in re: bally total fitness holding corporation securities litigation

Case 1:04-cv-03530 Document 77 Filed 01/03/2006 of 137

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TABLE OF CONTENTS

SUMMARY AND OVERVIEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

JURISDICTION AND VENUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

PARTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

CLASS ACTION ALLEGATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

MATERIALLY FALSE AND MISLEADING CLASS PERIOD STATEMENTS . . . . . . . . . . 13

THE TRUTH BEGINS TO EMERGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

POST-CLASS PERIOD DISCLOSURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

BALLY’S FINANCIAL STATEMENTS WERE MATERIALLY FALSE ANDMISLEADING WHEN MADE BECAUSE THEY VIOLATED GAAP . . . . . . . . . . . . 41

Accounting For Membership Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44Accounting For Membership Acquisition Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45Accounting For Recoveries Of Unpaid Dues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46Accounting For Acquired Payment Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47Accounting For Sales Of Future Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47Accounting For Prepaid Personal Training Services . . . . . . . . . . . . . . . . . . . . . . . . . . . 48Accounting For Multiple Element Arrangements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49Accounting For Self-Insurance Liabilities And Insurance Expense . . . . . . . . . . . . . . . . 50Accounting For Costs Incurred To Develop Internal-Use Computer Software . . . . . . . . 51Accounting For The Valuation Of Goodwill And For Separately Identifiable Intangible

Assets Apart From Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52Accounting For The Amortization Of Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53Accounting For Fixed Asset Impairment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54Accounting For Escheatment Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55Accounting For Advertising Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55Accounting For Maintenance Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56Accounting For Start-Up ("Presale") Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57Accounting For Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58Accounting For Accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59Accounting For Foreign Exchange Gains And Losses . . . . . . . . . . . . . . . . . . . . . . . . . . 60Accounting For Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61


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Accounting For Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

RESTATEMENT SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

DEFENDANTS’ SARBANES-OXLEY CERTIFICATIONS AND OTHER ATTESTATIONSTO THE EFFICACY OF INTERNAL CONTROLS WERE ALSO MATERIALLYFALSE AND MISLEADING WHEN MADE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

ADDITIONAL SEC VIOLATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

E&Y’S AUDIT OPINIONS WERE MATERIALLY FALSE AND MISLEADING WHENMADE BECAUSE BALLY’S FINANCIAL STATEMENTS DID NOT CONFORM TOGAAP AND E&Y’S AUDITS DID NOT CONFORM TO GAAS . . . . . . . . . . . . . . . . 74

ADDITIONAL SCIENTER ALLEGATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118

UNDISCLOSED ADVERSE INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

LOSS CAUSATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

APPLICABILITY OF PRESUMPTION OF RELIANCE:FRAUD-ON-THE-MARKET DOCTRINE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

NO SAFE HARBOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126

FIRST CLAIM

VIOLATION OF SECTION 10(b) OF THE EXCHANGE ACT AND RULE 10b-5PROMULGATED THEREUNDER AGAINST ALL DEFENDANTS . . . . . . . . . . . . 126

SECOND CLAIM

VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT AGAINST THEINDIVIDUAL DEFENDANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

JURY TRIAL DEMANDED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132


SUMMARY AND OVERVIEW

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

securities of Bally Total Fitness Holding Corporation (“Bally” or the “Company”) between August

3, 1999 and April 28, 2004, inclusive (the “Class Period”), against Bally, certain of its current and

former officers and directors, and its then external auditor, Ernst & Young LLP (“E&Y”), for

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

2. Bally describes itself as the largest commercial operator of fitness centers in North

America in terms of revenues, members, and the square footage of its facilities. Bally’s fitness

centers are concentrated in major metropolitan areas in the United States and Canada.

3. As alleged herein, during the Class Period, defendants falsely reported inflated

operating results to the market in publicly disseminated press releases and Securities and Exchange

Commission (“SEC”) filings. In addition, defendants repeatedly represented that the Company’s

financial statements, which were included in its SEC filings and press releases during the Class

Period, were reliable in that they were prepared in accordance with generally accepted accounting

principles (“GAAP”), and defendants further certified that the Company’s internal controls were

effective and reliable.

4. Unbeknownst to investors, however, the Company’s seeming success was not real.

Rather, the Company created the illusion of a healthy and growing business through wholly improper

accounting machinations. Subsequent to the Class Period, an independent review determined that

the Company’s improperly reported results were attributable to ineffective internal controls, multiple

accounting errors, and a “culture of aggressive accounting” that falsely inflated Bally’s reported

results.


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5. Throughout the Class Period, defendants employed a wide variety of techniques to

manipulate Bally's reported financial results, as set forth in detail below. While the manipulations

were often inconsistent and varied across many areas and many time frames, two themes remained

constant: (1) Bally was improperly recognizing revenue prematurely; and (2) Bally was improperly

delaying the recordation of expenses. These two related fraudulent techniques pervaded Bally's

publicly reported financial results, resulting in falsely inflated earnings and an artificial increase in

Bally' stock price throughout the Class Period.

6. The defendants, including Bally and E&Y, knew or were reckless in not knowing that

the accounting machinations were improper and violated GAAP (as well as certain of the company’s

own accounting policies). Indeed, each of the Individual Defendants (defined below) was, in

addition to being a high level officer of the Company, a certified public accountant (“CPA”) in his

own right.

7. Bally took advantage of the fraud by using its artificially inflated stock, in lieu of or

in combination with cash, to perform acquisitions, including the Planet Fitness and Crunch

acquisitions during the Class Period. Bally also did a secondary offering of its common stock, while

artificially inflated, to raise proceeds of $50 million for the Company, and otherwise used its

fraudulently reported financial statements to restructure debt on more favorable terms.

8. The truth concerning the Company’s chronic accounting improprieties began to

emerge on April 28, 2004. On that date, after the close of ordinary trading, the Company announced

that its Chief Financial Officer (“CFO”), defendant Dwyer, had resigned amid an SEC investigation


The April 2, 2004 initial restatement of previously reported 2003 financial results –1

first prominently disclosed in the April 28, 2004 press release – was a precursor to the ultimaterestatement of November 30, 2005, when the Company comprehensively restated results for 2000,2001, 2002, and 2003, and first reported results for 2004 and the first three quarters of 2005.However, the initial restatement was misleading and continued to conceal the massive accountingfraud during the Class Period. See ¶¶ 106-119.

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into the Company’s April 2, 2004 initial restatement of previously reported 2003 financial results.1

In a press release, the Company stated as follows in relevant part:

Bally Total Fitness Holding Corporation (NYSE:BFT) announced today that,effective immediately, John W. Dwyer, 51, has resigned as Chief Financial Officerand as a Director of the Company pursuant to the terms of a separation agreement

* * *

Separately, the Company announced that the Division of Enforcement of theSecurities and Exchange Commission has commenced an investigation in connectionwith the Company’s recent restatement regarding the timing of recognition of prepaiddues. The Company is cooperating fully with the SEC on this matter.

9. This announcement stunned the investment community. Having just completed a

significant change in accounting principle and the initial restatement of 2003 results within the past

month, the market had every expectation that Bally’s financial statements were accurate and reliable.

Accordingly, the April 28, 2004 press release first disclosing the CFO’s resignation amid an SEC

investigation cast serious doubt on the accuracy and reliability of Bally’s financial statements, and,

significantly, on the integrity of Bally’s management.

10. In response to this announcement, the price of Bally common stock fell sharply, from

$5.40 per share on April 28, 2004, to $4.50 per share on April 29th, a one day drop of 16.6% on

unusually heavy trading volume. As the truth about Bally’s accounting was revealed to and absorbed

by the market, Bally stock continued to languish, reaching a mean trading price of $4.56 for the 90

trading-day period following the April 28, 2004 disclosure.


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11. As set forth in an analyst report by Jefferies & Co., Inc. on April 30, 2004:

Investment Opinion: Hold rating maintained. Targeted price range changed to $4.40- $5.60 from $5.00 - $6.50. The stock came under severe pressure on Thursday inresponse to an announcement that the company’s CFO had resigned and that the SECwas investigating the recent change in the company’s accounting practices . . .

12. Simultaneous with the SEC’s April 2004 investigation, Bally itself initiated an

internal investigation, spearheaded by its Audit Committee. That investigation ultimately uncovered

a fraud of massive proportions.

13. On November 15, 2004, Bally announced that its Audit Committee had concluded,

based on its internal investigation, that the Company’s financial statements for the years ended

December 31, 2000 through December 31, 2003 (including the initial restatement of 2003, first

reported in March 2004) and the first quarter of 2004 should be restated and could no longer be

relied upon. Also on November 15, 2004, Bally announced that it would be unable to issue any

financial statements for the remainder of 2004 or 2005 until it had completed the restatements which

were expected in July 2005 (but were actually completed much later, in November 2005).

14. On February 10, 2005, Bally announced that it was suspending severance pay to

defendants Hillman and Dwyer, the former CEO and CFO respectively, who were responsible “for

multiple accounting errors and creating a culture within the accounting and finance groups that

encouraged aggressive accounting.”

15. Also on February 10, 2005, Bally announced that it had identified deficiencies in its

internal controls over financial reporting that, either individually or in the aggregate, constituted

material weaknesses. They included a lack of clear, acceptable policies on financial reporting,


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ineffective delegation of authority and responsibility, insufficient instruction regarding accurate and

responsible assumptions and judgments, and insufficiently experienced and trained staff.

16. According to an analyst report by Jefferies & Co, Inc. from that same day, the key

findings of the Audit Committee investigation were:

* Multiple accounting errors.

* Bally’s former CEO, Lee Hillman, and former CFO, John Dwyer, engagedin improper conduct, and were responsible for multiple accounting errors andfor a creating a culture of aggressive accounting. Mr. Dwyer also misled theSEC.

* Improper conduct on the part of the current Vice President and Controller,Ted Noncek (from 2001 to 2005) and current Vice President and TreasurerGeoff Scheitlin (former Controller from 1997 to 2001) was also found. Asa result, both have been terminated. Mr. Noncek was offered the opportunityto consult with the company on a short-term basis in order to facilitate timelycompletion of the ongoing audits.

* The company had and currently has material weaknesses in internal controlsover financial reporting.

* Prior auditors Ernst & Young are currently being evaluated given BFT’sbelief that the auditors made several errors in the course of their work forBally.

* BFT’s current auditor, KPMG, will likely issue a qualified opinion in thecompany’s 2004 10K and annual report as a result of the material weaknessesin financial controls that were not remediated by December 31, 2004.

17. On November 30, 2005 – a full 19 months after the first incomplete and misleading

disclosure of problems – Bally was finally able to quantify the full impact of the restatement and

announce its financial results for the year ended December 31, 2004, and also for the first three

quarters of 2005. Bally’s November 30, 2005 SEC filings completed the restatement of financial


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results for the first quarter of 2004 and for the years ended December 31, 2000, 2001, 2002, and

2003, and are referred to collectively herein as the “Restatement”.

18. The Restatement adjustments resulted in an increase in previously reported net loss

of approximately $96.4 million for the year ended December 31, 2002, and a decrease of $540

million in net loss for the year ended December 31, 2003. The decrease in 2003 reported net loss

includes the reversal of the cumulative effect of a change in accounting previously reported in 2003

of $583 million. Bally also increased the January 1, 2002 opening accumulated stockholders’

deficit by $1.7 billion to recognize the effects of corrections in financial statements prior to

2002.

19. As admitted by Bally itself, and as set forth in the Restatement, each of Bally’s

financial statements, earnings related press releases, and Sarbanes-Oxley certifications issued during

the Class Period were materially false and misleading when made. The true facts, which were

concealed from the investing public during the Class Period, are set forth in ¶¶ 127-179, below.

JURISDICTION AND VENUE

20. The claims asserted herein arise under and pursuant to Sections 10(b) and 20(a) of

the Exchange Act [15 U.S.C. §§ 78j(b) and 78t(a)], and Rule 10b-5 promulgated thereunder by the

SEC [17 C.F.R. § 240.10b-5].

21. This Court has jurisdiction over the subject matter of this action pursuant to 28 U.S.C.

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

22. Venue is proper in this District pursuant to Section 27 of the Exchange Act, and 28

U.S.C. § 1391(b). Many of the acts charged herein, including the preparation and dissemination of


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materially false and misleading information, occurred in substantial part in this District.

Additionally, defendants maintain their principal place of business within this District.

23. In connection with the acts alleged in this complaint, defendants, directly or

indirectly, used the means and instrumentalities of interstate commerce, including, but not limited

to, the mails, interstate telephone communications and the facilities of the national securities

markets.

PARTIES

24. Lead Plaintiff, Cosmos Investment Co., LLC (“Cosmos”) is an investment vehicle

through which Dr. Lokesh Sharma makes investments on behalf of himself, his wife, and his parents.

Cosmos is managed by Cosmos Capital Group, Inc., which in turn is managed by Dr. Sharma.

Cosmos, as set forth in the Certification previously filed with the Court, purchased the common

stock of Bally during the Class Period, and has sustained damages therefrom.

25. Defendant Bally Total Fitness Holding Corporation (“Bally”) is a Delaware company

with offices located in this District at 8700 West Bryn Mawr Avenue, Chicago, Illinois 60631. As

of February 29, 2004, Bally operated 418 fitness centers and had approximately 4 million members.

Its fitness centers are located in 29 states, Mexico, Canada, Asia, and the Caribbean. Bally fitness

centers feature a variety of cardiovascular and strength equipment, and offer personal training,

weight management, and group fitness training programs. In addition, the company’s fitness centers

include pools, racquet courts, spinning rooms, or other athletic facilities. Bally’s fitness centers

operate under the service mark ‘Bally Total Fitness’ ‘Bally Sports Clubs’, ‘Crunch Fitness’, ‘The

Sports Clubs of Canada’, ‘Pinnacle Fitness’, and ‘Gorilla Sports’.


