/9/2002 667 $7.01 $4,676

12/9/2002 100 $7.00 $700

5/6/2003 4,750 $8.01 $38,048

5/6/2003 250 $8.20 $2,050

7,289 $59,156

79.16%

89.46%

84


HAJEK

IIALAMKA JOHN

Date 11/8/2005 11/8/2005 11/9/2005 11/9/2005 11/9/2005 11/9/2005 11/9/2005 11/9/2005

12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005 12/21/2005

6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003

Shares 5,000 2,500 5,000 5,000 5,000 5,000 2,500 1,500 3,871 3,200 2,300 1,800 1,700 1,400 1,300 1,129 1,000 1,000

900 900 300 200 200 100

270,724

1,900 1,900 1,700 1,000

700 700 534 500 400 400 400 300 300 200

Price $24.00 $24.27 $24.39 $24.39 $24.39 $24.36 $24.36 $24.38 $25.87 $25.83 $25.88 $25.84 $25.86 $25.91 $25.80 $25.89 $25.81 $25.98 $25.90 $25.99 $25.92 $25.95 $25.96 $25.85

$13.80 $13.86 $13.81 $13.43 $13.60 $13.85 $13.93 $13.84 $13.44 $13.86 $13.92 $13.51 $13.83 $13.28

Proceeds $120,000

$60,675 $121,950 $121,950 $121,950 $121,800

$60,900 $36,570

$100,143 $82,656 $59,524 $46,512 $43,962 $36,274 $33,540 $29,230 $25,810 $25,980 $23,310 $23,391

$7,776 $5,190 $5,192 $2,585

$5,941,067

$26,220 $26,334 $23,477 $13,430

$9,520 $9,695 $7,439 $6,920 $5,376 $5,544 $5,568 $4,053 $4,149 $2,656

Last Name

First Name % Sold

37.24%

ANNA 11/1/2004 2,000 $18.98 $37,960 11/1/2004 1,500 $18.97 $28,455 11/1/2004 500 $18.96 $9,480 11/4/2005 1,000 $24.05 $24,050

5,000 $99,945 42.04%

85


% Sold Date 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003 6/26/2003

8/1/2003 8/4/2003 8/8/2003 8/8/2003

8/12/2003 8/20/2003 8/20/2003 8/20/2003 8/20/2003 8/20/2003

11/14/2002 11/14/2002 11/14/2002 11/14/2002 11/14/2002 11/14/2002 11/14/2002 11/18/2002 11/18/2002 11/18/2002 11/18/2002 11/18/2002 11/18/2002 11/18/2002 11/18/2002 11/18/2002 11/18/2002


200 $13.38 $2,676

200 $13.44 $2,688

200 $13.70 $2,740

200 $13.84 $2,768

200 $13.85 $2,770

100 $13.25 $1,325

100 $13.26 $1,326

100 $13.39 $1,339

100 $13.40 $1,340

100 $13.41 $1,341

100 $13.46 $1,346

100 $13.62 $1,362

100 $13.64 $1,364

100 $13.81 $1,381

100 $13.83 $1,383

12,934 $177,530

1,000 $14.75 $14,750

2,900 $15.03 $43,587

2,000 $13.02 $26,040

1,900 $13.01 $24,719

10,000 $13.00 $130,000

9,800 $15.61 $152,978

9,293 $15.60 $144,971

4,500 $15.62 $70,290

1,000 $15.63 $15,630

407 $15.64 $6,365

42,800 $629,330

4,700 $6.10 $28,670

2,000 $6.11 $12,220

1,500 $6.06 $9,090

1,400 $6.07 $8,498

900 $6.05 $5,445

900 $6.08 $5,472

600 $6.30 $3,780

3,200 $6.35 $20,320

2,000 $6.38 $12,760

2,000 $6.40 $12,800

2,000 $6.42 $12,840

2,000 $6.50 $13,000

2,000 $6.75 $13,500

1,900 $6.25 $11,875

1,073 $7.02 $7,532

800 $6.36 $5,088

100 $6.20 $620

Last Name First Name

MCCALLUM CATHERINE

MORTIMORE WILLIAM

100.00%

32.57%

['74


Last Name First Name Date 12/12/2002 9/17/2003 9/17/2003 9/17/2003 9/17/2003 9/17/2003 9/17/2003 9/18/2003 9/18/2003 9/18/2003 9/18/2003 9/18/2003 9/18/2003


3,565 $6.47 $23,066

1,900 $16.50 $31,350

1,000 $16.45 $16,450

900 $16.55 $14,895

800 $16.51 $13,208

300 $16.53 $4,959

100 $16.86 $1,686

2,000 $18.00 $36,000

1,000 $17.80 $17,800

800 $18.06 $14,448

800 $17.59 $14,072

200 $18.08 $3,616

200 $17.82 $3,564 42,638 $378,624

% Sold

12.06%

SEIDELMANN FRANK

8/10/2005 10,000 $19.21 $192,100

8/10/2005 10,000 $19.14 $191,400

8/10/2005 1,000 $19.25 $19,250

8/11/2005 3,000 $19.09 $57,270

8/11/2005 2,000 $19.25 $38,500

26,000 $498,520

8/25/2004 5,000 $14.81 $74,050

8/25/2004 4,000 $14.77 $59,080

8/25/2004 3,000 $14.88 $44,640

8/25/2004 2,500 $14.91 $37,275

8/25/2004 2,500 $14.92 $37,300

8/25/2004 2,000 $14.82 $29,640

8/25/2004 1,000 $14.81 $14,810

8/3/2005 15,000 $19.00 $285,000

8/3/2005 5,000 $19.38 $96,900

8/4/2005 5,000 $19.38 $96,900

8/4/2005 5,000 $19.43 $97,150

8/5/2005 10,000 $19.30 $193,000

8/8/2005 5,000 $19.09 $95,450

8/8/2005 5,000 $19.07 $95,350

8/9/2005 5,000 $19.10 $95,500

8/9/2005 5,000 $19.20 $96,000

8/9/2005 5,000 $19.30 $96,500

8/10/2005 4,867 $19.24 $93,641

8/10/2005 4,000 $19.27 $77,080

93,867 $1,715,266

9/1/2004 7,728 $15.53 $120,016

9/1/2004 4,600 $15.54 $71,484

9/1/2004 3,000 $15.59 $46,770

PEDLAR

BRIAN

QUIGG

DANIEL

100.00%

90.37%

87


Last Name First Name % Sold Date 9/1/2004 9/1/2004 9/1/2004 9/1/2004 9/1/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/7/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004 9/8/2004

Shares 3,000 2,200 2,000 2,000

472 1,403

900 700 500 400 400 397 300 300 200 200 200 200 200 200 200 200 200 200 200 100 100 100 100 73 27

500 500 500 500 500 400 400 350 300 300 268 264 200 200 200

Price $15.70 $15.56 $15.57 $15.60 $15.58 $15.55 $15.54 $15.81 $15.81 $15.56 $15.54 $15.57 $15.80 $15.61 $15.71 $15.70 $15.64 $15.63 $15.63 $15.62 $15.58 $15.57 $15.56 $15.56 $15.52 $15.65 $15.64 $15.53 $15.50 $15.46 $15.58 $16.14 $16.12 $15.75 $15.69 $15.66 $16.15 $15.76 $15.75 $15.61 $15.72 $15.76 $16.00 $16.09 $16.03 $16.00

Proceeds $47,100 $34,232 $31,140 $31,200

$7,354 $21,817 $13,986 $11,067

$7,905 $6,224 $6,216 $6,181 $4,740 $4,683 $3,142 $3,140 $3,128 $3,126 $3,126 $3,124 $3,116 $3,114 $3,112 $3,112 $3,104 $1,565 $1,564 $1,553 $1,550 $1,129

$421 $8,070 $8,060 $7,875 $7,845 $7,830 $6,460 $6,304 $5,513 $4,683 $4,716 $4,224 $4,224 $3,218 $3,206 $3,200

['I,'



Shares 200 200 200 200 200 192 168 132 132 100 100 100 100 100 100 100 100 68 36 32 32 26

4,000 4,000 2,833 2,400 2,200 2,017 1,707 1,500 1,300 1,100 1,100 1,000

964 900 826 800 800 600 600 540 500 500 300 300

Price $15.83 $15.82 $15.80 $15.78 $15.62 $15.77 $15.79 $16.08 $15.81 $16.14 $16.07 $16.06 $16.04 $15.98 $15.74 $15.68 $15.63 $15.97 $15.99 $15.84 $15.64 $15.60 $18.20 $18.58 $18.27 $18.21 $18.25 $18.56 $18.45 $18.26 $18.30 $18.33 $18.46 $18.25 $18.28 $18.54 $18.57 $18.34 $18.53 $18.26 $18.27 $18.50 $18.21 $18.44 $18.27 $18.28

Proceeds $3,166 $3,164 $3,160 $3,156 $3,124 $3,028 $2,653 $2,123 $2,087 $1,614 $1,607 $1,606 $1,604 $1,598 $1,574 $1,568 $1,563 $1,086