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26. Defendant Lee S. Hillman (“Hillman”) served as Bally’s Chief Executive Officer, and

President from the beginning of the Class Period until December 11, 2002. Hillman also served as

Chairman of the Board of Directors from December 2000 until December 11, 2002. In 2002,

Hillman received $638,654 in salary, $1,641,750 worth of restricted stock awards and $4,863,600

in cash payments pursuant to a separation agreement with Bally, which included $926,100 for

vesting of restricted stock. Hillman was a CPA at all relevant times.

27. Defendant Paul A. Toback (“Toback”) was named Chairman of the Board of

Directors in May 2003 and has served as a Director since March 2003 and as President and Chief

Executive Officer since December 2002. He was Executive Vice President from February 2002 to

December 2002, Chief Operating Officer from June 2001 to December 2002, Senior Vice President,

Corporate Development from March 1998 to June 2001 and a Vice President from November 1997

to March 1998. In 2003, Toback was paid $775,00 in salary and bonus compensation, $1,206,000

in restricted stock awards and $200,000 in stock options granted by Bally. Toback was a CPA at all

relevant times.

28. Defendant John W. Dwyer (“Dwyer”) served as Bally’s Chief Financial Officer and

Executive Vice President throughout the Class Period. Dwyer resigned his positions as CFO and

Director on April 28, 2004, in connection with the SEC investigation into Bally’s accounting

practices. In 2003, Dwyer received a salary of $375,000, $603,000 in restricted stock options and

$160,000 in securities underlying stock options. Dwyer was a CPA at all relevant times.

29. Defendants Hillman, Toback and Dwyer are collectively referred to herein as the

“Individual Defendants”. Defendants Bally, Hillman, Toback and Dwyer are collectively referred

to herein as the "Bally Defendants".


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30. Defendant Ernst & Young, LLP (“E&Y”) served as Bally’s external auditor

throughout the Class Period until it resigned the engagement, effective March 31, 2004. E&Y issued

unqualified audit opinions on Bally’s year-end financial statements for the years ended December

31, 1999, 2000, 2001, 2002, and 2003. E&Y opined that the financial statements were presented in

accordance with GAAP and that its audits were conducted in accordance with generally accepted

auditing standards (“GAAS”). E&Y received substantial fees from Bally for its audit opinions,

including, e.g., $1,844,000 in audit fees for 2003.

31. The Individual Defendants, because of their positions with the Company (CEO and

CFO), possessed the power and authority to control the contents of Bally’s quarterly and year-end

reports, press releases and presentations to securities analysts, money and portfolio managers and

institutional investors, i.e., the market. Each defendant was provided with copies of the SEC filings

and press releases alleged herein to be misleading, prior to or shortly after their issuance, and had

the ability and opportunity to prevent their issuance or cause them to be corrected. Accordingly,

each of the Individual Defendants is responsible for the accuracy of the public reports and releases

detailed herein and is therefore primarily liable for the representations contained therein.

32. Because of their positions and access to material non-public information, each of the

Individual Defendants knew or recklessly disregarded that Bally’s positive representations which

were being made were materially false and misleading.

33. It is appropriate to treat the Individual Defendants as a group for pleading purposes

and to presume that the false, misleading and incomplete information conveyed in the Company’s

public filings, press releases and other publications as alleged herein are the collective actions of the

narrowly defined group of defendants identified above. Each of the above officers of Bally, by virtue


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of their high-level positions with the Company (CEO and CFO), directly participated in the

management of the Company, was directly involved in the day-to-day operations of the Company

at the highest levels and was privy to confidential proprietary information concerning the Company

and its business, operations, products, growth, financial statements, and financial condition, as

alleged herein.

34. The Individual Defendants were involved in drafting, producing, reviewing and/or

disseminating the false and misleading financial statements, press releases, and Sarbanes-Oxley

certifications. Each was aware or recklessly disregarded that false and misleading statements were

being issued regarding the Company, and approved or ratified these statements, in violation of the

federal securities laws.

35. As officers and controlling persons of a publicly-held company whose common stock

was, and is, registered with the SEC pursuant to the Exchange Act, traded on the New York Stock

Exchange (“NYSE”) during the Class Period, and governed by the provisions of the federal securities

laws, the Individual Defendants each had a duty to disseminate promptly, accurate and truthful

information with respect to the Company’s financial condition and performance, growth, operations,

financial statements, business, products, markets, management, earnings and present and future

business prospects, and to correct any previously-issued statements that had become materially

misleading or untrue, so that the market price of the Company’s publicly-traded securities would be

based upon truthful and accurate information. The Individual Defendants’ misrepresentations and

omissions during the Class Period violated these specific requirements and obligations.

36. Each of the defendants is liable as a participant in a fraudulent scheme and course of

business that operated as a fraud or deceit on purchasers of Bally securities by disseminating


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materially false and misleading statements and/or concealing material adverse facts. The scheme:

(i) deceived the investing public regarding Bally’s business, finances, internal controls, financial

statements and the intrinsic value of Bally securities; and (ii) caused Lead Plaintiff and other

members of the Class to purchase Bally securities at artificially inflated prices.

CLASS ACTION ALLEGATIONS

37. Lead Plaintiff brings this action as a class action pursuant to Federal Rule of Civil

Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased or otherwise

acquired the securities of Bally between August 3, 1999 and April 28, 2004, inclusive, and who were

damaged thereby. Excluded from the Class are defendants, the officers and directors of the

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

heirs, successors or assigns and any entity in which defendants have or had a controlling interest.

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

impracticable. Throughout the Class Period, Bally had approximately 38 million shares of common

stock outstanding that were actively traded on the NYSE. While the exact number of Class members

is unknown to Lead Plaintiff at this time and can only be ascertained through appropriate discovery,

Lead Plaintiff believes that there are hundreds or thousands of members in the proposed Class.

Record owners and other members of the Class may be identified from records maintained by Bally

or its transfer agent and may be notified of the pendency of this action by mail, using the form of

notice similar to that customarily used in securities class actions.

39. Lead Plaintiff’s claims are typical of the claims of the members of the Class as all

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

law that is complained of herein.


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40. Lead Plaintiff will fairly and adequately protect the interests of the members of the

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

41. There is a well-defined community of interest in the questions of law and fact

involved in this case. Questions of law and fact common to the members of the Class which

predominate over questions which may affect individual Class members include:

a. whether the 1934 Act was violated by defendants;

b. whether defendants omitted and/or misrepresented material facts;

c. whether defendants’ statements omitted material facts necessary to make the

statements made, in light of the circumstances under which they were made, not misleading;

d. whether defendants knew or deliberately disregarded that their statements

were false and misleading;

e. whether the prices of Bally publicly traded securities were artificially inflated;

and

f. the extent of damages sustained by Class members and the appropriate

measure of damages.

42. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all members is impracticable. Furthermore, as the

damages suffered by individual Class members may be relatively small, the expense and burden of

individual litigation make it impossible for members of the Class to individually redress the wrongs

done to them. There will be no difficulty in the management of this action as a class action.


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MATERIALLY FALSE AND MISLEADING CLASS PERIOD STATEMENTS

43. The Class Period begins on August 3, 1999, when Bally announced its results for the

second quarter of 1999, which, as reported, represented marked growth over the Company’s

performance in the previous year’s second quarter. In a press release, the Company reported as

follows:

Bally Total Fitness Holding Corporation (NYSE:BFT) today announced secondquarter 1999 results -- with fully diluted earnings per share of $.34 versus $.08 in theprior year and operating income of $21.1 million -- an improvement of 82% over the1998 quarter. Earnings before interest, taxes, depreciation and amortization for the1999 quarter grew to $33.8 million, a 44% improvement over the 1998 quarter, andthe positive trend of growth in operating cash flows continued.

Commenting on achievement of another strong quarter, Lee Hillman, President andChief Executive Officer of Bally Total Fitness, said, “Bally continued to demonstratesuccess and gain momentum as evidenced by the growth in earnings and positivetrends in cash flows. By implementing the plan we presented two years ago, we arecontinuing to invest in programs that achieve results with rapid returns. Ouraggressive program of facility upgrades, new product and service offerings and clubexpansion efforts are demonstrating their value. We have now added 26 new fitnesscenters during 1999, including our recent acquisition of The Sports Clubs of Canada,a profitable, upscale 10-center group in Toronto. Also, as we had expected, secondquarter new member joins grew 9% over prior year levels while seasonal attritionwas 5% lower than prior year trends.” Mr. Hillman concluded, “A significant driverof our business success, member satisfaction, is improving dramatically, as seen bythese trends. And our focus is to make the member experience still better bycontinuing to execute those initiatives.”

44. On August 16, 1999, Bally filed its quarterly report for the second quarter of 1999

on Form 10-Q with the SEC. The report was signed by defendants Dwyer and Hillman and

represented that “[t]he accompanying condensed consolidated financial statements have been

prepared in conformity with generally accepted accounting principles.” The second quarter 1999

Form 10-Q reiterated the financial results set forth in Bally’s August 3, 1999 press release.


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45. The August 3, 1999 press release and the August 16, 1999 10-Q were materially false

and misleading, because Bally’s growth was not attributable to the implementation of management’s

plan, but rather to an undisclosed accounting fraud, and for the reasons set forth in ¶¶ 127-175,

below.

46. On October 26, 1999 Bally filed a Form 8-K with the SEC, signed by defendant

Dwyer, attaching a press release thereto as an exhibit. The press release stated, in relevant part:

Bally Total Fitness Holding Corporation today announced third quarter 1999 results– with fully diluted earnings per share of $.45 versus $.16 in the prior year andoperating income of $25.1 million – an improvement of 82% over the 1998 quarter.Earnings before interest, taxes, depreciation and amortization for the 1999 quartergrew to $38.4 million, a 49% improvement over the 1998 quarter. The strong,positive trend of growth in operating cash flows continued with a $15.8 millionincrease in cash flow from operations compared to the same quarter a year ago.

47. On November 15, 1999, the Company filed its quarterly report for the third quarter

of 1999 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented

that “[t]he accompanying condensed consolidated financial statements have been prepared in

conformity with generally accepted accounting principles.” In relevant part, the Company reiterated

the results set forth in the October 26, 1999 press release, reporting:

Operating income for the third quarter of 1999 was $25.1 million compared to $13.8million in 1998. The increase of $11.3 million (82%) was due to a $29.2 million(15%) increase in revenues offset by a $17.9 million (10%) increase in operatingcosts and expenses. The operating margin before depreciation and amortizationincreased to 17% from 14% in the prior year period.

48. The October 26, 1999 press release and the November 15, 1999 10-Q were materially

false and misleading, for the reasons set forth in ¶¶ 127-175, below.

49. On February 9, 2000, Bally announced its results for the fourth quarter and year ended

December 31, 1999. In its press release, Bally reported in relevant part that:


15

Bally Total Fitness Holding Corporation (NYSE: BFT) today announced results forthe fourth quarter and year ended December 31,1999 with diluted earnings per sharefor the quarter of $.53, compared to $.19 for the prior year's quarter. Operatingincome for the quarter was $28.8 million - up 87% over the prior year period whileoperating income before depreciation and amortization ("EBITDA") improved 59%to $43.3 million. Strong growth in operating cash flow continued with cash flowfrom operations growing $17.6 million versus the prior year's quarter.

For the full year, diluted earnings per share, before the cumulative effect ofa change in accounting principle, was $1.56 compared to $.51 per share in 1998.Operating income for 1999 was $93.3 million, an improvement of 77% over the prioryear, and EBITDA grew 45% to $146.2 million. Cash flow from operations increased$71.1 million over 1998. During the first quarter of 1999, the Company, as requiredby AICPA Statement of Position 98-5, Reporting Costs of Start-up Activities, wroteoff the net book value of start-up costs, reducing basic and diluted earnings per share$.01.

Lee Hillman, President and Chief Executive Officer of Bally Total Fitness,noted, "We are very pleased with our quarterly and full-year results and, in particular,that we have continued to deliver on our plans for improving earnings and cashflows. Since 1996, when the Company lost more than $2.00 per share, we haveexecuted against our business plan with earnings per share now at $1.56.

50. On March 31, 2000, the Company filed its annual report for the year 1999 with the

SEC on Form 10-K, reiterating the results set forth in the February 9, 2000 press release. The report

was signed by defendants Hillman and Dwyer, and represented that “[t]he accompanying

consolidated financial statements have been prepared in conformity with generally accepted

accounting principles.”

51. Also reassuring investors was a report from the Company’s auditors, E&Y, included

in the Form 10-K, representing that:

[i]n our opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position of Bally TotalFitness Holding Corporation at December 31, 1999 and 1998, and the consolidatedresults of its operations and its cash flows for each of the three years in the periodended December 31, 1999, in conformity with accounting principles generallyaccepted in the United States.


16

E&Y further stated that “[w]e conducted our audits in accordance with auditing standards generally

accepted in the United States. Those standards require that we plan and perform the audit to obtain

reasonable assurance about whether the financial statements are free of material misstatement.”

52. The February 9, 2000 press release and the 1999 Form 10-K were materially false

and misleading, because Bally was not delivering on plans for improving earnings and cash flows,

but rather, achieving results through an undisclosed accounting fraud, and for the reasons set forth

in ¶¶ 127-175, 183-262, below.

53. On May 3, 2000 Bally filed a Form 8-K with the SEC, signed by defendant Dwyer,

attaching a press release thereto as an exhibit. The press release stated, in relevant part:

Bally Total Fitness Holding Corporation today reported its financial results for thefirst quarter of 2000, with diluted earnings per share for the quarter of $.56, morethan double the $.25 earnings per share reported in the prior year quarter. Operatingincome grew 63% to $29.8 million and operating income before depreciation andamortization (“EBITDA”) improved 47% to $45.1 million. Net revenues for theperiod reached $249.3 million, a 20% increase over the prior year quarter. Cashprovided by operating activities increased to $18.0 million for the quarter.

54. On May 15, 2000, the Company filed its quarterly report for the first quarter of 2000

on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that “[t]he

accompanying condensed consolidated financial statements have been prepared in conformity with

generally accepted accounting principles.” In relevant part, the Company reiterated the results set

forth in the May 3, 2000 press release, reporting:

Operating income for the first quarter of 2000 was $29.8 million compared to $18.3million in 1999. The increase of $11.5 million (63%) was due to a $40.8 million(20%) increase in net revenue, offset, in part, by an increase in operating costs andexpenses of $26.4 million (15%) and a $2.9 million increase in depreciation andamortization. The operating margin before depreciation and amortization increasedto 18% from 15% for the 1999 quarter.


17

55. The May 3, 2000 press release and the May 15, 2000 Form 10-Q were materially false

and misleading, for the reasons set forth in ¶¶ 127-175, below.

56. On August 3, 2000 Bally filed a Form 8-K with the SEC, signed by defendant Dwyer,


Bally Total Fitness Holding Corporation today reported its financial results for thesecond quarter of 2000, with diluted earnings per share up more than 70% to $.58.Operating income for the quarter of $31.7 million was up 50% over the prior year.Earnings before interest, taxes, depreciation and amortization (EBITDA) grew to$47.3 million, a 40% improvement.

57. On August 14, 2000, the Company filed its quarterly report for the second quarter of

2000 on Form 10-Q with the SEC. The report was signed by defendant Dwyer and represented that

“[t]he accompanying condensed consolidated financial statements have been prepared in conformity

with generally accepted accounting principles.” In relevant part, the Company reiterated the results

set forth in the August 3, 2000 press release, reporting:

Operating income for the second quarter of 2000 was $31.7 million compared to$21.1 million in 1999. The increase of $10.6 million (50%) was due to a $41.4million (20%) increase in net revenue, offset, in part, by an increase in operatingcosts and expenses of $27.8 million (16%) and a $3.0 million increase in depreciationand amortization. The operating margin before depreciation and amortizationincreased to 19% from 16% in the prior year quarter.

58. The August 3, 2000 press release and the August 14, 2000 Form 10-Q were materially


59. On November 7, 2000, Bally issued a press release reporting its earnings for the third

quarter of 2000. The release stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported third quarter2000 results - with diluted earnings per share of $.58 (before the effects of a $20million, $.72 per diluted share, benefit from the reduction of tax valuationallowances) versus $.45 in the prior year quarter. Net income, inclusive of the effect


18

of this tax benefit totaled $35.9 million, $1.30 per diluted share, for the currentquarter.

Operating income for the quarter improved 29% to $32.4 million in the currentquarter from $25.1 million in the 1999 quarter. Earnings before interest, taxes,depreciation and amortization (EBITDA) grew to $49.3 million, a 29% improvementover the prior year quarter - while the Company's EBITDA margin continued toexpand to over 19% for the quarter. Cash flows from operations continued to buildas well, with a net improvement in operating cash flow of $12.4 million over the yearago quarter. Other liquidity measures continue to be positive as well - with keyreceivable portfolio measures of quality continuing to strengthen year over year.

In accordance with Financial Accounting Standard No. 109, Accounting forIncome Taxes, the Company reviewed the likelihood of realizing the future benefitof tax loss carryforwards. Based upon consistent and growing profitability over thepast three years and reasonably expected continuation of these trends, the Companyreduced its tax valuation allowance against net operating losses realized in priorperiods by $20 million. Valuation allowances totaling over $100 million remain andmay be reversed in future periods.

Lee Hillman, Chairman of the Board of Directors, CEO and President ofBally Total Fitness, noted that "Our third quarter results demonstrate yet again thepower of our business model. We are pleased with the growth and margin expansionwe continue to achieve, and believe the investments we have been making in ourbusiness will lead to further improvements in operating results going forward." Mr.Hillman continued, "We are pleased to have reached another key objective during thequarter - generating free cash flow while at the same time continuing to expand andgrow our operations."





the results set forth in the November 7, 2000 press release, reporting:

Operating income for the third quarter of 2000 was $32.4 million compared to $25.1million in 1999. The increase of $7.3 million (29%) was due to a $35.8 million(16%) increase in net revenue, offset, in part, by an increase in operating costs andexpenses of $24.8 million (14%) and a $3.7 million increase in depreciation and


19

amortization. The operating margin before depreciation and amortization increasedto 19% from 18% in the prior year quarter.

61. The November 7, 2000 press release and the November 14, 2000 Form 10-Q were

materially false and misleading, because results did not demonstrate the power of Bally’s business

model, but rather, were attributable to an undisclosed accounting fraud, and for the reasons set forth

in ¶¶ 127-175, below.

62. The Company reported another year of impressive top and bottom line growth the

following year. On February 14, 2001 Bally filed a Form 8-K with the SEC, signed by defendant


Bally Total Fitness Holding Corporation today announced results for the year andquarter ended December 31, 2000 with diluted earnings per share for the year of$2.35 (before the net benefit of unusual items of $13.5 million, $0.49 per dilutedshare) versus $1.56 in the prior year. Net income, inclusive of the effect of unusualitems totaled $78.6 million, $2.84 per diluted share for the year. Revenues exceeded$1.0 billion annually, for the first time, an increase of 17% over the prior year.

Operating income for the year improved 35% to $126.4 million from $93.3 millionin the prior year while earnings before taxes, depreciation and amortization(EBITDA) grew to $192.0 million, a 31% improvement over the prior year. TheCompany’s EBITDA margin continued to expand to over 19% for the year from 17%in the prior year. Cash flows from operation continued to build as well, with a netimprovement in operating cash flow of $18.7 million over the prior year, before theeffect of retail inventory growth of $8.6 million to support a 54% growth in retailoutlets.

For the quarter, net income before the effects of a non-cash unusual item totaled$18.0 million, an increase of 25% over the prior year quarter. Operating income forthe fourth quarter improved 13% to $32.5 million from $28.8 million in the prior yearquarter while EBITDA grew to $50.2 million, a 16% improvement over the prioryear quarter.

63. On March 9, 2001, Bally filed its annual report for the year 2000 on Form 10-K with

the SEC, reiterating the results set forth in the February 14, 2001 press release. The report was


20

signed by defendants Hillman and Dwyer, and represented that “[t]he accompanying consolidated

financial statements have been prepared in conformity with generally accepted accounting

principles.”

64. Further reassuring investors was the report of the Company’s auditors, E&Y, included

in the Form 10-K, representing that:






and misleading, for the reasons set forth in ¶¶ 127-175, 183-262, below.

66. On May 8, 2001 Bally filed a Form 8-K with the SEC, signed by defendant Dwyer,


Bally Total Fitness Holding Corporation today reported its financial results for thefirst quarter of 2001, with diluted earnings per share for the quarter of $.65, up 16%over the $.56 per share reported in the prior year quarter. Operating income grew16% to $34.7 million and operating income before depreciation and amortization(“EBITDA”) improved 17% to $52.6 million. Net revenues for the period grew to$280.3 million, a 12% increase over the prior year quarter.





21



Operating income for the first quarter of 2001 was $34.7 million compared to $29.8million in 2000. The increase of $4.9 million (16%) was due to a $30.5 million(12%) increase in net revenue, offset, in part, by an increase in operating costs andexpenses of $23.0 million (11%) and a $2.6 million increase in depreciation andamortization. The operating margin before depreciation and amortization increasedto 19% from 18% for the 2000 quarter.



69. On August 7, 2001, Bally reported its earnings for the second quarter of 2001. Bally

reported, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the second quarter of 2001, with net income of $19.2 million, up 21% overthe prior year quarter, and diluted earnings per share for the quarter of $.63. Netrevenues increased 11% to $281.3 million, while operating income for the quarterwas up 8% over the prior year to $34.1 million. Earnings before interest, taxes,depreciation and amortization (EBITDA) for the 2001 quarter grew to $52.1 million,a 10% improvement over 2000.

Lee Hillman, Chairman of the Board, President and CEO of Bally TotalFitness, stated "Our second quarter results are further demonstration of the strengthof our business model. We have grown revenues and profits despite challengingeconomic conditions. Our balance sheet has continued to improve, attrition hasremained at its low level and our portfolio of membership receivables has remainedstrong.







22

Operating income for the second quarter of 2001 was $34.1 million compared to$31.7 million in 2000. The increase of $2.4 million (8%) was due to a $28.5 million(11%) increase in net revenue, offset, in part, by an increase in operating costs andexpenses of $23.8 million (12%) and a $2.3 million increase in depreciation andamortization. The operating margin before depreciation and amortization was 19%in each period.


false and misleading, because results were not demonstrative of the strength of Bally’s business

model, but rather, attributable to an undisclosed accounting fraud, and for the reasons set forth in ¶¶

127-175, below.

72. On November 6, 2001, Bally reported its earnings for the third quarter of 2001.

Bally’s press release stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the third quarter of 2001, with net income of $18.2 million, up 14% overthe prior year quarter, and diluted earnings per share for the quarter of $.61, beforethe net benefit of unusual items of $8.3 million ($.27 per diluted share). Net revenuesincreased 5% to $209.9 million, while operating income, exclusive of special chargesfor the quarter, was up 6% over the prior year to $16.1 million. Earnings beforeinterest, taxes, depreciation and amortization, including finance charges earned("EBITDA") for the 2001 quarter, exclusive of the impact of $6.7 million of specialcharges, was $52.2 million, a 6% improvement over 2000.

"The third quarter was a uniquely challenging period for business," said LeeHillman, chairman of the board, president and CEO of Bally Total Fitness. "Whilea number of obvious factors made this period one of the most difficult, Ballyremained strong and resilient. Continued revenue and profit growth in our coreoperations and continued strength of our contracts receivable portfolio highlightedBally's performance this quarter. In October, new membership sales rebounded tolevels above those experienced for the same month a year ago and personal trainingrevenues reached an all time high. Our products and services businesses havecontinued to grow despite disruptions during September."

"During this quarter, we also made progress on our goal to monetize our morethan $500 million receivables portfolio, completing another bulk sale and reducingdebt. In 2001, we have reduced debt by 15%, nearly $105 million, strengthening ourfinancial position. We also made significant progress toward our long-term goal with


23

a pending new agreement to replace our existing securitization facility. This newfacility is expected to be completed in the coming weeks," Hillman added.

"Also, in October, we announced a merger agreement with Crunch Fitness,the preeminent fitness brand serving the very important and fast-growing young,upscale, urban market segment. Crunch will give us terrific new positioning inexceptionally visible, high-growth markets, including New York, Los Angeles,Chicago, Atlanta, Miami and San Francisco. All in all, we have made a lot ofprogress in difficult times," Hillman concluded.





the results set forth in the November 6, 2001 press release, reporting:

Operating income for the third quarter of 2001, excluding special charges of $6.7million, was $16.1 million compared to $15.1 million in 2000. The increase of $1.0million (6%) was due to an $11.0 million (6%) increase in net revenue, offset, in part,by an increase in operating costs and expenses of $10.0 million (5%), including a$2.2 million increase in depreciation and amortization. The special charges relatedto cancelled or reformatted marketing events and other direct or indirect costs fromdisruptions and shutdowns of various club operations and programs resulting fromthe September 11th terrorist events and a one-time markdown of retail apparel inconnection with management's strategic repositioning of in-club retail stores, addingjuice bars to replace slow moving, lower margin fashion apparel. Earnings beforeinterest, taxes, depreciation and amortization, including finance charges earned("EBITDA"), exclusive of the impact of the special charges, was $52.2 million versus$49.3 for the last year quarter, a 6% increase.


materially false and misleading, because Bally had not made progress in difficult times, but rather

created the illusion of progress through an undisclosed accounting fraud, and for the reasons set forth

in ¶¶ 127-175, below.


24

75. On February 13, 2002, Bally reported its fourth quarter and year end results for 2001.

In its press release, Bally stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the year ended December 31, 2001, with net income of $72.4 million, anincrease of 11% over the prior year, and diluted earnings per share of $2.43, up 3%from 2000, before the net benefit of unusual items of $8.3 million ($0.27 per dilutedshare) in 2001, and $13.5 million ($0.49 per diluted share) in 2000.

The average number of diluted shares increased 8%. Net revenues increased

8% to $852.0 million, while operating income increased 11% to $64.5 million, beforespecial charges of $6.7 million and $6.5 million, in 2001 and 2000, respectively.Earnings before interest, taxes, depreciation and amortization, including financecharges earned (EBITDA), was $205.0 million before special charges, a 7%improvement over 2000. Pretax income rose 12% to $67.0 million.

Net income for the fourth quarter was $16.3 million ($0.54 per diluted share)

compared with $11.5 million ($0.41 per diluted share) in the prior year quarter.Excluding the special charge, net income in fourth quarter 2000 was $18.0 million($0.65 per diluted share). Net revenues increased 5% during the quarter to $211.8million compared to $201.6 million.

"Despite the many challenges of 2001, Bally had considerable success and

made progress toward our long-term objectives," said Lee Hillman, Chairman andCEO, Bally Total Fitness Holding Corporation. "In a difficult economy, we were ableto increase revenues, with products and services growing very well, and marginsholding steady for the year. We exceeded our cash flow expectations, finishing theyear cash flow positive, exclusive of our year-end acquisition of Crunch Fitness. Inaddition, we've worked hard to improve our sales processes and services for ourmembers, and believe the progress we're making is having an impact."

"Our 2001 results have enabled us to continue to improve our already strongbalance sheet, a primary objective over the past three years, reducing debt by nearly$30 million. Clearly, this business model has been confirmed through the successfulcompletion of new bank and asset-backed facilities during the quarter, as well as therecent credit upgrade by Moody's," said Hillman.

76. On March 27, 2002, Bally filed its 2001 annual report with the SEC on Form 10-K.

The report reiterated the results set forth in the February 13, 2002 press release, was signed by


25

defendants Hillman and Dwyer and represented that “[t]he accompanying consolidated financial

statements have been prepared in conformity with generally accepted accounting principles.”