$576 $507 $500 $406

$72,800 $74,320 $51,759 $43,704 $40,150 $37,436 $31,494 $27,390 $23,790 $20,163 $20,306 $18,250 $17,622 $16,686 $15,339 $14,672 $14,824 $10,956 $10,962

$9,990 $9,105 $9,220 $5,481 $5,484



Shares 300 269 241 241 200 200 200 169 100 100 100 100 75 51 45 37

13,716 3,900 3,198 2,898 2,802 2,665 2,664 2,600 2,539 2,336 2,335 2,100 1,800 1,200 1,066 1,066

934 934 900 400 200 200 200 100 100

2,685 2,628 2,611 2,580 2,561

Price $18.47 $18.48 $18.25 $18.26 $18.29 $18.22 $18.51 $18.28 $18.15 $18.16 $18.20 $18.42 $18.36 $18.19 $18.55 $18.12 $18.40 $19.45 $19.09 $19.30 $19.09 $19.10 $19.06 $19.38 $19.30 $19.06 $19.10 $19.27 $19.26 $19.28 $19.28 $19.16 $19.29 $19.16 $19.30 $19.39 $19.48 $19.46 $19.34 $19.47 $19.31 $19.27 $19.26 $19.28 $19.30 $19.25

Proceeds $5,541 $4,971 $4,398 $4,401 $3,658 $3,644 $3,702 $3,089 $1,815 $1,816 $1,820 $1,842 $1,377

$928 $835 $670

$252,374 $75,855 $61,050 $55,931 $53,490 $50,902 $50,776 $50,388 $49,003 $44,524 $44,599 $40,467 $34,668 $23,136 $20,552 $20,425 $18,017 $17,895 $17,370

$7,756 $3,896 $3,892 $3,868 $1,947 $1,931

$51,740 $50,615 $50,340 $49,794 $49,299


Last Name First Name % Sold Date 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005 8/5/2005

8/23/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005 8/24/2005

Shares 2,120 1,788 1,512 1,300 1,100

700 200 200 200 200 161 139 100 100 100 100

12,262 1,066

934 746 654 640 560 533 467 382 373 334 327 213 187 141 123 107 107

93 93 53 53 53 53 47 47 47 47

172,895

Price $19.29 $19.20 $19.21 $19.24 $19.22 $19.23 $19.05 $19.10 $19.19 $19.31 $19.12 $19.13 $19.07 $19.15 $19.17 $19.18 $19.31 $19.31 $19.31 $19.23 $19.23 $19.23 $19.23 $19.29 $19.29 $19.22 $19.27 $19.22 $19.27 $19.28 $19.28 $19.21 $19.21 $19.30 $19.26 $19.30 $19.26 $19.32 $19.28 $19.24 $19.21 $19.32 $19.28 $19.24 $19.21

Proceeds $40,895 $34,330 $29,046 $25,012 $21,142 $13,461

$3,810 $3,820 $3,838 $3,862 $3,078 $2,659 $1,907 $1,915 $1,917 $1,918

$236,779 $20,584 $18,036 $14,346 $12,576 $12,307 $10,769 $10,282

$9,008 $7,342 $7,188 $6,419 $6,301 $4,107 $3,605 $2,709 $2,363 $2,065 $2,061 $1,795 $1,791 $1,024 $1,022 $1,020 $1,018

$908 $906 $904 $903

$3,136,793 78.93%


Last Name First Name Date Shares Price Proceeds % Sold

STAFFORD WILLIAM 8/21/2002 14,700 $4.73 $69,531 8/21/2002 2,700 $4.90 $13,230 8/22/2002 3,725 $5.03 $18,737

21,125 $101,498 19.31%

Total: 1,143,788 $18,987,487

Transaction and Loss Causation

223. The material misrepresentations and omissions particularized in this Complaint

directly or proximately caused or were a substantial contributing cause of the damages sustained by

Plaintiff and other members of the Class.

224. During the Class Period, Defendants engaged in the fraudulent scheme described

herein and made or caused to be made a series of materially false or misleading statements about

Merge Technologies' business, prospects and operations. Specifically, Defendants misrepresented

the Company's business, prospects, financial results and operations by, among other things,

improperly recognizing revenue by: (i) shipping products to customers before the customers entered

into contracts; (ii) shipping products not ordered by customers in situations when the Company did

not have the correct product in stock; (iii) shipping products to customers prior to the customer's

requested shipment date; (iv) shipping used and damaged products to customers when the customer

ordered new products; (v) shipping empty boxes to customers; (vi) entering into "secret side

agreements that were specifically designed to hide the fact that the underlying contract contained

certain contingencies that would prohibit the immediate recognition of revenue; (vii) purposefully

using incorrect terminology when describing products in sales contracts; (viii) requiring sales

representatives to provide free products to customers without accounting for those products; (ix)

recognizing revenue equal to the full purchase price of software that did not meet the client's

specifications; (x) recognizing revenue equal to the full purchase price of software prior to the

ZIN


software's implementation; (xi) requiring sales representatives to offer "deep discounts at the end of

a quarter so that the Company could meet its projections; (xii) ignoring documentation that indicated

the proper amount of revenue to recognize; and (xiii) threatening to terminate any employees who

dared to question them.

225. Defendants' scheme, including the material misstatements and omissions, had the

cause and effect of creating in the market an unrealistically positive assessment of Merge

Technologies and its business, prospects and operations, thus causing the Company's securities to be

overvalued and artificially inflated during the Class Period. Defendants' scheme, including the

materially false and misleading statements during the Class Period, resulted in Plaintiff and other

members of the Class purchasing the Company's securities at artificially inflated prices.

226. Defendants' fraudulent conduct caused the damages complained of herein when

Merge Technologies stock price subsequently declined each time the Company revealed additional

information concerning its true business, prospects and operations.

227. For example, Merge Technologies stock price declined 16% on February 24, 2006,

when the Company announced that it would delay the issuance of its fourth quarter results in order to

allow additional time to complete the audit of the Company's financial statements. Defendant

Linden blamed this delay on the "complexities associated with accounting for sales transactions.

228. Thereafter, on the day of Company's March 17, 2006, disclosure that it delayed filing

its Form 10-K as a result of, among other things, revenue recognition issues that resulted in a

determination that its previously issued financial statements for the quarters ended June 30, 2005 and

September 30, 2005 should no longer be relied upon, the Company's stock price declined an

additional 12%.

229. Merge Technologies stock price dropped by another 41% on the day of the

Company's July 3, 2006, disclosure that it would be required to restate its financial results for the


fiscal years from 2002 through 2005 as a result of, among other things, improper revenue recognition

practices at the Company.

230. As a result of these revelations, and the corresponding drop in the price of Merge

Technologies stock, investors suffered real economic loss.

231. Further, the timing and magnitude of Merge Technologies stock price declines

negates any inference that the loss suffered by Lead Plaintiff and other Class members was caused

by changed market conditions, microeconomic or industry factors or Company-specific facts

unrelated to the Defendants' fraudulent conduct. The economic loss, i.e., damages, suffered by Lead

Plaintiff and other members of the Class was a direct result of Defendants' fraudulent scheme to

artificially inflate Merge Technologies stock price and the subsequent significant decline in the value

of Merge Technologies stock when the true state of the Company's operations and finances were

revealed to the market and investors.

Applicability of Presumption of Reliance: Fraud on the Market Doctrine

232. At all relevant times, the market for Merge Technologies' publicly traded securities

was an efficient market for the following reasons, among others:

(a) Merge Technologies' stock met the requirements for listing and was listed and

actively traded on the NASDAQ, a highly efficient and automated market;

(b) as a regulated issuer, Merge Technologies filed periodic public reports with

the SEC, including reports on Form S-3;

(c) Merge Technologies 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) Merge Technologies was followed by several securities analysts and

employed by major brokerage firms who wrote reports that 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.

233. As a result, the market for Merge Technologies' publicly traded securities promptly

digested current information regarding Merge Technologies from all publicly-available sources and

reflected such information in Merge Technologies' stock price. Under these circumstances, all

purchasers of Merge Technologies' publicly traded securities during the Class Period suffered

similar injury through their purchase of Merge Technologies' publicly traded securities at artificially

inflated prices, and suffered damages when the artificial inflation was removed from Merge

Technologies' stock as the truth was revealed, and a presumption of reliance applies.

No Safe Harbor

234. The federal statutory safe harbor provided for forward-looking statements under

certain circumstances does not apply to any of the false statements pleaded in this Complaint.

Further, many of the 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.

235. Alternatively, to the extent that the statutory safe harbor might 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 Merge Technologies who knew that those

statements were false when made. Moreover, to the extent that Defendants issued any disclosures

IZR


designed to "warn or "caution investors of certain "risks, those disclosures were also false and

misleading because they did not disclose that Defendants were actually engaging in the very actions

about which they purportedly warned and/or had actual knowledge of material adverse facts

undermining such disclosures.

236. In addition, to the extent that Defendants issued any disclosures designed to "warn

or "caution investors of certain "risks, those disclosures remained fixed even as the risks they

purported to warn of changed. Defendants left both their forecasts and cautions as is throughout the

Class Period.