77. In addition, the annual report contained a report of Bally’s auditors, E&Y,

representing that:

In our opinion, the consolidated financial statements referred to above present fairly,in all material respects, the consolidated financial position of Bally Total FitnessHolding Corporation at December 31, 2001 and 2000, and the consolidated resultsof its operations and its cash flows for each of the three years in the period endedDecember 31, 2001, in conformity with accounting principles generally accepted inthe United States.

E&Y further stated that “We conducted our audits in accordance with auditing standards generally




and misleading, because Bally had not had considerable success nor made progress toward long-term

objectives, but rather, created that illusion through an undisclosed accounting fraud, and for the

reasons set forth in ¶¶ 127-175, 183-262, below.

79. On May 2, 2002, Bally reported its earnings for the first quarter of 2002. In its press

release, Bally stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the three months ended March 31, 2002, with net income of $19.4 million,an increase of 4% over the prior year quarter, and diluted earnings per share of $0.59versus $0.65 in the prior year quarter on a 15% increase in average diluted shares.Net revenues increased 12% to $240.4 million inclusive of 8% attributable to recentlyacquired Crunch Fitness. Cash flows from operations on a comparable basisimproved 84% over the prior year quarter.


26






Operating income for the first quarter of 2002 of $16.8 million was unchanged fromthe prior year period. Net revenues increased $26.6 million (12%) for the first quarterof 2002, offset by a $27.1 million (15%) increase in operating costs and expenses,and depreciation and amortization decreased by $.5 million. Earnings before interest,taxes, depreciation and amortization, including finance charges earned ("EBITDA")was $51.9 million versus $52.6 million for the last year quarter, a 1% decrease. TheEBITDA margin was 22% in the 2002 quarter compared to 25% in the 2001 period.



82. On August 6, 2002, Bally reported its earnings for the second quarter of 2002. In its

press release, Bally stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the second quarter of 2002, with net revenues up 14%, net income of $16.1million ($.48 per diluted share), and pretax income of $21.2 million, up 8%.Assuming comparable tax rates for both periods, second quarter 2002 net incomegrew $1.2 million (8%). Income tax provisions are not comparable between periods,due to an increase in the Company's effective tax rate during the quarter, whichresulted in a $4.2 million non-cash deferred income tax charge in the second quarterof 2002. Diluted earnings per share were $.63 in the prior year quarter on net incomeof $19.2 million. Net revenues increased 14% to $246.4 million inclusive of $18.3million attributable to Crunch Fitness centers acquired at the end of 2001. Cash flowsfrom operations, on a comparable basis, increased $4.0 million, more than doublingfrom the prior year quarter. Earnings before interest, taxes, depreciation andamortization, including finance charges earned ("EBITDA"), was $53.6 millionduring the quarter, an increase of 3% over the prior year.


27






Operating income for the second quarter of 2002 was $17.2 million compared to$16.8 million in 2001. Net revenues increased $29.9 million (14%) for the secondquarter of 2002, offset by a $28.5 million (16%) increase in operating costs andexpenses, and an increase in depreciation and amortization of $1.0 million. Earningsbefore interest, taxes, depreciation and amortization, including finance chargesearned ("EBITDA") was $53.6 million versus $52.1 million for the last year quarter,a 3% increase. The EBITDA margin was 20% in the 2002 quarter compared to 22%in the 2001 period.



85. On November 12, 2002 Bally reported its earnings for the third quarter of 2002. In

its press release, Bally stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the third quarter of 2002, with net revenues up 16% over the prior yearperiod to $243.1 million. During the quarter, comparable club revenue grew 4%,driven primarily by increases in monthly membership dues and products and services.Net income before the effect of a special charge was $12.2 million, $.37 per dilutedshare, within the range estimated in the Company's business outlook announcedOctober 4, 2002. Pretax income, inclusive of the special charge, was $9.5 million,down 20%. Assuming comparable tax rates for both the 2002 and 2001 periods, thirdquarter 2002 net income declined $1.8 million to $7.2 million. The income taxprovisions are not comparable between periods due to an increase in the Company'seffective tax rate during 2002, which resulted in a $2.3 million non-cash deferredincome tax charge in the third quarter of 2002, compared to a $14.6 million non-cashdeferred income tax benefit in the 2001 quarter.

Net revenues increased 16% including 8% attributable to Crunch Fitnessacquired at the end of 2001. Cash flows from operations, on a comparable basis, were


28

$18.7 million in the quarter versus $21.8 million in the prior year period. Earningsbefore interest, taxes, depreciation and amortization, including finance chargesearned ("EBITDA") before special charges were $49.9 million during the quarter, a4% decrease from the prior year.


of 2002 on Form 10-Q with the SEC. The report was signed by defendants Dwyer and Hillman, and


prepared in conformity with generally accepted accounting principles.” In relevant part, the

Company reiterated the results set forth in the November 12, 2002 press release, reporting:

Operating income for the third quarter of 2002, excluding special charges, was $13.5million compared to $16.1 million in 2001. Net revenues increased $33.3 million(16%) for the third quarter of 2002, offset by a $35.4 million (20%) increase inoperating costs and expenses, excluding special charges, and an increase indepreciation and amortization of $.4 million. In the third quarter of 2002, werecorded a non-recurring charge of $6.5 million ($.15 per diluted share on an after taxbasis) to settle a class action lawsuit arising in the early 1990's. In the prior yearquarter, we recorded a non-recurring charge of $6.7 million ($.21 per diluted shareon an after tax basis) related to costs from disruptions and shutdowns of various cluboperations resulting from the September 11th terrorist attacks and a one-timeinventory markdown related to our repositioning of in-club retail stores. Earningsbefore interest, taxes, depreciation and amortization, including finance chargesearned ("EBITDA"), exclusive of special charges, were $49.9 million versus $52.2million for the last year quarter, a 4% decrease. The EBITDA margin, before specialcharges, was 19% in the third quarter of 2002 compared to 23% in the 2001 period.

87. Moreover, the November 14, 2002 Form 10-Q contained Sarbanes-Oxley

certifications from both defendants Dwyer and Hillman attesting to the accuracy of the reported

results and the efficacy of the Company’s internal controls. Specifically, in the Form 10-Q, both

Hillman and Dwyer represented that:

1. I have reviewed this quarterly report on Form 10-Q of Bally Total FitnessHolding Corporation;


29

2. Based on my knowledge, this quarterly report does not contain any untruestatement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financialinformation included in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

4. The registrant's other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

a) Designed such disclosure controls and procedures to ensure thatmaterial information relating to the registrant, including its consolidated subsidiaries,is made known to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

b) Evaluated the effectiveness of the registrant's disclosure controls andprocedures as of a date within 90 days prior to the filing date of this quarterly report(the "Evaluation Date"); and

c) Presented in this quarterly report our conclusions about theeffectiveness of the disclosure controls and procedures based on our evaluation as ofthe Evaluation Date;

5. The registrant's other certifying officer and I have disclosed, based on ourmost recent evaluation, to the registrant's auditors and the audit committee ofregistrant's board of directors:

a) All significant deficiencies in the design or operation of internalcontrols which could adversely affect the registrant's ability to record, process,summarize and report financial data and have identified for the registrant's auditorsany material weaknesses in internal controls; and

b) Any fraud, whether or not material, that involves management or otheremployees who have a significant role in the registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to the date of our


30

most recent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.


materially false and misleading, for the reasons set forth in ¶¶ 127-179, below.

89. On February 12, 2003, Bally issued a press release reporting its results for the fourth

quarter and full year ended December 31, 2002. In its release, Bally stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the year ended December 31, 2002, with net income before special chargesof $58.4 million or $1.77 per diluted share, versus net income before the net benefitof unusual items of $72.4 million in 2001, or $2.43 per diluted share. Includingspecial charges of $72.2 million for 2002 ($1.66 per diluted share), net income was$3.5 million ($.11 per diluted share), versus $80.7 million ($2.70 per diluted share)in 2001 which included the net benefit of unusual items of $8.3 million ($.27 perdiluted share). Net revenues increased 14% to $968.1 million during 2002 from$852.0 million in the prior year, including 9% attributable to the Crunch Fitnessacquisition completed at the end of 2001. Same club net revenues grew 3%, drivenby increases in monthly membership dues and products and services, offset by adecline in new member initiation fees. Earnings before interest, taxes, depreciationand amortization, including finance charges earned ("EBITDA") before specialcharges were $201.7 million for 2002, a decline of 2% from the prior year. Cashflows from operations, on a comparable basis, were $88.2 million in 2002, comparedto $57.7 million in the prior year, a 53% increase.

Net income before special charges for the fourth quarter of 2002 was $10.8 million,or $.33 per diluted share. Including the special charges of $65.7 million, theCompany had a net loss in the fourth quarter of $39.2 million, or $1.21 loss perdiluted share. Net income in the fourth quarter of 2001 was $16.3 million or $.54 perdiluted share. Net revenues for the quarter increased 12%, including 8% attributableto Crunch Fitness. Same club net revenues increased 2% during the quarter. EBITDAbefore special charges were $46.3 million during the quarter, a 4% decrease from theprior year fourth quarter.

90. On March 28, 2003, Bally filed its 2002 annual report with the SEC on Form 10-K/A.

The report reiterated the results set forth in the February 12, 2003 press release, was signed by


31

defendants Toback and Dwyer and represented that “[t]he accompanying consolidated financial

statements have been prepared in conformity with generally accepted accounting principles.”

91. A report from the Company’s auditors, E&Y, included in the annual report,

represented that:





92. The March 28, 2003 Form 10-K/A also contained Sarbanes-Oxley certifications from

defendants Dwyer and Toback, in which each represented that:

1. I have reviewed this annual report on Form 10-K of Bally Total FitnessHolding Corporation ("Registrant");

2. Based on my knowledge, this annual report does not contain any untruestatement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financialinformation included in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the Registrant as of, andfor, the periods presented in this annual report;

4. The Registrant's other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the Registrant, and we have:


32

a. designed such disclosure controls and procedures to ensure thatmaterial information relating to the Registrant, including its consolidatedsubsidiaries, is made known to us by others within those entities, particularly duringthe period in which this annual report is being prepared;

b. evaluated the effectiveness of the Registrant's disclosure controls andprocedures 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 our conclusions about the effectivenessof the disclosure controls and procedures based on our evaluation as of theEvaluation Date;

5. The Registrant's other certifying officer and I have disclosed, based on ourmost recent evaluation, to the Registrant's auditors and the audit committee ofRegistrant's board of directors (or persons performing the equivalent function):

a. all significant deficiencies in the design or operation of internalcontrols which could adversely affect the Registrant's ability to record, process,summarize and report financial data and have identified for the Registrant's auditorsany material weaknesses in internal controls; and

b. any fraud, whether or not material, that involves management or otheremployees who have a significant role in the Registrant's internal controls; and 6. The Registrant's other certifying officer and I have indicated in this annualreport whether or not there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

93. The February 12, 2003 press release, and the March 28, 2003 Form 10-K/A were


94. On May 7, 2003, Bally reported its earnings for the first quarter of 2003. In its press

release, Bally stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the quarter ended March 31, 2003, with net income of $9.7 million ($.30per diluted share), versus $19.4 million ($.59 per diluted share) in the prior yearquarter. Net revenues increased 5% to $253.1 million during the quarter. Cash flows


33

from operations ($19.3 million) less cash used in investing activities ($9.8 million),free cash flow, was $9.5 million.


on Form 10-Q with the SEC. The report was signed by defendants Toback and Dwyer, and



Company reiterated the results set forth in the May 7, 2003 press release, reporting:

Operating income for the first quarter of 2003 was $8.2 million compared to $16.8million in 2002. Net revenues increased $12.7 million (5%) for the first quarter of2003, offset by a $19.1 million (9%) increase in operating costs and expenses ($14.0million of which is related to the growth in products and services revenues), and anincrease in depreciation and amortization of $2.1 million. Earnings before interest,taxes, depreciation and amortization, including finance charges earned ("EBITDA"),was $46.7 million, a decrease of $5.2 million from the prior year period. TheEBITDA margin was 17% in the first quarter of 2003, compared to 20% in the 2002period.

96. The May 15, 2003 10-Q also reiterated Toback and Dwyer’s Sarbanes-Oxley

certifications with respect to the efficacy of internal controls, as set forth in ¶ 92 above.

97. The May 7, 2003 press release, and the May 15, 2003 Form 10-Q were materially


98. On August 5, 2003, Bally reported its earnings for the second quarter of 2003. In its

press release, Bally stated, in relevant part:

Bally Total Fitness Holding Corporation (NYSE: BFT) today reported its financialresults for the quarter ended June 30, 2003. Second quarter net revenues totaled$251.3 million, a $5.0 million increase over the prior year quarter (2%). Free cashflow, defined as cash flow from operations ($12.1 million) less cash used in investingactivities ($10.8 million), was $1.3 million during the quarter bringing the year todate total to $10.8 million compared to deficits during the prior year periods of $24.7million and $33.9 million, respectively.


34


2003 on Form 10-Q with the SEC. The report was signed by defendants Toback and Dwyer, and



Company reiterated the results set forth in the August 5, 2003 press release, reporting:

Operating income for the second quarter of 2003 was $8.5 million compared to $17.6million in 2002. Net revenues increased $5.0 million (2%) for the second quarter of2003, offset by a $13.9 million (7%) increase in operating costs and expenses ($13.8million of which is related to the growth in products and services revenues), and anincrease in depreciation and amortization of $.1 million. Earnings before interest,taxes, depreciation and amortization, including finance charges earned ("EBITDA")as adjusted, was $46.2 million, a decrease of $7.8 million from the prior year period.The EBITDA margin was 17% in the second quarter of 2003, compared to 20% inthe 2002 period.

100. The August 14, 2003 10-Q also reiterated Toback and Dwyer’s Sarbanes-Oxley

certifications with respect to the efficacy of internal controls, as set forth in ¶ 92 above.

101. The August 5, 2003 press release, and the August 14, 2003 Form 10-Q were


102. On October 28, 2003 Bally filed a Form 8-K with the SEC, signed by defendant


Bally Total Fitness Holding Corporation today reported net revenues of $241.5million for the quarter ended September 30, 2003. This compares to net revenues of$243.1 million for the third quarter of 2002. Net income for the third quarter was$4.7 million, or $.14 per diluted share, compared to $7.2 million, or $.22 per dilutedshare, in the prior year quarter.


of 2003 on Form 10-Q with the SEC. The report was signed by defendants Toback and Dwyer, and



35


Company reiterated the results set forth in the October 28, 2003 press release, reporting:

Operating income for the third quarter of 2003 was $5.5 million compared to $7.6million in 2002. Net revenues decreased $1.6 million (1%) and operating costs andexpenses increased $.8 million for the third quarter of 2003 offset by a decrease indepreciation and amortization of $.3 million. Earnings before interest, taxes,depreciation and amortization, loss from discontinued operations, including financecharges earned ("EBITDA") as adjusted, was $44.4 million, a decrease of $6 millionfrom the prior year period. The EBITDA margin (as adjusted) was 17% in the thirdquarter of 2003, compared to 19% in the 2002 period.

104. The November 12, 2003 10-Q also reiterated Toback and Dwyer’s Sarbanes-Oxley

certifications with respect to the efficacy of internal controls, as set forth in ¶ 92 above. The 10-Q

also represented that:

The Company's Chief Executive Officer and Chief Financial Officer have evaluatedthe effectiveness of the Company's disclosure controls and procedures (as such termis defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of1934, as amended (the "Exchange Act")) as of a date within 90 days prior to the filingdate of this quarterly report (the "Evaluation Date"). Based on such evaluation, suchofficers have concluded that, as of the Evaluation Date, the Company's disclosurecontrols and procedures are effective in alerting them on a timely basis to materialinformation relating to the Company (including its consolidated subsidiaries)required to be included in the Company's reports filed or submitted under theExchange Act.

Since the Evaluation Date, there have not been any significant changes in theCompany's internal controls or in other factors that could significantly affect suchcontrols.

105. The October 28, 2003 press release and the November 12, 2003 Form 10-Q were


106. On March 11, 2004, the Company issued a press release announcing its results for

the fourth quarter and year ended December 31, 2003, reporting increased revenues and free cash

flow:


36

__ 2003 net revenues grew 5% over 2002 to $953.5 million.

__ Products and services rendered increased 18% over prior year to $192.3 million.

__ Company generated 2003 free cash flow of $15.7 million versus a deficit of $39.7million in 2002.

__ Gross committed membership fees grew to record levels in December 2003 andJanuary and February 2004, up 14% in December, 18% in January and 30% inFebruary over the prior year.

__ The number of new members joining increased 3% during 2003 over the prior year.

107. In addition, the Company discussed a change in accounting method, from its prior

method of estimation-based deferral accounting to a modified cash basis of accounting for its

membership revenues, resulting in a $675 million charge. The Company represented as follows in

relevant part:

Importantly, effective with the 2003 period, the Company has elected to change fromits prior method of estimation-based deferral accounting to a preferable, modifiedcash basis of accounting for its membership revenues. Under the modified cash basisof accounting, revenue is recognized upon the later of when collected or earned andcosts associated with the sale of memberships are no longer deferred but arerecognized when incurred. This change, which is an extension of the guidance inEITF 00-21 “Revenue Arrangements with Multiple Deliverables” pertaining torevenues from products and services embedded in membership contracts, is fullysupported by the Company’s independent auditors. The Company’s independentauditors will be providing the Company with a preferability letter supporting thechanges. In related actions, the Company also reduced the balance sheet carryingvalue of its deferred tax assets and corrected an error in the recognition of prepaiddues. The accounting change and these actions result in total non-cash charges of$675 million . . .

108. The Company then listed components of the charge and other matters associated with

the so-called accounting change. The Company also disclosed that it would be restating results,

supposedly due to errors in calculating a portion of prepaid dues. In this regard, the Company stated

as follows:


37

The accounting change and these actions result in total non-cash charges of $675million consisting of:

__ Cumulative effect as of the beginning of 2003 of the changes in accounting principlestotaling $581 million.

__ $441 million to defer revenues previously recognized that will now be recognizedwhen the cash is collected.

__ $119 million from the elimination of deferred membership origination costs.

__ $21 million principally from a previously reported change in accounting forrecoveries on inactive memberships.

__ $51 million related to a special tax charge recorded effective the first quarter of 2003to reduce the balance sheet carrying value of deferred tax assets.

__ $43 million as of December 31, 2002 resulting from the correction of an error relatedto the prior calculation of prepaid dues. This change is reflected as a restatement ofprior periods and represents less than 2% of the reported revenues during each annualrestatement period.

109. The March 11, 2004 press release was materially false and misleading, for the reasons

set forth in ¶¶ 127-175, below.

110. On March 30, 2004 and April 2, 2004, the Company filed its 2003 annual report on

Forms 10-K and 10-K/A with the SEC. The 10-K/A stated:

Historical Analysis of Restated Prepaid Dues

As described in the “Changes in accounting principles” section above, in applyingthe new accounting method for membership revenue we undertook an evaluation ofour methods and processes related to accounting for deferral of revenue forprepayments of non-obligatory membership dues. In consultation with ourindependent auditors, it was determined that our previous methodology resulted inerrors in calculating prepaid dues and accelerated dues recognition for certainprepaying members. As a result, we have restated prior periods in accordance withthe requirements of APB No. 20, “Accounting Changes.”


38

In relevant part, the Company included the following chart, which purportedly quantified the impact

of the initial restatement:

Income Statement Member Revenue

Balance Sheet Deferred Revenues

As Reported Prepaid Dues

Increase/(Decrease)

in Membership Revenue

PeriodEnded

AsReported

AsRestated

Under-statementError

AsReported

AsRestated

Over/(Under)-Statement

TotalAssets

DeferredRevenue

NetRevenue

Dec. 31,2002 $55.3 $98.3 $43.0 $0.2 $(7.9) $8.0 $1,771.9 $334.7 $912.9

Dec. 31,2001 55.4 90.5 35.0 8.5 (2.2) 10.6 1.716.0 366.3 851.5

Dec. 31,2000 63.9 88.3 24.4 (7.7) (3.7) (4.0) 1,560.6 389.2 785.9

Dec. 31,1999 56.2 84.6 28.4 (5.0) (9.9) 4.9 1,348.6 373.3 663.0

Dec. 31,1998 51.2 74.7 23.5 (0.8) (4.3) 3.5 1,128.8 361.8 573.8

Dec. 31,1997 50.4 70.4 20.0 2.0 (8.8) 10.7 967.6 361.8 525.7

Dec. 31,1996 52.4 61.7 9.3 893.3 363.5

111. The April 2, 2004 Form 10-K/A also contained assurances from E&Y that:

in our opinion, the consolidated financial statements referred to above present fairly,in all material respects, the consolidated financial position of Bally Total FitnessHolding Corporation at December 31, 2003 and 2002, and the consolidated resultsof its operations and its cash flows for each of the three years in the period endedDecember 31, 2003, in conformity with accounting principles generally accepted inthe United States.

E&Y further stated that “We conducted our audits in accordance with auditing standards generally




39

112. The March 30, 2004 Form 10-K and the April 2, 2004 Form 10-K/A were materially


THE TRUTH BEGINS TO EMERGE

113. The truth concerning the Company’s accounting improprieties was not known to the

market until April 28, 2004. On that date, after the close of ordinary trading, the Company

announced that defendant Dwyer had resigned as the Company’s CFO and that the SEC was

investigating the Company in connection with its initial restatement. In a press release, the Company

stated as follows in relevant part:

Bally Total Fitness Holding Corporation (NYSE:BFT) announced today that,effective immediately, John W. Dwyer, 51, has resigned as Chief Financial Officerand as a Director of the Company pursuant to the terms of a separation agreement. . .

Separately, the Company announced that the Division of Enforcement of theSecurities and Exchange Commission has commenced an investigation in connectionwith the Company’s recent restatement regarding the timing of recognition of prepaiddues. The Company is cooperating fully with the SEC on this matter.

Bally recently reported its results for 2003, which included a restatement to correcterrors in a portion of its revenues relating to non-obligatory prepaid membershipdues. The errors accelerated dues recognition for certain prepaying members. Therestated amounts aggregated approximately $43 million during the seven-yearrestatement period. The Company’s amended Annual Report on Form 10-K for theyear ended December 31, 2003, which was filed on April 2, 2004, contains restatedfinancial statements audited by Ernst & Young LLP and describes the impact ofcorrecting the errors for each annual and quarterly period from January 1, 1997through September 30, 2003. The amended Annual Report on Form 10-K alsodiscloses that the Company made changes to its systems and processes related to thedeferral of prepayments of non-obligatory dues and believes its current controls oversuch systems and processes are effective.

114. In response to this announcement, the price of Bally common stock fell sharply, from

$5.40 per share on April 28, 2004, to $4.50 per share on April 29, a one day drop of 16.6% on

unusually heavy trading volume. As the truth about Bally’s accounting was revealed to and absorbed


40

by the market, Bally stock continued to languish, reaching a mean trading price of $4.56 for the 90

trading-day period following the April 28, 2004 disclosure.

115. Simultaneous with the SEC’s investigation, Bally initiated its own internal

investigation, spearheaded by its Audit Committee, which ultimately uncovered a fraud of massive

proportions.

POST-CLASS PERIOD DISCLOSURES

116. On November 15, 2004, Bally announced that its Audit Committee had concluded,

based on its internal investigation, that the Company’s financial statements for the years ended

December 31, 2000 through December 31, 2003 and the first quarter of 2004 should be restated and

could no longer be relied upon. Also on November 15, 2004, Bally announced that it would be

unable to issue any financial statements for the remainder of 2004 or 2005 until it had completed the

restatements which were expected in July 2005 (but were actually completed over a year later, in

November 2005).

117. On February 10, 2005, Bally announced that it was suspending severance pay to

defendants Hillman and Dwyer, the former CEO and CFO respectively, who were responsible “for

multiple accounting errors and creating a culture within the accounting and finance groups that

encouraged aggressive accounting.” Also on February 10, 2005, Bally announced that it had

identified deficiencies in its internal controls over financial reporting that, either individually or in

the aggregate, constituted material weaknesses. They included a lack of clear, acceptable policies

on financial reporting, ineffective delegation of authority and responsibility, insufficient instruction

regarding accurate and responsible assumptions and judgments, and insufficiently experienced and

trained staff.


41

118. On November 30, 2005, Bally finally announced its financial results for the year

ended December 31, 2004, and also for the first three quarters of 2005. Bally also completed the

ultimate Restatement of financial results for the first quarter of 2004 and for the years ended

December 31, 2000, 2001, 2002, and 2003.

119. The Restatement adjustments resulted in an increase in previously reported net loss

of approximately $96.4 million for the year ended December 31, 2002, and a decrease of $540

million in net loss for the year ended December 31, 2003. The decrease in 2003 reported net loss

includes the reversal of the cumulative effect of a change in accounting previously reported in 2003

of $583 million. Bally also increased the January 1, 2002 opening accumulated stockholders’

deficit by $1.7 billion to recognize the effects of corrections in financial statements prior to

2002.

120. As admitted by Bally itself, and as set forth in the Restatement, each of Bally’s

financial statements, earnings related press releases, and Sarbanes-Oxley certifications issued during

the Class Period were materially false and misleading when made. The true facts, which were

concealed from the investing public during the Class Period are set forth in ¶¶ 127-179.

BALLY’S FINANCIAL STATEMENTS WERE MATERIALLY FALSE ANDMISLEADING WHEN MADE BECAUSE THEY VIOLATED GAAP

121. At all relevant times during the Class Period, defendants represented that Bally’s

financial statements, when issued, were prepared in conformity with GAAP, which are recognized

by the accounting profession and the SEC as the uniform rules, conventions and procedures

necessary to define accepted accounting practices at a particular time.


42

122. As set forth in Financial Accounting Standards Board (“FASB”) Statement of

Financial Accounting Concepts (“Concepts Statement”) No. 1, Objectives of Financial Reporting

by Business Enterprises (November 1978), one of the fundamental objectives of financial reporting

is that it provide accurate and reliable information concerning an entity’s financial performance

during the period being presented. Concepts Statement No. 1, paragraph 42, states:

Financial reporting should provide information about an enterprise’s financialperformance during a period. Investors and creditors often use information about thepast to help in assessing the prospects of an enterprise. Thus, although investmentand credit decisions reflect investors’ and creditors’ expectations about futureenterprise performance, those expectations are commonly based at least partly onevaluations of past enterprise performance.

123. As set forth in SEC Rule 4-01(a) of SEC Regulation S-X, “[f]inancial statements filed

with the [SEC] which are not prepared in accordance with [GAAP] will be presumed to be

misleading or inaccurate,” despite footnote or other disclosure. 17 C.F.R. § 210.4-01(a)(1).

124. Management is responsible for preparing financial statements that conform to GAAP.

As noted by the American Institute of Certified Public Accountants (“AICPA”) Codification of

Statements on Auditing Standards § 110.03:

The financial statements are management’s responsibility . . . . Management isresponsible for adopting sound accounting policies and for establishing andmaintaining internal control that will, among other things, initiate, record, process,and report transactions (as well as events and conditions) consistent withmanagement’s assertions embodied in the financial statements. The entity’stransactions and the related assets, liabilities and equity are within the directknowledge and control of management . . . . Thus, the fair presentation of financialstatements in conformity with generally accepted accounting principles is an implicitand integral part of management’s responsibility.

125. In view of “the potential dilution of public confidence in financial statements

resulting from restating the financial statements of prior periods,” according to GAAP, a retroactive


43

restatement of financial statements is reserved for material accounting errors that existed at the time

the financial statements were prepared. APB Opinion No. 20, Accounting Changes, ¶¶ 18, 27, 34-38

(July 1971). This accounting mandate was reaffirmed through the issuance of FASB Statement No.

154 in May 2005. Since GAAP allows only for correction of errors that are “material,” by restating

its financial statements, Bally admitted the materiality of the errors in its previously issued financial

statements for fiscal years 2000 through 2003.