Class Action Allegations

237. Plaintiff brings this action as a class action pursuant to Federal Rules of Civil

Procedure 23(a) and 23(b)(3) on behalf of itself and the Class of all purchasers of the publicly traded

securities of Merge Technologies between April 25, 2002 and July 3, 2006, inclusive, who were

damaged thereby. Excluded from the Class are Defendants, the officers and directors of the

Company, members of the immediate family of each of the Defendants and other related non-parties,

any person, firm, trust, corporation, officer, director or other individual or entity in which any

Defendant or other related non-party has a controlling interest or which is related to or affiliated with

any of the Defendants or other related non-parties, and the legal representatives, agents, affiliates,

heirs, successors-in-interest or assigns of any such excluded party or other related non-party.

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

impracticable. Throughout the Class Period, Merge Technologies securities were actively traded on

the NASDAQ. While the precise number of Class members is unknown to Plaintiff at this time and

can only be ascertained through appropriate discovery (i.e., the books and records of Merge

Technologies or its transfer agent), Plaintiff believes that there are thousands of members of the

proposed Class. Notice can be provided to such record owners by a combination of published notice


and first-class mail, using techniques and a form of notice similar to those customarily used in class

actions arising under the federal securities laws.

239. Plaintiff will fairly and adequately represent and protect the interests of the members

of the Class and have retained competent counsel experienced in class action litigation under the

federal securities laws to further ensure such protection and intends to prosecute this action

vigorously.

240. Plaintiffs claims are typical of the claims of the other members of the Class because

Plaintiffs and all Class members' damages arise from and were caused by the same false and

misleading representations and omissions made by or chargeable to Defendants. Plaintiff does not

have any interests antagonistic to, or in conflict with, the Class.

241. A class action is superior to other available methods for the fair and efficient

adjudication of this controversy, as joinder of all members is impracticable. Furthermore, because

the damages suffered by individual Class members may be relatively small, the expense and burden

of individual litigation make it virtually impossible for the Class members to seek redress for the

wrongful conduct alleged. Plaintiff knows of no difficulty that will be encountered in the

management of this litigation that would preclude its maintenance as a class action.

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

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

law and fact common to the Class are:

(a) whether the federal securities laws were violated by Defendants' acts and/or

omissions as alleged herein;

(b) whether the Company's Class Period public statements and filings during the

Class Period misrepresented and/or omitted material facts;


(c) whether Defendants acted with knowledge or with reckless disregard for the

truth in misrepresenting and/or omitting material facts;

(d) whether Defendants participated in and pursued the common course of

conduct complained of herein;

(e) whether the market price of Merge Technologies' securities was inflated

artificially as a result of Defendants' material misrepresentations and/or omissions during the Class

Period complained of herein; and

(f) whether the members of the Class have sustained damages as a result of the

decline in value of Merge Technologies' stock when the truth was revealed and the artificial inflation

came out and, if so, what is the appropriate measure of damages.

COUNT I

For Violations of Section 10(b) of the Exchange Act and Rule 10(b)(5) Promulgated Thereunder Against Merge Technologies and the Individual Defendants

243. Plaintiff repeats and realleges the allegations set forth as though fully set forth herein.

244 During the Class Period, Defendants disseminated or approved the false statements

specified above, which they knew or deliberately disregarded were misleading in that they contained

misrepresentations and failed to disclose material facts necessary in order to make the statements

made, in light of the circumstances under which they were made, not misleading.

245. Defendants violated Section 10(b) of the Exchange Act and Rule lOb-S in that they:

(a) Employed devices, schemes, and artifices to defraud;

(b) Made untrue statements of material facts or omitted to state material facts

necessary in order to make the statements made, in light of the circumstances under which they were

made, not misleading; or


(c) Engaged in acts, practices, and a course of business that operated as a fraud or

deceit upon Plaintiff and others similarly situated in connection with their purchases of Merge

Technologies' publicly traded securities during the Class Period.

246. Plaintiff and the Class have suffered damages in that, in reliance on the integrity of

the market, they paid artificially inflated prices for Merge Technologies securities. Plaintiff and the

Class would not have purchased Merge Technologies securities at the prices they paid, or at all, if

they had been aware that the market prices had been artificially and falsely inflated by Defendants'

misleading statements.

247. As a direct and proximate result of these Defendants' wrongful conduct, Plaintiff and

the other members of the Class suffered damages in connection with their purchases of Merge

Technologies securities during the Class Period.

COUNT II

For Violations of Section 20(a) of the 1934 Act Against the Individual Defendants

248 Plaintiff repeats and realleges each and every allegation contained above as if alleged

in full herein.

249 The Individual Defendants acted as controlling persons of Merge Technologies within

the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their high-level

positions, and their ownership and contractual rights, participation in and/or awareness of the

Company's operations and/or intimate knowledge of the false financial statements filed by the

Company with the SEC and disseminated to the investing public, the Individual Defendants had the

power to influence and control and did influence and control, directly or indirectly, the decision-

making of the Company, including the content and dissemination of the various statements which

plaintiff contends are false and misleading. The Individual Defendants were provided with or had

unlimited access to copies of the Company's reports, press releases, public filings and other


statements alleged by plaintiff 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.

250. In particular, each of these defendants had direct and supervisory involvement in the

day-to-day operations of the Company and, therefore, is presumed to have had the power to control

or influence the particular transactions giving rise to the securities violations as alleged herein, and

exercised the same.

251. As set forth above, Merge Technologies and the Individual Defendants each violated

Section 10(b) and Rule 1 Ob-5 by their acts and omissions as alleged in this Complaint. By virtue of

their positions as controlling persons, the Individual Defendants are liable pursuant to Section 20(a)

of the Exchange Act. Plaintiffs and the members of the Class have been damaged by the decline in

Merge Technologies stock price near and at the end of the Class Period, which was a direct and

proximate result of the nature and extent of Defendants' prior misstatements and fraudulent conduct

finally being revealed to investors and the market.

COUNT III

For Violations of Section 10(b) of the Exchange Act and Rule 10b-5 Promulgated Thereunder Against KPMG

252. Plaintiff repeats and realleges each and every allegation contained above as if alleged

in full herein.

253. Defendant KPMG is a worldwide firm of Certified Public Accountants, auditors and

consultants. Through its Chicago office, KPMG served as Merge Technologies' auditor since at

least 1995.8

Merge Technologies went public in 1997. Accordingly, the earliest publicly issued KPMG audit opinion is on Merge Technologies' 1995 financial statements.

100


Defendant KPMG's Participation in the Fraud

254. KPMG has served Merge Technologies it in various capacities for many years.

Certain of the services rendered by KPMG to Merge Technologies included: the "audit of its annual

financial statements and the review of its interim financial statements; the review of filings made

with the SEC; an internal control "audit ; tax compliance and consulting; and registration statement

related services and consents.

255. Given its intimate knowledge of Merge Technologies' financial reporting practices

and the nature of the auditing and other services rendered to Merge Technologies, the allegations

herein demonstrate strong circumstantial evidence of conscious misbehavior or recklessness by

KPMG's personnel in the performance of its "audits of Merge Technologies' financial statements

during the Class Period.

KPMG's Materially False and Misleading Statements During the Class Period

256. As detailed below, KPMG knew or recklessly ignored that it falsely represented that

Merge Technologies' annual financial statements for at least the years ended 2002 through to 2004

were presented in conformity with GAAP. In addition, KPMG knew or recklessly ignored that it

falsely represented that its audits of such financial statements had been performed in accordance

with Generally Accepted Auditing Standards ("GAAS ) and the standards of the Public Company

Accounting Oversight Board ("PCAOB )9

The PCAOB is a private-sector corporation created by Sarbanes-Oxley to oversee the auditors of public companies. Section 103 of Sarbanes-Oxley directs the PCAOB to establish auditing, quality control, ethics, and independence standards and rules to be used by registered public accounting firms in the preparation and issuance of audit reports.

101


257. KPMG issued the following false and misleading unqualified audit report, dated

March 28, 2003, on Merge Technologies' financial statements for the year ended December 31,

2002: 'o

The Board of Directors and Shareholders Merge Technologies Incorporated:

We have audited the accompanying consolidated balance sheets of Merge Technologies Incorporated and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, shareholders' equity, cash flows, and comprehensive income (loss) for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States ofAmerica. 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 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 Merge Technologies Incorporated and subsidiaries as ofDecember 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States ofAmerica.

As discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards Board No. 142, Goodwill and Other Intangible Assets, on January 1, 2002. [Emphasis added.]

258. KPMG issued the following false and misleading unqualified audit report dated,

February 18, 2004, on Merge Technologies' financial statements for the years ended December 31,

2003 and 2002:

10 KPMG's false and misleading audit reports on Merge Technologies' 2002, 2003 and 2004 year-end financial statements and its 2004 report on Merge Technologies' internal controls were included in the Company's filings with the SEC during the Class Period.