126. On January 31, 2002, the SEC, the ultimate authority regarding GAAP and matters

of financial reporting (SEC Accounting Series Release Nos. 4 and 150), submitted an Amicus Curiae

Brief (In Re: Sunbeam Securities Litigation, 98-8258-Civ - Middlebrooks, S.D. FL, Miami Div.) (the

“SEC Brief") which unequivocally stated its position with regard to restated financial statements

as follows:

. . . corrected financial statements are highly probative of at least two of the elementsof a private action under the federal securities laws: whether there was amisstatement in the original financial statements and whether the misstatement wasmaterial. See, e.g., In re Telxon Corp. Secs. Litig., 133 F. Supp. 2d 1010, 1025 (N.D.Ohio 2000) (when ruling on defendants' motion to dismiss action under PSLRA,court held that company defendant was not in a position to dispute that it misstatedmaterial facts in its financial disclosures because company admitted its priordisclosures were materially misstated when it issued the restatements which gave riseto the litigation) (citing In re Peritus Software Servs., Inc. Secs. Litig., 52 F. Supp.2d 211, 223 (D. Mass. 1999) ("after the fact accounting admissions may suffice toshow that material misstatements occurred")). Restated financial statements areprobative of these two issues because under GAAP and GAAS they cannot befiled unless the original financial statements contained material errors asdefined in GAAP. See pages 11-12, above. Thus, under GAAP, restated financialstatements must constitute an admission of past errors. . . By filing restatedfinancial statements with the Commission, a company announces that it hadpreviously materially misstated its financial condition or its results ofoperations. This exposes it to a high risk of civil and criminal investigations andlegal actions by the federal government . . ." (Emphasis added).


44

There is no question that by filing restated financial statements with the SEC, Bally announced that

it had previously disseminated materially misstated financial statements to the investing public.

127. The Company used improper accounting practices in violation of GAAP and SEC

reporting requirements to falsely inflate Bally’s reported revenues, net income and earnings per share

in the interim quarters and fiscal years during the Class Period, as follows:

Accounting For Membership Revenue:

128. GAAP (SEC Staff Accounting Bulletin No. 101) addresses the appropriate accounting

for the recognition of membership revenue. It states:

Supply or service transactions may involve the charge of a nonrefundable initial feewith subsequent periodic payments for future products or services. The initial feesmay, in substance, be wholly or partly an advance payment for future products orservices. In the examples above, the on-going rights or services being provided orproducts being delivered are essential to the customers receiving the expected benefitof the up-front payment. Therefore, the up-front fee and the continuing performanceobligation related to the services to be provided or products to be delivered areassessed as an integrated package. In such circumstances, the staff believes thatup-front fees, even if nonrefundable, are earned as the products and/or services aredelivered and/or performed over the term of the arrangement or the expected periodof performance and generally should be deferred and recognized systematically overthe periods that the fees are earned. . . A systematic method would be on astraight-line basis, unless evidence suggests that revenue is earned or obligations arefulfilled in a different pattern, in which case that pattern should be followed.

129. Bally did not comply with the foregoing GAAP. Instead, Bally improperly recognized

membership revenue based upon a computed “average contractual life of twenty-two months.” As

a part of the Restatement, the Company changed its prior membership revenue recognition

methodology "such that membership revenue is earned on a straight-line basis over the longer of the

initial membership term or the estimated membership life" with membership life estimated at time

of contract execution based on historical trends of actual attrition, and with these estimates updated


45

quarterly to reflect actual membership retention. In this regard, Bally revised its previous financial

reporting to reflect the proper amount of Bally's membership revenue in the appropriate time periods,

thus admitting that its previously issued financials statements were materially false and misleading.

Accounting For Membership Acquisition Expenses:

130. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) states that:

"Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of

both) from delivering or producing goods, rendering services, or carrying out other activities that

constitute the entity's ongoing major or central operations." Bally's expenditures which were

incurred in connection with obtaining customers (i.e., signing up members) were primary costs of

Bally's "ongoing major or central operations." Accordingly, these expenditures were required to

have been expensed as incurred, just as rent, utilities, payroll and other day to day primary costs of

doing business were required to have been expensed.

131. Bally did not comply with the foregoing GAAP. Instead of recognizing membership

acquisition expenses (substantially all of which were sales commissions) when incurred, Bally

improperly "deferred" costs incurred in signing up members ("the Company improperly accounted

for membership acquisition costs by improperly deferring certain costs in 2002 and prior"), thereby

reflecting the costs as an asset (FASB Statement Of Financial Accounting Concepts No. 6 defines

assets as "probable future economic benefits obtained or controlled by a particular entity as a result

of past transactions or events") and gradually expensed these deferred costs over the same period

used for revenue recognition (twenty-two months). As a part of the Restatement, the Company

changed its prior method of accounting for membership acquisition costs and properly expensed such

costs as incurred. In this regard, Bally revised its previous financial reporting to reflect the proper


46

amount of Bally's membership acquisition expenses in the appropriate time periods, thus admitting

that its previously issued financials statements were materially false and misleading.

Accounting For Recoveries Of Unpaid Dues:

132. GAAP (Accounting Research Bulletin No. 43 and Accounting Principles Board

Opinion No. 10) states that "revenues should ordinarily be accounted for at the time a transaction is

completed, with appropriate provision for uncollectible accounts." The uncollectible accounts

should be written off and presented as a bad debt expense in accordance with Regulation S-X article

5-03 (b)(5). GAAP (Accounting Research Bulletin No. 43 and Accounting Principles Board Opinion

No. 10) also states where there is "no reasonable basis for estimating the degree of collectibility. . .

either the installment method or the cost recovery method of accounting may be used." It notes that:

"Under the cost recovery method, equal amounts of revenue and expense are recognized as

collections are made until all costs have been recovered, postponing any recognition of profit until

that time."

133. Bally did not comply with the foregoing GAAP. Instead, Bally established accruals

for unpaid dues on inactive membership contracts. As a part of the Restatement, the Company

appropriately changed its prior method of accounting for recoveries of unpaid dues to the cash basis

("the Company should have adopted the cash basis for recoveries of unpaid dues on inactive

memberships prior to 2003"). In this regard, Bally revised its previous financial reporting to reflect

the proper amount of Bally's unpaid dues recoveries associated with inactive memberships in the

appropriate time periods, thus admitting that its previously issued financials statements were

materially false and misleading.


47

Accounting For Acquired Payment Obligations:

134. GAAP (Accounting Principles Board Opinion No. 16) states that upon acquisition

of a business, all liabilities (company obligations) should be accounted for and reflected "normally

equal to their fair values at date of acquisition."

135. Bally did not comply with the foregoing GAAP. Instead, upon its acquisition of a

business "in the late 1980s," the Company "improperly accounted for $22,000[,000] of face amount

repayment obligations due in 2015 or later." As a part of the Restatement, the Company changed

its prior method of accounting for repayment obligations at less than its fair value and recognized

a liability for this repayment obligation based upon fair value. In this regard, Bally revised its

previous financial reporting to reflect the proper amount of Bally's repayment obligation liabilities

and associated interest expense in the appropriate time periods, thus admitting that its previously

issued financials statements were materially false and misleading.

Accounting For Sales Of Future Receivables:

136. GAAP (EITF 88-18: Sales of Future Revenues) states that proceeds from the "sale"

of a future revenue stream are required to be classified as debt if the selling company "has

significant continuing involvement in the generation of the cash flows due the investor (for example,

active involvement in the generation of the operating revenues of a product line, subsidiary, or

business segment)." Furthermore, GAAP (FASB Statement No. 140) states: "If a transfer of financial

assets in exchange for cash or other consideration (other than beneficial interests in the transferred

assets) does not meet the criteria for a sale. . . the transferor and transferee shall account for the

transfer as a secured borrowing with pledge of collateral."


48

137. Bally did not comply with the foregoing GAAP. Instead, Bally recorded a "sale" upon

the exchange of cash for "future member receivables" (a revenue stream that would only exist

through Bally's performance of services for its members) which could only come into existence

through Bally's active involvement in the generation of the operating revenues. As a part of the

Restatement, the Company changed its method of accounting for its surrender of "future member

receivables" to properly reflect such transactions as borrowings. In this regard, Bally revised its

previous financial reporting to reflect its exchanges of "future member receivables" for cash as

financings and to correct previously reported income and interest expense, thus admitting that its

previously issued financials statements were materially false and misleading.

Accounting For Prepaid Personal Training Services:

138. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) explains the

relationship between prepayments and deferrals, and the appropriate accounting for these items as

follows:

Deposits and prepayments received for goods or services to be provided--"unearnedrevenues," such as subscriptions or rent collected in advance--. . . qualify asliabilities. . . because an entity is required to provide goods or services to those whohave paid in advance.

*****

Deferral is concerned with past cash receipts and payments--with prepaymentsreceived (often described as collected in advance) or paid: it is the accountingprocess of recognizing a liability resulting from a current cash receipt (or theequivalent) or an asset resulting from a current cash payment (or the equivalent) withdeferred recognition of revenues, expenses, gains, or losses. Their recognition isdeferred until the obligation underlying the liability is partly or wholly satisfied oruntil the future economic benefit underlying the asset is partly or wholly used or lost.


49

139. Bally received cash in advance of the performance of personal training services and,

in material part, recognized such proceeds as fees earned, and not as a liability (deferred revenue)

as required by GAAP ("we inappropriately estimated deferred revenue related to personal training

services that had been paid for but not yet earned"). As a part of the Restatement, the Company

changed its prior method of accounting for customers' prepayment of personal training services to

properly recognize a liability for the amounts prepaid and eliminate the improperly recognized

revenue. In this regard, Bally revised its previous financial reporting to reflect the proper amount

of Bally's personal training revenue and Bally's prepaid personal training liabilities in the appropriate

time periods, thus admitting that its previously issued financials statements were materially false and

misleading.

Accounting For Multiple Element Arrangements:

140. GAAP (EITF 00-21) states that, except in certain limited instances, "all deliverables

(that is, products, services, or rights to use assets) within contractually binding arrangements

(whether written, oral, or implied, and hereinafter referred to as `arrangements') in all industries

under which a vendor will perform multiple revenue-generating activities. . . should be divided into

separate units of accounting" and that: "Applicable revenue recognition criteria should be considered

separately for separate units of accounting."

141. Bally did not comply with the foregoing GAAP. The Company entered into bundled

contracts that included a combination of (i) health club services, (ii) personal training services, and

(iii) nutritional products, and it "improperly separated these multiple element arrangements into

multiple units of accounting resulting in premature recognition of early delivered nutritional products

and personal training services." As a part of the Restatement, the Company appropriately classified


50

and recognized revenue for the three single components of revenue (health club services, personal

training services, and nutritional products), and recognized revenue for these arrangements on a

straight-line basis over the later of when collected or earned in the appropriate time periods.

Accounting For Self-Insurance Liabilities And Insurance Expense:

142. GAAP (FASB Statement of Financial Accounting Standards No. 5) states that an

estimated loss from a loss contingency shall be accrued by a charge to income if information

available prior to issuance of the financial statements indicates that it is probable that an asset had

been impaired or that a liability had been incurred at the date of the financial statements and the

amount of the loss can be reasonably estimated. When a company self-insures, additional GAAP

(FASB Statement of Financial Accounting Standards No. 60) specifies that the charge to income and

the related liability for unpaid claims "shall be based on the estimated ultimate cost of settling the

claims (including the effects of inflation and other societal and economic factors), using past

experience adjusted for current trends, and any other factors that would modify past experience" and

that "changes in estimates of claim costs resulting from the continuous review process and

differences between estimates and payments for claims shall be recognized in income of the period

in which the estimates are changed or payments are made." (Emphasis added).

143. Bally did not comply with the foregoing GAAP because it self-insured for workers'

compensation, health and life, and general liability claims and did not estimate the ultimate cost of

settling these claims (including the effects of inflation and other societal and economic factors) using

past experience adjusted for current trends, and other factors that would modify past experience, and

because it did not undertake to engage in a continuous review process. As a result, the Company

materially understated its liability for self-insured workers' compensation, health and life and general


51

insurance claims ("We concluded that our previous methodologies for estimating our self-insured

workers' compensation, health and life and general insurance claims resulted in an understatement

of our self-insured liabilities."). As a part of the Restatement, the Company appropriately performed

the procedures described above and used "generally accepted actuarial reserving methods" to

compute reasonable estimates of "ultimate obligations for reported claims plus those incurred but

not reported," and established appropriate liabilities and charges to income in the appropriate time

periods.

Accounting For Costs Incurred To Develop Internal-Use Computer Software:

144. GAAP (Statement Of Position 98-1) states that the capitalization of costs to develop

internal-use computer software may only begin after the preliminary project stage has been

completed and management, with relevant authority, commits to funding the project and it is

probable that the project will be completed and the software will be used to perform the internal-use

function intended. It further provides that cost-capitalization shall cease when the software project

is substantially completed and the software is ready for its intended use.

145. Bally did not comply with the foregoing GAAP because it did not adhere to these

cost-capitalization requirements and it improperly capitalized costs that were required to have been

expensed ("We improperly deferred recognition of internal and external costs incurred to develop

internal-use computer software."). As a part of the Restatement, the Company appropriately

reviewed the internal and external costs which had been capitalized and expensed those costs which

had been improperly capitalized. In addition, as an integral part of this restatement adjustment, the

Company corrected depreciation which had been recorded on the costs which had been capitalized.

In this regard, Bally revised its previous financial reporting to appropriately reflect the proper


52

carrying value of Bally's internal-use computer software and the proper software development

expenses in the appropriate time periods, thus admitting that its previously issued financials

statements were materially false and misleading.

Accounting For The Valuation Of Goodwill And For Separately Identifiable IntangibleAssets Apart From Goodwill:

146. GAAP (Accounting Principles Board Opinion No. 16) states that, in connection with

the acquisition of a business, "all identifiable assets acquired, either individually or by type, and

liabilities assumed in a business combination, whether or not shown in the financial statements of

the acquired company, should be assigned a portion of the cost of the acquired company, normally

equal to their fair values at date of acquisition."

147. Bally did not comply with the foregoing GAAP because it improperly failed to record

and assign a fair value to certain separately identifiable acquired intangible assets as follows:

a) "Membership Relations" which represent the fair market value of relationships withexisting members as of the acquisition date:

b) "Non-compete Agreements" which represent the fair market value of thenon-competition agreement with the seller of the company:

c) "Trade name" which represents the fair market value of the trade names associatedwith the acquired operations, and;

d) "Leasehold Rights" which represent the estimate of the favorable and unfavorablelease agreements in place as of the acquisition date.

148. As a part of the Restatement, the Company revisited its previous acquisitions,

identified all assets and liabilities acquired, assigned appropriate valuations to the acquired assets

(including the above specified intangible assets), and corrected the Company's previously issued

financial statements to reflect proper amounts for each such acquired asset ("We concluded that our

previous method of allocating purchase prices of acquired businesses resulted in an overstatement


53

of goodwill. Specifically, in applying APB 16, Business Combinations, we should have allocated

a portion of the purchase price to certain separately identifiable intangible assets").

Accounting For The Amortization Of Goodwill:

149. GAAP (Accounting Principles Board Opinion No. 17) states that "the cost of each

type of intangible asset should be amortized by systematic charges to income over the period

estimated to be benefitted. The period of amortization should not, however, exceed forty years."

150. Bally did not comply with the foregoing GAAP because it established a practice of

amortizing goodwill over 40 years when this amortization period was inconsistent with the

maximum reasonable and likely duration of material benefit from the acquired goodwill ("We

concluded that our practice of amortizing goodwill over 40 years was inconsistent with the

maximum reasonably likely duration of material benefit from the acquired goodwill."). Moreover,

when it became apparent that the goodwill had become impaired, the Company did not properly

apply the guidance in FASB Statement No. 121 (as discussed in the paragraph below). As a part of

the Restatement, the Company revised its previously issued financial statements to properly reflect

appropriate amortization periods taking into account the "likely duration of material benefit from the

acquired goodwill" and to properly recognize apparent impairment losses. In this regard, Bally

revised its previous financial reporting to appropriately reflect the proper carrying value of the

amount of Bally's goodwill and the proper goodwill amortization expenses in the appropriate time

periods, thus admitting that its previously issued financials statements were materially false and

misleading.


54

Accounting For Fixed Asset Impairment:

151. GAAP (FASB Statement No. 121 and FASB Statement No. 142) requires that

long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for

impairment whenever events or changes in circumstances indicate that the carrying amount of an

asset may not be recoverable. It further provides that, in performing the review for recoverability,

the entity should estimate the future cash flows expected to result from the use of the asset and its

eventual disposition. If the sum of the expected future cash flows is less than the carrying amount

of the asset, an impairment loss is required to be recognized.

152. Bally did not comply with the foregoing GAAP because it ignored "trigger events"

and other existing conditions which, at various dates, indicated that the carrying amounts of fixed

assets were impaired, and it failed to perform any impairment analyses or recognized impairment

losses ("we determined that the Company did not properly apply the guidance in FASB Statement

No. 121, "Accounting for the Impairment of Long-Lived Assets and Assets to be Disposed Of" and

in FASB Statement No. 142, "Goodwill and Other Intangible Assets", to measure the amount of

impairment losses. In addition, we determined conditions at various dates which indicated the

carrying amounts of fixed assets were impaired, but determined that impairment analyses had not

been performed even though trigger events were present."). As a part of the Restatement, the

Company revised its previously issued financial statements to (i) properly reflect the carrying

amounts of fixed assets, equipment (including trade-in equipment: "We determined that the

Company's accounting for equipment trade-ins resulted in an overstatement of the cost basis of the

Company's investment in exercise equipment."), other long-lived assets and identifiable intangibles,

and to (ii) recognize obvious and discernable impairment losses in the appropriate time periods.


55

Accounting For Escheatment Obligations:

153. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) defines a liability

as "probable future sacrifices of economic benefits arising from present obligations of a particular

entity to transfer assets. . . to other entities in the future as a result of past transactions or events."

Uncashed payroll and other checks (and any other items that may meet the definition of "unclaimed

property") may, through the operation of law, convert to escheatment obligations and, therefore, are

required to be reflected as liabilities in a company's financial statements.

154. Bally did not comply with the foregoing GAAP because it reported the dollar amount

of uncashed checks as income in its financial statements, not as escheatment liabilities as required

by GAAP ("We determined that the liability for the potential escheatment of certain payroll-related

and supplier-related checks was understated."). As a part of the Restatement, the Company revised

its previously issued financial statements to eliminate the improperly recognized income and to

properly reflect escheatment liabilities in the appropriate time periods.

Accounting For Advertising Expense:

155. GAAP (Statement of Position 93-7) states that "the costs of advertising should be

expensed either as incurred or the first time the advertising takes place" except in certain instances

of direct-response advertising (i.e., advertising that clearly reflects a measurable and direct

correlation between the cost of selling and the closing of a sale transaction, such as the relationship

which is often measurable in the telemarketing industry).

156. Bally did not comply with the foregoing GAAP because it capitalized advertising

costs, and amortized these costs as expenses over the estimated life of the advertising campaign

("We determined that our previous method of deferring recognition of production costs over the


56

estimated life of the advertising resulted in an overstatement of capitalized advertising and that the

cost of advertising should be expensed no later than the first time the advertising takes place."). As

a part of the Restatement, the Company changed its prior method of accounting for advertising costs

to properly expense such costs as incurred, or in the case of television commercial productions, upon

the first airing. In this regard, Bally revised its previous financial reporting to reflect the proper

amount of Bally's deferred advertising costs and advertising expenses in the appropriate time periods,

thus admitting that its previously issued financials statements were materially false and misleading.

Accounting For Maintenance Expense:

157. GAAP (FASB Statement Of Financial Accounting Concepts No. 6) states that:

"Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of

both) from delivering or producing goods, rendering services, or carrying out other activities that

constitute the entity's ongoing major or central operations." The costs which Bally incurred in

connection with maintaining its facilities were primary costs of Bally's "ongoing major or central

operations" as evidenced by the following:

a. "Most of our leases require us to pay real estate taxes, insurance, maintenance and,in the case of shopping center and office building locations, common-areamaintenance fees." (2000 Form 10-K, 2001 Form 10-K, 2002 Form 10-K and 2003Form 10-K)

b. "We implemented a comprehensive fitness equipment preventive maintenanceprogram that provides for regular service and replacement of high-wear equipmentcomponents resulting in both an improvement in our members' workout experience,and a reduction in the incidence and severity of liability claims by members injuredas a result of fitness equipment malfunctions." (2002 Form 10-K)

158. Accordingly, the Company's maintenance costs (described by the Company as

"internal compensation costs") were required to have been expensed as incurred, just as rent costs,


57

utilities costs, payroll costs and other day to day primary costs of doing business were required to

have been expensed.

159. Bally did not comply with the foregoing GAAP because it added (capitalized)

maintenance costs to the cost of property and equipment, and then depreciated this improperly

established "asset" ("We improperly deferred recognition of internal compensation costs incurred

in conjunction with the remodeling and construction of various clubs. These payments should have

been recorded as expense when services were rendered, rather than deferred and recorded as an

expense in later periods."). As a part of the Restatement, the Company changed its prior method of

accounting for maintenance costs to properly expense such costs as incurred. In this regard, Bally

revised its previous financial reporting to reflect the proper amount of Bally's property and

equipment, depreciation, and maintenance expense in the appropriate time periods, thus admitting


160. Similarly, Bally improperly capitalized other costs which were required to have been

expensed ("We determined that other capitalized costs, none of which were individually significant,

should have been expensed as incurred.") and, as part of the Restatement, revised its previous

financial reporting to reflect the proper amount of Bally's other current assets, net property and

equipment, accounts payable and expenses.

Accounting For Start-Up ("Presale") Costs:

161. GAAP (Statement Of Position 98-5 defines "start-up activities" as "those one-time

activities related to opening a new facility, introducing a new product or service, conducting business

in a new territory, conducting business with a new class of customer or beneficiary, initiating a new


58

process in an existing facility, or commencing some new operation." It states that: "Costs of start-up

activities, including organization costs, should be expensed as incurred."

162. Bally did not comply with the foregoing GAAP because it deferred (it did not

expense) costs associated with start-up activities (principally costs related to opening new facilities)

such as rent ("We determined that our previous method of deferring rent costs associated with club

leases during the construction period resulted in an overstatement of leasehold improvements and

that the rent costs during the construction period should be expensed as incurred."). As a part of the

Restatement, the Company changed its prior method of accounting for "costs associated with club

leases during the construction period" (alternatively referred to as "presale costs" by Bally) to

properly expense such costs as incurred. In this regard, Bally revised its previous financial reporting

to reflect the proper amount of Bally's operating costs and deferred costs in the appropriate time

periods, thus admitting that its previously issued financials statements were materially false and

misleading.

Accounting For Inventory:

163. GAAP (Accounting Research Bulletin No. 43) states: "Whenever the operation of a

business includes the ownership of a stock of goods, it is necessary for adequate financial accounting

purposes that inventories be properly compiled periodically and recorded in the accounts. Such

inventories are required both for the statement of financial position and for the periodic measurement

of income. . . In accounting for the goods in the inventory at any point of time, the major objective

is the matching of appropriate costs against revenues in order that there may be a proper

determination of the realized income. Thus, the inventory at any given date is the balance of costs


59

applicable to goods on hand remaining after the matching of absorbed costs with concurrent

revenues."

164. Bally did not comply with the foregoing GAAP because it failed to (i) properly

compile and record inventory in the accounts of the Company on a periodic basis and because it

failed to (ii) match appropriate costs against revenues in order that there may be a proper

determination of the realized income ("We determined that the recorded value of retail inventories

were overstated, primarily as a result of differences in physical count and as a result of incorrect

accounting for cost of goods sold."). As a part of the Restatement, the Company changed its prior

method of accounting for inventory to reflect differences detected during physical counts and to

correct its prior incorrect accounting for inventory and cost of goods sold. In this regard, Bally

revised its previous financial reporting to reflect the proper amount of Bally's inventory and cost of

goods sold in the appropriate time periods, thus admitting that its previously issued financials

statements were materially false and misleading.

Accounting For Accruals:

165. GAAP (FASB Statement Of Financial Accounting Concepts No. 1) states: "Accrual

accounting attempts to record the financial effects on an enterprise of transactions and other events

and circumstances that have cash consequences for the enterprise in the periods in which those

transactions, events, and circumstances occur rather than only in the periods in which cash is

received or paid by the enterprise."

166. Bally did not comply with the foregoing GAAP because it failed to accrue obligations

as of the end of each accounting period although transactions and events giving rise to these

obligations arose during these accounting periods ("The Company identified obligations that were


60

not properly accrued for as of the end of an accounting period."). In this regard, Bally revised its

previous financial reporting to recognize these obligations in the period in which the underlying

transactions giving rise to these obligations occurred, thus admitting that its previously issued

financials statements were materially false and misleading. As a result, Bally's Restatement adjusted

the reported amounts of current assets, property and equipment, other current assets, accounts

payable and accrued liabilities, membership services, advertising, and general and administrative

expense to reflect proper amounts in the appropriate time periods.

Accounting For Foreign Exchange Gains And Losses:

167. GAAP (FASB Statement No. 52) states: "The economic effects of an exchange rate

change on a foreign operation that is an extension of the parent's domestic operations relate to

individual assets and liabilities and impact the parent's cash flows directly. Accordingly, the

exchange gains and losses in such an operation are included in net income."

168. Bally did not comply with the foregoing GAAP because it failed to recognize gains

and losses from various foreign currency transactions which impacted individual assets (such as

management fees and foreign receivables), liabilities (such as foreign payables), and cash flows

("The Company determined that gains and losses from various foreign currency transactions, such

as those relating to management fees and. . . the settlement of foreign receivables or payables, were

not properly accounted for in prior periods."). Upon Restatement, Bally properly (in compliance with

FASB Statement No. 52) caused the foreign operations of non-U.S. subsidiaries whose functional

currency was not the U.S. Dollar to be translated into U.S. dollars with all assets, liabilities, and

minority interests translated at the period end exchange rates, stockholders' equity translated at

historical rates, and revenues and expenses translated at the average rates of exchange prevailing


61

during the period. Translation adjustments were included in the accumulated other comprehensive

income component of stockholders' equity (deficit); gains and losses resulting from foreign currency

transactions were reflected in net earnings. In this regard, Bally revised its previous financial

reporting to recognize the impact of the recordation of the proper amount of these foreign exchange

translation adjustments and gains and losses on the Company's current assets, property and

equipment, net, goodwill, deferred income taxes, other assets, accounts payable, deferred income

taxes, accounts payable, current maturities of long term debt, long-term debt, other liabilities and

accumulated other comprehensive income in the appropriate time periods, thus admitting that its

previously issued financials statements were materially false and misleading.

Accounting For Leases:

169. GAAP (FASB Technical Bulletin No. 85-3) states: "The effects of. . . scheduled rent

increases, which are included in minimum lease payments. . . should be recognized by lessors and

lessees on a straight-line basis over the lease term unless another systematic and rational allocation

basis is more representative of the time pattern in which the leased property is physically employed."

In addition, GAAP (FASB Technical Bulletin No. 88-1) states:

a. "If rents escalate in contemplation of the lessee's physical use of the leased property,including equipment, but the lessee takes possession of or controls the physical useof the property at the beginning of the lease term, all rental payments, including theescalated rents, should be recognized as rental expense or rental revenue on astraight-line basis in accordance with paragraph 15 of Statement 13 and TechnicalBulletin 85-3 starting with the beginning of the lease term."

b. "Payments made to or on behalf of the lessee represent incentives that should beconsidered reductions of rental expense by the lessee and reductions of rental revenueby the lessor over the term of the new lease."