102


The Board of Directors and Shareholders Merge Technologies Incorporated:

We have audited the accompanying consolidated balance sheets of Merge Technologies Incorporated and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders' equity, cash flows, and comprehensive income for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States ofAmerica. 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 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 Merge Technologies Incorporated and subsidiaries as ofDecember 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States ofAmerica.

As discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards Board No. 142, Goodwill and Other Intangible Assets, on January 1, 2002. [Emphasis added.]

259. KPMG issued the following false and misleading unqualified audit report, dated

March 4, 2005, on Merge Technologies' financial statements for the years ended December 31,

2004, 2003 and 2002:

The Board of Directors and Stockholders Merge Technologies Incorporated:

We have audited the accompanying consolidated balance sheets of Merge Technologies Incorporated and subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders' equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards ofthe Public Company Accounting Oversight Board (United States) . Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial

103


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 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 Merge Technologies Incorporated and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Merge Technologies Incorporated's internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 4, 2005 expressed an unqualified opinion on management's assessment of; and the effective operation of internal control over financial reporting. [Emphasis added.]

260. Additionally, KPMG issued the following false and misleading report, dated March 4,

2005, on Merge Technologies' system of internal control over its financial reporting: 11


We have audited management's assessment, included in the accompanying report on internal control over financial reporting in Item 9A of Form 10–K, that Merge Technologies Incorporated (the Company) maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Merge Technologies Incorporated's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States) . Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal

Section 404 of Sarbanes-Oxley requires registered auditors of public companies to attest to management's assessment of its company's internal controls.

104


control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management's assessment that Merge Technologies Incorporated maintained effective internal control over financial reporting as ofDecember 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Merge Technologies Incorporated maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). [Emphasis added.]

261. In addition, during the Class Period, Article 10 of Regulation S-X [17 C.F.R. 2 10. 10

01(d)] required KPMG to review, in accordance with professional standards, the 2002, 2003, 2004

and 2005 quarterly financial statements Merge Technologies filed with the SEC.

105


KPMG Knew or Recklessly Disregarded that Merge Technologies' Class Period Financial Statements Were Materially Misstated

262. The above-noted KPMG reports were materially false and misleading because, as

alleged in detail herein, Merge Technologies' Class Period financial statements, by its own

admission, violated GAAP in numerous respects, including:

Merge Technologies' accounting revenue violated GAAP;

• Merge Technologies' accounting for income taxes violated GAAP;

• Merge Technologies' accounting for accounts receivable and related accounts receivable reserves and bad debt expense violated GAAP; and

• Merge Technologies' recognized revenue when customer payment was not reasonably assured.

263. The myriad of ways in which Merge Technologies' financial statements violated

GAAP coupled with the duration of such violations and the magnitude of the financial metrics now

restated by Merge Technologies is indicative of KPMG's conscious misbehavior or recklessness

associated with its "audits of such financial statements.

264. Indeed, the above noted violations of GAAP, which occurred over more than a three

year period, resulted in the material misstatement of the following income statement metrics:

• Software and other sales;

• Services and maintenance sales;

• Total net sales;

• Software and other cost of sales;

• Amortization expense;

• Total cost of sales;

• Gross margin;

• Sales and marketing expense;

• General and administrative expense;

106


• Depreciation expense;

• Total operating costs and expenses;

• Income before taxes;

• Income tax expense; and

• Net income.

265. In fact, Merge Technologies has now admitted that virtually every single audited

income statement line item during the three years ended December 31, 2004 was materially

misstated.

266. Merge Technologies' material financial misstatements during the Class Period did not

end with its completely distorted audited income statements. For example, the misstated line items

in Merge Technologies' audited balance sheets from 2002 through December 31, 2004 include: 12

At or for the year ended December 31, 2004 2003 2002

Total Liabilities (48.5)% (31.9)% (16.5)%

Accumulated Deficit NM (97.9)% (12.0)%

Total Stockholders' Equity 14.3% 5.2% 4.1%

Accounts Receivable, net 7.7% ND ND

Prepaid Expenses (29.4)% ND ND

Deferred Income Taxes (57.9)% ND ND

Other Current Assets (67.2)% ND ND

Total Current Assets (12.6)% NT) NT)

Other Accrued Liabilities 19.4% ND ND

Deferred Revenue (64.7)% ND ND

Total Current Liabilities (54.1 )% ND ND

Deferred Income Tax Payable 137.6% ND ND

12 The designation "ND indicates the Merge Technologies has "not disclosed the amount by which such line item was restated. "NM refers to "not meaningful in that Merge Technologies' restatement resulted in a positive number being changed to a negative number.

107


267 As a result of Merge Technologies' numerous violations of GAAP, its restated

financial statements for the years ended December 31, 2002, 2003 and 2004 bear little resemblance

to those "audited by Defendant KPMG during the Class Period. Indeed, the myriad of ways in

which Merge Technologies' financial statements violated GAAP, coupled with the duration of such

violations and the magnitude and number of the financial statement line items now restated by

Merge Technologies, evidences KPMG's conscious misbehavior or recklessness in the performance

of its "audits of Merge Technologies' financial statements. In truth and in fact, KPMG's "audits

were tantamount to no audits at all.

KPMG Knew or Recklessly Disregarded that Its "Audit" of Merge Technologies' Class Period Financial Statements Were Not Conducted in Accordance with GAAS

268. In certifying Merge Technologies' financial statements, Defendant KPMG also

falsely represented that its audits were conducted in accordance with GAAS. 13 In fact, KPMG

violated GAAS in numerous respects during the course of its "audits of Merge Technologies'

financial statements during the Class Period.

269. For example, GAAS, as set forth in AU §326, required KPMG to:

• Obtain sufficient competent evidential matter through inspection, observation, inquiries and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit;

• Consider whether specific audit objectives have been achieved in evaluating evidential matter;

Be thorough in the search for evidential matter and unbiased in its evaluation;

• Design audit procedures to obtain competent evidential matter; and

13 Prior to the creation of the PCAOB, the AICPA promulgated U. S. audited standards. To the extent they have not been superseded or amended by the PCAOB, the auditing standards issued by the AICPA (which are codified and referred to as "AU § ) have been adopted by the PCAOB as its interim standards to be used on an initial, transitional basis.

108


Consider relevant evidential matter regardless of whether it appears to corroborate or to contradict the assertions in the client's financial statements.

270 In violation of the above GAAS standard, and contrary to the representations in its

reports on Merge Technologies' financial statements, KPMG did not obtain sufficient competent

evidential matter to support Merge Technologies' financial statement assertions during the Class

Period.

271. In accumulating sufficient competent evidential matter, GAAS, in AU §330 states

that auditor should generally confirm accounts receivable during all audits. AU §330 explains that:

the Confirmation of accounts receivable is the "process of obtaining and evaluating a direct communication from a third party in response to a request for information;

"During the performance ofconfirmation procedures, the auditor should maintain control over the confirmation requests and responses. Maintaining control means establishing direct communication between the intended recipient and the auditor to minimize the possibility that the results will be biased because of interception and alteration of the confirmation requests or responses." [Emphasis added.]

272. During the Class Period, KPMG violated the above auditing standard and

relinquished control over the confirmation process to Merge Technologies. As a result, Defendant

Linden learned which of Merge Technologies' customers were going to receive audit confirmations

and then directed such customers to falsify the audit confirmations. In fact, CW2 stated that after

Defendant Linden learned which customers were to receive audit confirmations, Defendant Linden

e-mailed Merge Technologies' customer reps and directed them to contact those customers and

instruct them to timely return the confirmations without taking exception to the information that was

being confirmed. 14

273. In addition, the SEC and AICPA, which promulgated audited standards before

PCAOB was created by Sarbanes-Oxley, issued numerous caveats to auditors during the Class

14 This representation was confirmed by CW9 and CW2 1. Merge Technologies has now stated that it will "establish formal policies and procedures for the customer audit confirmation process.

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Period about improper and/or aggressive revenue recognition practices. In fact, in 2003, the AICPA

issued a "Practice Alert which emphasized to auditors that GAAS, in AU 316, requires that that an

auditor ordinarily presume that there is a risk of material misstatement due to fraud relating to

revenue recognition. The Practice Alert also indicated the necessity of confirming terms of

transactions and the existence of side agreements if the auditor encounters, among others, any of the

following items:

Significant sales or high sales volume at or near the end of the reporting period;

. Contracts or contract clauses that are not standard;

. Use of letters of authorization as opposed to signed contracts or agreements;

. Sales (other than software sales) with commitments for future upgrades; and

. Sales where significant uncertainties and/or obligations to the seller exist.

274. In addition, the Practice Alert reminded auditors to communicate directly with

intended recipients of confirmations and to maintain control over the confirmation process.

275. These caveats, and numerous documents and speeches by the SEC and its staff,

repeatedly put KPMG on notice to focus its attention on improper revenue recognition practices

during the Class Period. Had KPMG obtained sufficient competent evidential matter in the course

of "auditing Merge Technologies' financial statements during the Class Period, it would have

learned, if it did not already know, of Merge Technologies' myriad, material violations of GAAP

alleged herein.

276. KPMG also violated Standard of Field Work No.2 which required KPMG to make a

proper study of existing internal controls, including accounting, financial and managerial controls, to

determine whether reliance thereon was justified, and if such controls are not reliable, to expand the

nature and scope of the auditing procedures to be applied. The standard provides that a sufficient

understanding of an entity's internal control structure be obtained to adequately plan the audit and to

determine the nature, timing and extent of tests to be performed. 110


277 KPMG knew or recklessly ignored that it failed to understand the numerous internal

control deficiencies which were later identified by Sidley Austin and Alvarez & Marsal as noted

herein.

278. In addition to the foregoing violations of GAAS, KPMG violated at least the

following provisions of GAAS in "auditing Merge Technologies' financial statements during the

Class Period:

(a) AU §316 which required KPMG to plan and perform its audits in a manner

which reasonably assured that Merge Technologies' Class Period financial statements were free

from misstatements caused by error or fraud. KPMG failed to adequately plan and perform its audit

procedures in a manner reasonably designed to identify the numerous financial improprieties alleged

herein. Such failure permitted Merge Technologies to issue materially false and misleading financial

statements over a multi-year period. Moreover, Section 10A of the Securities Exchange Act

required KPMG to "determine whether, in the course of its audits, an illegal act occurred and to

notify the SEC if it became aware of information indicating that an illegal act occurred if Merge

Technologies' management or Board of Directors failed to take appropriate remedial action with

respect to the illegal acts. KPMG knew or recklessly ignored that it violated Section 1 0A of the

Securities Exchange Act in the performance of its audits of Merge Technologies' 2002, 2003 and

2004 year end financial statements;

(b) General Standard No. 3 which requires that due professional care be exercised

by the auditor in the performance of the audit and the preparation of the audit report. Due

professional care also requires that the auditor maintain professional skepticism in the course of

auditing a client's financial statements. KPMG conducted its audits of Merge Technologies'

financial statements with such lack of care that it permitted systemic internal control deficiencies to

exist over a multi-year period;

111


(c) Auditing standard AU §342 which required that KPMG perform the audit

procedures necessary to determine that Merge Technologies' accounting estimates were reasonable

during the Class Period. AU §342 provides that in establishing the reasonableness of an accounting

estimate, the auditor normally concentrates on key factors and assumptions including the

significance of the accounting estimate and its susceptibility to misstatement and bias;

(d) Auditing standard AU §431, which provides that if management omits from

the financial statements, including the accompanying notes, information that is required by GAAP,

the auditor should express a qualified or an adverse opinion and should provide the required

undisclosed information in its audit report;

(e) GAAS Standard of Reporting No. 1 which requires the audit report to state

whether the financial statements are presented in accordance with GAAP. KPMG's opinion falsely

represented that Merge Technologies' 2002, 2003 and 2004 financial statements were presented in

conformity with GAAP when they were not for the myriad reasons herein alleged;

(f) GAAS Standard of Reporting No.4 which requires that, when an opinion on

the financial statements as a whole cannot be expressed, the reasons therefore must be stated.

KPMG was required to state that no opinion could be issued by it on Merge Technologies' 2002,

2003 or 2004 financial statements or issue an adverse opinion stating that such financial statements

were not fairly presented in conformity with GAAS. KPMG's failure to make such a qualification,

correction, modification and/or withdrawal of its audit opinions was a violation of GAAS, including

the fourth standard of reporting. KPMG also failed to require Merge Technologies to restate its

Class Period financial statements to correct the numerous violations of GAAP alleged herein;

(g) GAAS General Standard No. 2, which requires that independence in mental

attitude is to be maintained by the auditor in all matters related to the audit;

112


(h) GAAS General Standard No. 1, which requires that audits be performed by

persons having adequate technical training and proficiency;

(i) GAAS Standard of Field Work No. 1, which requires that the audit is to be

adequately planned and that assistants should be properly supervised; and

U) GAAS Standard of Reporting No. 2, which requires that the audit report

identify circumstances in which GAAP has not been consistently observed.

279. In certifying Merge Technologies' financial statements, Defendant KPMG falsely

represented that it conducted its audits of Merge Technologies' financial statements in accordance

with each of the above-noted auditing standards.

KPMG Knew or Recklessly Disregarded that Its "Audit" Report on Merge Technologies' 2004 System of Internal Control over Financial Reporting Was Materially Misstated

280. As noted above, Defendant KPMG's 2005 "audit report stated, among other things,

that "[un our opinion, management's assessment that Merge Technologies Incorporated maintained

effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all

material respects and "in our opinion, Merge Technologies Incorporated maintained, in all material

respects, effective internal control over financial reporting as of December 31, 2004.

281. These conclusions were purportedly reached after KPMG: (1) obtained an

understanding of Merge Technologies' internal control over financial reporting; (2) evaluated

management's assessment of such system of internal control; (3) tested and evaluated the design and

operating effectiveness of the internal control system; and (4) performed such other procedures as it

deemed necessary.

282. Prior to issuing its report on Merge Technologies' 2004 system of internal control, the

PCAOB, in its Auditing Standard ("AS) No. 2, required that KPMG obtain an in depth

understanding of, and conduct an extensive evaluation of management's process for assessing the

effectiveness of Merge Technologies' internal control over financial reporting.

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283 In obtaining an understanding of Merge Technologies' internal control over its

financial reporting, AS No. 2 required that KPMG:

. Make inquiries of appropriate management, supervisory, and staffpersonnel;

. Inspect company documents;

Observe the application of specific controls;

. Trace transactions through the information system relevant to financial reporting;

. Understand Merge Technologies' control environment, which sets the tone of an organization and is the foundation of all other components of internal control including integrity, ethical values, and commitment to competence;

. Understand the risk of errors or fraud that could result in material financial statement misstatements;

Understand the control activities that Merge Technologies' management implemented to prevent or detect errors or fraud that could result in material misstatement in the accounts and disclosures and related assertions of the financial statements;

Understand management's information and communication systems and processes;

Understand management's monitoring of all controls, including control activities, which management identified and designed to prevent or detect material misstatement in the accounts and disclosures and related assertions of the financial statements;

Identify significant accounts and disclosures, both quantitatively and qualitatively; and

. Perform "walkthroughs for each major class of transactions, in which the auditor traces a transaction from origination through the company's information systems until it is reflected in the company's financial reports.

284. After complying with the above-noted requirements, AS No. 2 required KPMG to

thoroughly test and evaluate Merge Technologies' systems design and operating effectiveness by:

S

Identifying the company's control objectives in each area;

S

Identifying the controls that satisfy each objective;

S

Determining whether properly operating controls can effectively prevent or detect errors of fraud that could result in material misstatements in the financial statements;

114


Testing controls by inquiring of appropriate personnel, inspection of relevant documentation, observation of the company's operations, and re-performance of the application of the control;

Performing tests of controls over a period of time to determine whether, as of the date specified in management's report, the controls necessary for achieving the objectives of the control criteria are operating effectively;

. Communicate all identified significant deficiencies and material weaknesses in controls to the audit committee in writing;

Obtain sufficient evidence about whether the company's internal control over financial reporting, including the controls for all internal control components, is operating effectively. In determining the extent of procedures to perform, the auditor should design the procedures to provide a high level of assurance that the control being tested is operating effectively. In making this determination, the auditor is required to: (1) subject manual controls to more extensive testing than automated controls; and (2) assess the complexity of the controls, the significance of the judgments that must be made in connection with their operation, and the level of competence of the person performing the controls that is necessary for the control to operate effectively. As the complexity and level ofjudgment increase or the level of competence of the person performing the control decreases, the extent of the auditor's testing should increase; and

Conduct the audit of internal control over financial reporting and the audit of the financial statements with professional skepticism.

285. Now, after Alvarez & Marsal, LLC was retained by Sidley Austin LLP to investigate

Merge Technologies' financial reporting during the Class Period and has issued their investigative

findings, Defendant KPMG has admitted in its report dated August 29, 2006, that its initial report on

Merge Technologies' 2004 system of internal control over its financial reporting and audited

financial statements was materially false and misleading:


We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting (Item 9A((c)), that Merge Technologies Incorporated (the Company) did not maintain effective internal control over financial reporting as of December 31, 2005, because of the effect of material weaknesses identified in management's assessment, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

* * *

115


A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management's assessment:

1. The Company's control environment was not adequate because certain former members of senior management did not set a proper ethical tone within the Company's organization and instill an attitude of control compliance. Certain former members of the Company's management were directly involved in circumventing the Company's accounting controls, and other former members of the Company's management were aware, or should have been aware, that such controls were being circumvented.

This deficiency contributed to material misstatements in the Company's interim consolidated financial statements as of, and for the interim periods ended, September 30,2005, June 30, 2005 and March 31, 2005 and the Company's annual consolidated financial statements as of, and for the years ended, December 31, 2004, 2003 and 2002, as well as the Company's consolidated financial statements for interim periods within those years.

2. The Company did not maintain effective policies andprocedures relating to revenue recognition associated with the Company's sales contracts. This lack of effective policies and procedures contributed to the Company's premature recognition of revenue related to components of its software contracts that were undelivered as of a reporting date, for which the Company was unable to establish fair value, or to contracts for which collectibility was not reasonably assured. These deficiencies resulted in material misstatements in the Company's interim consolidated financial statements as of, and for the interim periods ended, September 30,2005, June 30, 2005 and March 31, 2005 and the Company's annual consolidated financial statements as of, and for the years ended, December 31, 2004, 2003 and 2002, as well as the Company's consolidated financial statements for interim periods within those years.

3. The Company did not maintain effective policies and procedures over the accounting for income taxes. Specifically, the Company's policies and procedures did not provide for obtaining third party technical assistance in connection with the Company's accounting for the income tax consequences of complex transactions. This deficiency resulted in material misstatements in the Company's interim consolidated financial statements as of and for interim periods ended September 30, 2005 and June 30, 2005.

4. The Company did not maintain effective controls over the accounting for business combinations. Specifically, the Company did not have formal policies and procedures to provide for a sufficient analysis to identify all assets acquired in business combinations to appropriately allocate the purchase price. This deficiency resulted in material misstatements in the Company's interim consolidated financial statements as of, and for the interim periods ended, September 30, 2005 and June 30, 2005.

116


In our opinion, management's assessment that the Company did not maintain effective internal control overfinancial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). [Emphasis added.]

286. Defendant KPMG knew or recklessly ignored that it violated the PCAOB's AS No.2

when it issued its report on Merge Technologies' 2004 system of internal control over financial

reporting. Indeed, the myriad of internal control deficiencies now admitted to by Merge

Technologies, evidences KPMG's conscious misbehavior or recklessness in the performance of its

"audit and issuance of its report of Merge Technologies' 2004 system of internal control over its

financial reporting. In fact, KPMG's audit of Merge Technologies' 2004 system of internal control

over financial reporting was tantamount to no audit at all.

287. In fact, had KPMG made appropriate inquires of Merge Technologies' personnel in

accordance with AS No. 2, it would have learned, if it did not already know, of the improper revenue

recognition practices alleged herein. Indeed, numerous former Merge Technologies employees

willingly informed Plaintiffs counsel of the wrongdoing alleged herein.

288. In fact, PCAOB's AS No. 2 provides the following example of significant and

material internal control weaknesses:

Modifications to Standard Sales Contract Terms Not Reviewed To Evaluate Impact on Timing and Amount of Revenue Recognition

Scenario A - Significant Deficiency

The company uses a standard sales contract for most transactions. Individual sales transactions are not material to the entity. Sales personnel are allowed to modify sales contract terms. The company's accounting function reviews significant or unusual modifications to the sales contract terms, but does not review changes in the standard shipping terms. The changes in the standard shipping terms could require a delay in the timing of revenue recognition. Management reviews gross margins on a monthly basis and investigates any significant or unusual relationships. In addition,

117


management reviews the reasonableness of inventory levels at the end of each accounting period. The entity has experienced limited situations in which revenue has been inappropriately recorded in advance of shipment, but amounts have not been material.

Based only on these facts, the auditor should determine that this deficiency represents a significant deficiency for the following reasons: The magnitude of a financial statement misstatement resulting from this deficiency would reasonably be expected to be more than inconsequential, but less than material, because individual sales transactions are not material and the compensating detective controls operating monthly and at the end of each financial reporting period should reduce the likelihood of a material misstatement going undetected. Furthermore, the risk of material misstatement is limited to revenue recognition errors related to shipping terms as opposed to broader sources of error in revenue recognition. However, the compensating detective controls are only designed to detect material misstatements. The controls do not effectively address the detection of misstatements that are more than inconsequential but less than material, as evidenced by situations in which transactions that were not material were improperly recorded. Therefore, there is a more than remote likelihood that a misstatement that is more than inconsequential but less than material could occur.

Scenario B - Material Weakness

The company has a standard sales contract, but sales personnel frequently modify the terms of the contract. The nature of the modifications can affect the timing and amount of revenue recognized. Individual sales transactions are frequently material to the entity, and the gross margin can vary significantly for each transaction.

The company does not have procedures in place for the accounting function to regularly review modifications to sales contract terms. Although management reviews gross margins on a monthly basis, the significant differences in gross margins on individual transactions make it difficult for management to identify potential misstatements.

Improper revenue recognition has occurred, and the amounts have been material. Based only on these facts, the auditor should determine that this deficiency represents a material weakness for the following reasons: The magnitude of a financial statement misstatement resulting from this deficiency would reasonably be expected to be material, because individual sales transactions are frequently material, and gross margin can vary significantly with each transaction (which would make compensating detective controls based on a reasonableness review ineffective). Additionally, improper revenue recognition has occurred, and the amounts have been material. Therefore, the likelihood of material misstatements occurring is more than remote. Taken together, the magnitude and likelihood of misstatement of the financial statements resulting from this internal control deficiency meet the definition of a material weakness.

118


289 Had KPMG performed its audit of Merge Technologies' internal controls in

accordance with the standards of the PCAOB, as it represented, it would have learned, if it did not

already know, that:

(a) Merge Technologies routinely modified the standard terms of its customer

contracts. Former Company employees (CW9 and CW16) stated that Merge Technologies regularly

modified the terms of its standard contracts. In fact, CW9 stated that on most large sales contracts

(over $300,000), customers typically demanded non-standard terms;

(b) The individual sales transactions were frequently material;

From 2002 through 2004, Merge Technologies' quarterly revenues averaged less than $6 million.

Accordingly, any contract in excess of $300,000 (which typically contained modified terms) would

equal to more than five percent of the Company's quarterly revenues;

(c) Merge Technologies recognized a disproportionate amount ofrevenue during

the last few days of a quarter. Numerous former Merge Technologies employees stated the

Company routinely scrambled to recognize revenue near the end of the quarter. In fact, CW1 6 stated

that Defendant Linden called Merge Technologies customers directly to close a sale at or near a

quarter end; and

(d) KMPG was on notice that Merge Technologies improperly recognized

revenue. A former Merge Technologies controller, CW1O, stated that during at least 2003, KPMG

was aware that Merge Technologies had improperly recognized revenue on a contract with Shands

Medical Center of Jacksonville, Florida.

290. The red flags noted above are precisely the conditions that the PCAOB illustrated in

AS No. 2 being indicators of significant and/or material deficiencies in a system of internal control

over financial reporting.

119


291. In fact, Merge Technologies has now announced that it adopted the following actions

to address internal control deficiencies identified by Sidley Austin and Alvarez & Marsal:

We will create an internal audit function and appoint a Director of Internal Audit, who will report directly to the Audit Committee of our Board of Directors, to oversee the internal audit function for us. This internal audit function will include the review of each of our sales contracts under which we expect to receive revenue in excess of $100,000;

We have retained Alvarez & Marsal, the forensic accounting firm retained by Sidley Austin in connection with its investigation, to consult on a variety of accounting and financial reporting matters, at least until such time as we appoint a Director of Internal Audit;

On August 28, 2006, our Board of Directors approved a revised Audit Committee Charter;

. We will further standardize our OEM contracts to provide additional clarity on issues related to revenue recognition;

Our product documentation and marketing materials will clearly present product functionality available for sale;

. We will enhance our contract review process to include a cross functional group that is responsible for reviewing contracts and providing information required to assist us in our determination of revenue recognition;

. We will formalize our procedures for project status determination and customer acceptance sign-off

. We will establish formal policies and procedures for the customer audit confirmation process;

. We will enhance our continuing education program for our sales and service organization to educate them regarding our revenue recognition policies and we will require sales personnel to verify their compliance with these policies;

. We will work with KPMG LLP, our independent registered public accounting firm, to institute a formal disclosure review procedure between the Audit Committee of our Board and our management;

. We will establish an ongoing contract review process, related to contracts with non- standard or complex terms, with a goal of determining appropriate accounting treatment prior to quarter-end;

. In connection with complex transactions, we will seek expert outside advice on tax issues;

120


We will establish formal policies and procedures to identify all assets we acquire in business combination transactions;

We have established a disclosure committee to, among other things, assist our principal executive officer and principal financial officer in fulfilling their responsibilities with respect to Sections 3 02, 404 and 906 of the Sarbanes-Oxley Act of 2002 and the rules of the SEC;

We intend to hire a General Counsel to, among other things, work with our principal executive officer, principal financial officer, principal accounting officer and Director of Internal Audit to further improve our control environment.

292. While Merge Technologies' Proxy Statements during the Class Period stated that its

Audit Committee discussed with KPMG "the matters required by Statement of Auditing Standards

No. 61, KPMG turned a blind eye toward such red flags during the Class Period. 15 Had KPMG

"audited Merge Technologies' system of internal control over its financial reporting in accordance

with the standards established by the PCAOB, it would have discovered, if it did not already know,

that such deficiencies were in existence.

KPMG Knew or Recklessly Disregarded Risk Factors Associated With Merge Technologies' Operations

293. GAAS, in AU §316, provides examples of various factors which indicate an elevated

level of risk of fraudulent financial reporting. During the course of its audits, KPMG knew of or

recklessly ignored each of the following red flags that were present at Merge Technologies during

the Class Period:

A significant portion of management's compensation is represented by bonuses, stock options, or other incentives, the value of which is contingent upon the entity achieving unduly aggressive targets for operating results;

Management displays excessive interest in maintaining or increasing the entity's stock price or earnings trend through the use of unusually aggressive accounting policies;

15 Among other things, Statement of Auditing Standards No. 61 provides that auditors and audit committee discuss a company's internal control structure and whether the financial statements are free of material misstatement.

121


A practice by management of committing to analysts, creditors and other third parties to achieve what appears to be unduly aggressive or clearly unrealistic forecasts;

• A failure by management to display and communicate an appropriate attitude regarding internal controls and the financial reporting process;

• An ineffective means of communicating and supporting the entity's values or ethics, or communication of inappropriate values or ethics;

• Domination of management by a single person or small group without compensating controls such as effective oversight by the board of directors or audit committee;

Management setting unduly aggressive financial targets and expectations for operating personnel; and

Management failing to employ an internal audit staff.

294. According to the auditing standards set forth above, as well as the procedures

conducted by KPMG pursuant to its proprietary audit process, KPMG knew or recklessly

disregarded the deficiencies in Merge Technologies internal controls. GAAS also requires the

auditor to assess the risk that financial statements are materially misstated and provides the auditor

with specific factors to be considered in connection with the auditor's assessment. There were

numerous red flags which KPMG flagrantly ignored during the Class Period. For example:

• KPMG was on notice that Merge Technologies improperly recognized revenue;

• KPMG knew or recklessly ignored that Merge Technologies recognized a disproportionate amount of revenue at or near the end of a quarter;

• KPMG knew or recklessly ignored that Merge Technologies recognized revenue on the shipment of systems that were inconsistent with what the customer ordered;

• KPMG knew or recklessly ignored that Merge Technologies recognized revenue on shipments of systems without proper customer authorization;

• KPMG knew or recklessly ignored that Merge Technologies used non-standard contract or contract clauses;

• KPMG knew or recklessly ignored that Merge Technologies recognized revenue on systems in process of being assembled prior to shipment;

• KPMG knew or recklessly ignored that Merge Technologies put pressure on management to increase revenue and earnings; and

122


S

KPMG knew or recklessly ignored that Merge Technologies utilized "side agreements. 16

295 In fact, each and every one of above conditions were identified as revenue recognition

red flags in an "Audit Risk Alert issued by the AICPA just prior to the beginning of the Class

Period.

296. As a result of KPMG's turning a blind eye toward the above noted red flags, Merge

Technologies was able to perpetuate the following improper revenue recognition practices:

Merge Technologies recognized revenue on shipments to customers before the customers entered into contracts;

Merge Technologies recognized revenue of products not ordered by customers in situations when the Company did not have the correct product in stock;

Merge Technologies recognized revenue of products to customers prior to the requested shipment date;

Merge Technologies recognized revenue of used and damaged products when the customer ordered new products;

Merge Technologies recognized revenue of empty boxes to be shipped to customers;

Merge Technologies entered into "secret side agreements that were specifically designed to hide the fact that the underlying contract contained certain contingencies that would prohibit the immediate recognition of revenue;

• Merge Technologies purposefully used incorrect terminology when describing products in sales contracts;

• Merge Technologies required sales representatives provided free products to customers but failed to account for the free products when recognizing revenue;

• Merge Technologies recognized revenue equal to the full purchase price of software that did not meet the client's specifications; and

• Merge Technologies recognized revenue equal to the full purchase price of software prior to the software's implementation.

16 GAAS, in AU §316, provides that auditors confirm with customers the existence of "side agreements.

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297 In addition, Defendants' conscious misbehavior and recklessness is further evidenced

by the fact that Defendants made revenue and earnings projections that they knew could not be met,

as demonstrated by the following:

• Defendants Linden, Veech and Noshay all knew that the Company's sales had slowed dramatically. (CW5, CW19, CW14)

• Defendants Linden, Veech and Noshay regularly reviewed information concerning the Company's current and future sales prospects by accessing the Company's sales database and participating in sales meeting and conference calls. (CW2, CW5, CW7, CW9, CW15, CW16, CW18, CW19)

• Defendant Linden or Defendant Veech signed every sales contract entered into by the Company. (CW2)

• Defendants Linden and Veech did not take the true future prospects of the Company when setting forecasts and issuing guidance. (CW2, CW20)

298. Moreover, Defendants were highly motivated to have Merge Technologies' common

shares trading at as high of a price as possible in order to maximize the capital raised through the

Company's private placements.

299. Toward that end, on July 8, 2003, Defendants announced that Company was able to

raise $8 million in cash from the sale of 667,000 shares of its common stock at the artificially

inflated price of $12 per share.

300. Defendants also were able to use the Company's artificially inflated stock price to

finance the merger with Cedara.

301. Specifically, on January 18, 2005, Defendants announced that the Company had

entered into definitive merger agreement with Cedara in an all stock transaction. Based upon the

Company's stock price, the merger, which closed on June 1, 2005, was valued at $393 million.

302. As a worldwide firm of Certified Public Accountants, auditors and business

consultants, KPMG was well aware of duties and obligations in serving as Merge Technologies'

"independent auditor. In fact, KPMG's website states:

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An independent audit of financial statements is one of the foundations for the effective operation of the capital markets. Audit quality is vital for maintaining trust in the financial reporting process and the integrity of financial information. Audit teams equipped with a high level of technical skills and empowered with professional skepticism provide the heart and soul of a good audit. In addition, we believe:

Audit methodologies must focus on fundamentals and guide good audit judgments. Technology can provide for effective information gathering, allow for critical data comparisons, and enhance contextual analysis. Compliance tools help the auditor meet professional and regulatory requirements. Cultural values should encourage sound judgment and objectivity. KPMG's approach to audit services addresses each of these areas.

A multidisciplinary approach means audit engagement teams include experienced professionals in such areas as forensics, tax, information risk management and valuation, providing them with a broad understanding of an organization, and enabling teams to focus on key areas of risk, adequacy of internal controls, and potential fraud.

Using KPMG's global training platform, KPMG member firm professionals have access to industry training, technical skill building, and instruction in KPMG's audit methodology.

Recognizing the importance of audit committees, KPMG established the Audit Committee Institute (ACT) to help provide a resource to audit committee members to help them keep pace with evolving business issues related to governance, audit issues, accounting, and financial reporting.

KPMG understands the increased regulatory pressures that companies are facing. In 2004, KPMG launched the 404 Institute to provide a forum where organizations could learn more about the requirements of section 404 of the Sarbanes-Oxley Act, share leading practices, and discuss ways to address the evolution of effective internal controls.

We believe organizational culture has a significant impact on audit quality. Central to our culture are our values and our code of conduct, which are fundamental to how business is done. KPMG member firms understand and value their role in the capital markets and will continually seek to enhance the perception of our profession by supporting our people, strengthening quality, and affirming the importance of trust and integrity.

KPMG's Additional Scienter Allegations

303. In connection with Merge Technologies' operations, KPMG had virtually limitless

access to information concerning the Company's operations as KPMG had been Merge

Technologies' auditor since at least 1995 and it provided Merge Technologies with substantial non-

125


audit services prior to and during the Class Period. As a result, KPMG knew or recklessly ignored

the audit risks associated with Merge Technologies.

304. As a result, of the services rendered to the Company, KPMG's personnel were

regularly present at Merge Technologies' offices and had continual access to, and knowledge of,

Merge Technologies' internal accounting records, its confidential financial and non-public business

documents and employees. KPMG had continual access to and knowledge of Merge Technologies'

confidential corporate financial and business information and the ability to communicate with the

Company's employees and review the Company's non-public documents. In addition, KPMG's

familiarity with Merge Technologies' financial reporting processes and practices was particularly

acute during Class Period given the enactment of Sarbanes-Oxley and the procedures that KPMG

was required to render to Merge Technologies as a result.

305. Despite its intimate knowledge of Merge Technologies' business and financial

reporting practices resulting from the nature of the auditing and other services rendered to Merge

Technologies, KPMG falsely represented that the Company's Class Period financial statements were

prepared in conformity with GAAP. In so doing, KPMG knew of or recklessly ignored adverse facts

concerning the myriad of ways in which the Company's financial statements violated GAAP during

the Class Period.

306. Indeed, there can little dispute that the number and magnitude of the financial

statement line items restated by Merge Technologies bear little resemblance to those presented in

thefinancialstatements certified by Defendant KPMG as being in conformity with GAAP during

the Class Period.

307. Now Merge Technologies has admitted that its massive financial restatement is

largely the result of a multitude of improper transactions over an extended period of time. Given its

intimate knowledge of Merge Technologies' accounting and financial reporting practices, KPMG

126


knew or recklessly disregarded adverse facts indicating that such transactions, which are now the

subject of Federal investigation, were highly irregular.

308. In truth and in fact, the personnel at KPMG's Chicago office abandoned their role as

independent auditor and turned a blind eye to each of numerous violations of GAAP, GAAS and

PCAOB standards alleged herein and participated in the instant wrongdoing to retain Merge

Technologies as its client, thereby protecting the fees it received, which totaled more than $4

million from 2001 through 2005.17

309. These fees were particularly important to the partners in KPMG's Chicago office as

their standing within the firm and their incomes were dependent on the continued business from

Merge Technologies. KPMG participated in the wrongdoing alleged herein in order to retain Merge

Technologies as a client and to protect the fees it received from the Company.

310. As a result of its absolute failure to properly report on Merge Technologies' Class

Period financial statements and internal controls, KPMG utterly failed in its role as an auditor as

noted by the SEC:

[T]he capital formation process depends in large part on the confidence of investors in financial reporting. An investor's willingness to commit his capital to an impersonal market is dependent on the availability of accurate, material and timely information regarding the corporations in which he has invested or proposes to invest. The quality of information disseminated in the securities markets and the continuing conviction of individual investors that such information is reliable are thus key to the formation and effective allocation of capital. Accordingly, the audit function must be meaningfully performed and the accountants' independence not compromised.

Relationships Between Registrants and Independent Accountants, SEC Accounting Series Release

No. 2961, 1981 SEC LEXIS 858, at *8..*9 (Aug. 20, 1981).

17 KPMG was also Cedara's auditor. The fees paid by Merge Technologies to KPMG do not include payments KPMG received from Cedara.

127


311 During the Class Period, KPMG disseminated or approved the false statements

specified above, which they knew or deliberately disregarded were misleading in that they contained

misrepresentations and failed to disclose material facts necessary in order to make the statements

made, in light of the circumstances under which they were made, not misleading.

312. KPMG violated Section 10(b) of the Exchange Act and Rule lOb-5 in that they:

(a) Employed devices, schemes, and artifices to defraud;

(b) Made untrue statements of material facts or omitted to state material facts

necessary in order to make the statements made, in light of the circumstances under which they were

made, not misleading; or

(c) Engaged in acts, practices, and a course of business that operated as a fraud or

deceit upon plaintiff and other similarly situated in connection with their purchases of Merge

publicly traded securities during the Class Period.

(d) Plaintiffs and the Class have suffered damages in that, in reliance on the

integrity of the market, they paid artificially inflated prices for Merge Technologies securities.

Plaintiff and the Class would not have purchased Merge Technologies securities at the prices they

paid, or at all, if they had been aware that the market prices had been artificially and falsely inflated

by KPMG's misleading statements.

313. As a direct and proximate result of these KPMG's wrongful conduct, Plaintiff and the

other members of the Class suffered damages in connection with their purchases of Merge

Technologies securities during the Class Period.

PRAYER FOR RELIEF

WHEREFORE, Plaintiff, on behalf of itself and the Class, pray for judgment as follows:

A. declaring this action to be a class action properly maintained pursuant to Rule 23(a)

and (b)(3) of the Federal Rules of Civil Procedure;

128


B. awarding Plaintiff and other members of the Class damages together with interest

thereon;

C. awarding Plaintiff and other members of the Class their costs and expenses of this

litigation, including reasonable attorneys' fees, accountants' fees and experts' fees and other costs

and disbursements; and

D. awarding Plaintiff and other members of the Class such other and further relief as

may be just and proper under the circumstances.

JURY TRIAL DEMANDED

Plaintiff hereby demands a trial by jury.

DATED: March 21, 2007 K. Scott Wagner, SBN 1004668 HALE & WAGNER, S.C.

Is/K Scott Wagner K. SCOTT WAGNER

205 East Wisconsin Avenue, Suite 300 Milwaukee, WI 53202 Telephone: 414/278-7000 414/278-7590 (fax) [email protected]

Liaison Counsel

LERACH COUGHLJN STOIA GELLER RUDMAN & ROBBINS LLP

SAMUEL H. RUDMAN ROBERT M. ROTHMAN 58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631/367-7100 631/367-1173 (fax)

129


LERACH COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP

PAUL J. GELLER MICHAEL L. GREENWALD 120 East Palmetto Park Road, Suite 500 Boca Raton, FL 33432 Telephone: 561/750-3000 561/750-3364 (fax)

Lead Counsel for Plaintiff

DECARLO & CONNOR DANIEL M. SHANLEY 533 South Fremont Avenue, 9th Floor Los Angeles, CA 90071-1706 Telephone: 213/488-4100

POMERANTZ HAUDEK BLOCK GROSSMAN &

GROSS LLP MARK I. GROSS 100 Park Avenue New York, NY 10017-5516 Telephone: 212/661-1100

Additional Plaintiffs Counsel

130

AO 440 (Rev. 8/0Se206M,QQ49RTR Filed 03/21/2007 Page 1 of 3 Document 44-2

United States District Court EASTERN DISTRICT OF WISCONSIN

Rosalind Maiden, on behalf of herself and others similarly situated,

V. SUMMONS IN A CIVIL CASE

Merge Technologies, Inc., (d.b.a. Merge Healthcare), Richard A. Linden and Scott T. Veech

CASE NUMBER: 06-CV-349

TO: KPMG LLP 303 East Wacker Drive Chicago, IL 60601-5212

YOU ARE HEREBY SUMMONED and required to serve upon PLAINTIFF'S ATTORNEY (Name and Address)

Lerach Coughlin Stoia Geller Rudman & Robbins, LLP 58 South Service Road, Suite 200 Melville, NY 11747

an answer to the complaint which is served on you with this summons, within 20 days after service of this summons on you, exclusive of the day of service. If you fail to do so, judgment by default will be taken against you for the relief demanded in the complaint. Any answer that you serve on the parties to this action must filed with the Clerk of this Court within a reasonable period of time after service.

.JON W. SANFILIPPO CLERK OF COURT DATE

(BY) DEPUTY CLERK

AO 440 (Rev. 8/0

Service of the Summons and cor

NAME OF SERVER

Check one box below to indicate

)-RTR Filed 03/21/2007 Pa

RETURN OF SERVICE

was made by me' DATE

TITLE

method of service

2 of 3 Document 44-2

=

El Served personally upon the defendant. Place where served:

Left copies thereof at the defendant's dwelling house or usual place of abode with a person of suitable age and discretion then residing therein.

=

Name of person with whom the summons and complaint were left:

=

Returned unexecuted:

=

Other (specify):

STATEMENT OF SERVICE FEES

TRAVEL SERVICES TOTAL

DECLARATION OF SERVER

I declare under penalty of perjury under the laws of the United States of America that the foregoing information contained in the Return of Service and Statement of Service Fees is true and correct.

Executed on Date Signature of Server

Address of Server

(1) As to who may serve a summons see Rule 4 of the Federal Rules of Civil Procedure.

AO 440 (Rev. 8/0Se206M,QQ49RTR Filed 03/21/2007 Page 1 of 3 Document 44-3

United States District Court EASTERN DISTRICT OF WISCONSIN

Rosalind Maiden, on behalf of herself and others similarly situated,

V. SUMMONS IN A CIVIL CASE

Merge Technologies, Inc., (d.b.a. Merge Healthcare), Richard A. Linden and Scott T. Veech

CASE NUMBER: 06-CV-349

TO: David Noshay W145N6701 Cedar Ridge Lane Menomonee Falls, WI 63051

YOU ARE HEREBY SUMMONED and required to serve upon PLAINTIFF'S ATTORNEY (Name and Address)

Lerach Coughlin Stoia Geller Rudman & Robbins, LLP 58 South Service Road, Suite 200 Melville, NY 11747

an answer to the complaint which is served on you with this summons, within 20 days after service of this summons on you, exclusive of the day of service. If you fail to do so, judgment by default will be taken against you for the relief demanded in the complaint. Any answer that you serve on the parties to this action must filed with the Clerk of this Court within a reasonable period of time after service.

.JON W. SANFILIPPO CLERK OF COURT DATE

(BY) DEPUTY CLERK

AO 440 (Rev. 8/0

Service of the Summons and cor

NAME OF SERVER

Check one box below to indicate

)-RTR Filed 03/21/2007 Pa

RETURN OF SERVICE

was made by me' DATE

TITLE

method of service

2 of 3 Document 44-3

=

El Served personally upon the defendant. Place where served:

Left copies thereof at the defendant's dwelling house or usual place of abode with a person of suitable age and discretion then residing therein.

=

Name of person with whom the summons and complaint were left:

=

Returned unexecuted:

=

Other (specify):

STATEMENT OF SERVICE FEES

TRAVEL SERVICES TOTAL

DECLARATION OF SERVER

I declare under penalty of perjury under the laws of the United States of America that the foregoing information contained in the Return of Service and Statement of Service Fees is true and correct.

Executed on Date Signature of Server

Address of Server

(1) As to who may serve a summons see Rule 4 of the Federal Rules of Civil Procedure.

case 2:06-cv-00349-rtr filed 03/21/2007 page 1 of 131...

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