170. Bally did not recognize rent expense on club leases with escalating rental obligations

using the required straight-line rent method, and it did not reflect lease incentives as reductions of


62

rental expense over the term of the lease. Moreover, Bally reflected tenant allowances as a reduction

to property and equipment and depreciated these amounts (and the related leasehold improvements)

over periods which exceeded either the useful life of the improvement or the lease term, or both

("The Company did not maintain effective policies and procedures related to its accounting for leases

and did not. . . document and review its accounting for leases to ensure that such accounting

complied with U.S. generally accepted accounting principles."). This accounting was improper and

in violation of GAAP (Accounting research Bulletin No. 43) which states:

The cost of a productive facility is one of the costs of the services it renders duringits useful economic life. Generally accepted accounting principles require that thiscost be spread over the expected useful life of the facility in such a way as to allocateit as equitably as possible to the periods during which services are obtained from theuse of the facility. This procedure is known as depreciation accounting, a system ofaccounting which aims to distribute the cost or other basic value of tangible capitalassets, less salvage (if any), over the estimated useful life of the unit (which maybe a group of assets) in a systematic and rational manner. It is a process ofallocation, not of valuation. (Emphasis added).

171. Through Restatement, Bally revised its previous financial reporting to (i) properly

reflect rent expense using the straight-line method over the lease term; to (ii) properly reflect lease

incentives (such as rent allowances) to be amortized as a reduction to rent expense; and to (iii)

depreciate leasehold improvements over the lesser of the assets economic life or the contractual term

of the lease, excluding all renewal options. In this regard, Bally revised its previous financial

reporting to recognize the impact of the foregoing changes, thereby effecting changes to reported

goodwill, deferred rent, accrued liabilities, long term liabilities, net property and equipment, long

term debt, interest expense, depreciation expense, and membership services expenses, thus admitting



63

Accounting For Income Taxes:

172. GAAP (FASB Statement No. 109) states:

A deferred tax asset is recognized for temporary differences that will result indeductible amounts in future years and for carryforwards. For example, a temporarydifference is created between the reported amount and the tax basis of a liability forestimated expenses if, for tax purposes, those estimated expenses are not deductibleuntil a future year. Settlement of that liability will result in tax deductions in futureyears, and a deferred tax asset is recognized in the current year for the reduction intaxes payable in future years. A valuation allowance is recognized if, based on theweight of available evidence, it is more likely than not that some portion or all of thedeferred tax asset will not be realized.

173. Bally did not comply with this GAAP because it caused its financial statements to

reflect deferred tax assets and valuation allowances thereon based upon improperly determined

taxable income and without having performed a realistic and objective assessment as to whether or

not it is more likely than not that some portion or all of the deferred tax asset will not be realized

("the Company reviewed the likelihood of realizing a future benefit from the related restatement

adjustments. As a result of this review, the Company increased its valuation allowance for the net

effect of the tax benefits resulting from the restatement adjustments and determined that the

valuation adjustment originally reversed in 2003 should be restated back to the period

recognized . . . In addition, the Company reviewed actual and contingent tax liabilities for the

restatement period and increased its contingency reserve accordingly."). (Emphasis added). In this

regard, Bally revised its previous financial reporting to properly reflect the amount of its reported

deferred tax and tax expense based upon a properly determined taxable income and a realistic and

objective assessment of the realizability of deferred taxes, thus admitting that its previously issued

financials statements were materially false and misleading.


64

174. Each of the foregoing misapplications of accounting principles, set forth above in ¶¶

128-173, served to overstate reported earnings, either by overstating reported revenues or by

understating reported expenses.

RESTATEMENT SUMMARY

175. The effects of the initial restatement and the Restatement on the reported revenue and

earnings may be summarized as follows:

($ In Millions)Quarter Ended 3/31/04Net revenues:

Membership revenue 184.2Products and services 55.7Miscellaneous revenue 4.8

Net revenues as reported in 3/31/04 Form 10-Q 244.7 Net revenues as restated in 12/31/04 Form 10-K 259.0

Net loss as reported in 3/31/04 Form 10-Q (13.8)Net loss as restated in 12/31/04 Form 10-K (15.8)

Year Ended 12/31/03Net revenues:


Net revenues as reported in 12/31/03 Form 10-K 953.5 Net revenues as restated in 12/31/04 Form 10-K 1,002.9

Net loss as reported in 12/31/03 Form 10-K (646.0)Net loss as restated in 12/31/04 Form 10-K (106.0)


65

Quarter Ended 9/30/03Net revenues:


Net revenues as reported in 9/30/03 Form 10-Q 241.5 Net revenues as restated in 12/31/03 Form 10-K 235.1Net revenues as restated in 12/31/04 Form 10-K 250.0

Net income as reported in 9/30/03 Form 10-Q 4.7Net loss as restated in 12/31/03 Form 10-K (2.8)Net loss as restated in 12/31/04 Form 10-K (4.8)



Net revenues as reported in 6/30/03 Form 10-Q 251.3Net revenues as restated in 12/31/03 Form 10-K 239.6Net revenues as restated in 12/31/04 Form 10-K 256.1




Net revenues as reported in 3/31/03 Form 10-Q 253.1 Net revenues as restated in 12/31/03 Form 10-K 240.2 Net revenues as restated in 12/31/04 Form 10-K 247.6



66


Membership revenue 730.6Products and services 217.6Miscellaneous revenue 19.9Special charge to receivable reserve (55.0)

Net revenues as reported in 12/31/02 Form 10-K 913.1Net revenues as restated in 12/31/03 Form 10-K 904.9Net revenues as restated in 12/31/04 Form 10-K 937.8

Net income as reported in 12/31/02 Form 10-K 3.5Net loss as restated in 12/31/03 Form 10-K (4.5)Net loss as restated in 12/31/04 Form 10-K (100.9)




Net income as reported in 9/30/02 Form 10-Q 7.2Net income as restated in 12/31/03 Form 10-K 5.4



Net revenues as reported in 6/30/02 Form 10-Q 246.4Net revenues as restated in 12/31/03 Form 10-K 244.9

Net income as reported in 6/30/02 Form 10-Q 16.1Net income as restated 4/04 14.9


67



Net revenues as reported in 3/31/02 Form 10-Q 240.4 Net revenues as restated 4/04 in 12/31/03 Form 10-K 238.1




Net revenues as reported in 12/31/01 Form 10-K 852.0Net revenues as restated in 12/31/03 Form 10-K 840.9Net revenues as restated in 12/31/04 Form 10-K 810.1

Net income as reported in 12/31/01 Form 10-K 80.7Net income as restated in 12/31/03 Form 10-K 70.1Net loss as restated in 12/31/04 Form 10-K (100.0)






68


Initial membership fees on financed memberships originated 137.4Initial membership fees on paid-in-full memberships originated 5.8Dues collected 72.8Change in deferred revenues 5.7Finance charges earned 17.3Products and services 37.5Miscellaneous revenue 4.8




Initial membership fees on financed memberships originated 146.2Initial membership fees on paid-in-full memberships originated 7.6Dues collected 73.2Change in deferred revenues (5.1)Finance charges earned 17.8Products and services 36.4Miscellaneous revenue 4.2




69


Initial membership fees on financed memberships originated 518.4Initial membership fees on paid-in-full memberships originated 24.6Dues collected 281.5Change in deferred revenues (12.4)Finance charges earned 68.4Products and services 111.0Miscellaneous 15.6

Net revenues as reported in 12/31/00 Form 10-K 1,007.1Net revenues as restated in 12/31/03 Form 10-K 789.9Net revenues as restated in 12/31/04 Form 10-K 735.6

Net income as reported in 12/31/00 Form 10-K 78.6 Net income as restated in 12/31/03 Form 10-K 82.6Net loss as restated in 12/31/04 Form 10-K (141.9)






70



Net revenue as reported in 6/30/00 Form 10-Q 250.9Net revenues as restated in 12/31/03 Form 10-K 194.9







71


Initial membership fees on financed memberships originated 465.4Initial membership fees on paid-in-full memberships originated 23.7Dues collected 243.0Change in deferred revenues (4.0)Finance charges earned 59.4Products and services 62.6Fees and other 11.0

Net revenues as reported in 12/31/99 Form 10-K 861.1Net revenues as restated in 12/31/03 Form 10-K 658.1

Net income as reported in 12/31/99 Form 10-K 42.2Net income as restated in 12/31/03 Form 10-K 37.3


Initial membership fees on financed memberships originated 120.0Initial membership fees on paid-in-full memberships originated 5.6Dues collected 58.9Change in deferred revenues (0.3)Finance charges earned 15.0Products and services 20.3

Net revenues as reported in 9/30/99 Form 10-Q 219.5Net revenues as restated in 12/31/03 Form 10-K/A 167.2

Net income as reported in 9/30/99 Form 10-Q 12.2Net income as restated in 12/31/03 Form 10-K/A 11.2


72


Initial membership fees on financed memberships originated 118.9Initial membership fees on paid-in-full memberships originated 5.4Dues collected 55.4Change in deferred revenues (0.8)Finance charges earned 15.4Fees and other 15.5

Net revenues as reported in 6/30/99 Form 10-Q 209.8Net revenues as restated in 12/31/03 Form 10-K/A 158.7

Net income as reported in 6/30/99 Form 10-Q 9.1 Net income as restated in 12/31/03 Form 10-K/A 8.7

DEFENDANTS’ SARBANES-OXLEY CERTIFICATIONS AND OTHERATTESTATIONS TO THE EFFICACY OF INTERNAL CONTROLS WERE ALSO

MATERIALLY FALSE AND MISLEADING WHEN MADE

176. Section 13(b)(2) of the Exchange Act states, in pertinent part, that every reporting

company must: (A) make and keep books, records and accounts which, in reasonable detail,

accurately and fairly reflect the transactions and disposition of the assets of the issuer; and (B) devise

and maintain a system of internal controls sufficient to provide reasonable assurances that

transactions are recorded as necessary to permit the preparation of financial statements in conformity

with GAAP. These provisions require an issuer to employ and supervise reliable personnel, to

maintain reasonable assurances that transactions are executed as authorized, to properly record

transactions on an issuer’s books and, at reasonable intervals, to compare accounting records with

physical assets.

177. Bally violated Section 13(b)(2)(B) of the Exchange Act by failing to implement

procedures reasonably designed to prevent accounting irregularities. Bally failed to put into place


73

proper reviews and checks to ensure that its management did not engage in accounting improprieties.

It failed to ensure that transactions were reported in accordance with GAAP.

178. Bally’s lack of adequate internal controls rendered the Company’s Class Period

financial reporting inherently unreliable and precluded the Company from preparing financial

statements that complied with GAAP. Nonetheless, during the Class Period, the Company regularly

issued quarterly and annual financial statements without ever disclosing the existence of the

significant and material deficiencies in its internal accounting controls and falsely asserted that its

financial statements complied with GAAP.

179. Each Sarbanes-Oxley certification issued during the Class Period, in which the

Individual Defendants specifically warranted that they had personally designed and implemented

internal control procedures to ensure the disclosure of “any fraud, whether or not material, that

involves management or other employees who have a significant role in the Registrant's internal

controls” were false and misleading when made for the reasons set forth above.

ADDITIONAL SEC VIOLATIONS

180. Item 7 of Form 10-K and Item 2 of Form 10-Q, Management’s Discussion and

Analysis of Financial Condition and Results of Operations (“MD&A”), require the issuer to furnish

information required by Item 303 of Regulation S-K [17 C.F.R. 229.303]. In discussing results of

operations, Item 303 of Regulation S-K requires the registrant to:

Describe any known trends or uncertainties that have had or that the registrantreasonably expects will have a material favorable or unfavorable impact on net salesor revenues or income from continuing operations.

The instructions to Paragraph 303(a) further state:


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The discussion and analysis shall focus specifically on material events anduncertainties known to management that would cause reported financial informationnot to be necessarily indicative of future operating results . . . .

181. In addition, the SEC, in its May 18, 1989 Interpretive Release No. 34-26831, has

indicated that registrants should employ the following two-step analysis in determining when a

known trend or uncertainty is required to be included in the MD&A disclosure pursuant to Item 303

of Regulation S-K:

A disclosure duty exists where a trend, demand, commitment, event or uncertaintyis both presently known to management and is reasonably likely to have a materialeffect on the registrant’s financial condition or results of operations.

182. Nonetheless, Bally’s Class Period Forms 10-K and 10-Q failed to disclose the

Company’s improper accounting practices as noted above as well as its internal control system

deficiencies, all of which were reasonably likely to have a material adverse effect on Bally’s

operating results, and the disclosure of such was necessary for a proper understanding and evaluation

of the Company’s operating performance and an informed investment decision.

E&Y’S AUDIT OPINIONS WERE MATERIALLY FALSE AND MISLEADING WHENMADE BECAUSE BALLY’S FINANCIAL STATEMENTS DID NOT CONFORM TO

GAAP AND E&Y’S AUDITS DID NOT CONFORM TO GAAS

183. On or about February 9, 2000, E&Y issued its unqualified audit opinion on the

consolidated financial statements of Bally as of December 31, 1999 and 1998, and for each of the

three years in the period ended December 31, 1999. This audit opinion, which was contained in

E&Y's report as reproduced in the Company's Form 10-K for the year ended December 31, 1999

which was filed with the SEC on or about March 30, 2000 ("the 1999 Form 10-K") with the written

consent of E&Y (which was appended to the 1999 Form 10-K as exhibit 23), stated:


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REPORT OF INDEPENDENT AUDITORSThe Board of Directors and StockholdersBally Total Fitness Holding Corporation

We have audited the accompanying consolidated balance sheets of Bally TotalFitness Holding Corporation as of December 31, 1999 and 1998, and the relatedconsolidated statements of operations, stockholders’ equity and cash flows for eachof the three years in the period ended December 31, 1999. Our audits also includedthe financial statement schedule listed in the Index at Item 14(a)2. These financialstatements and the schedule are the responsibility of the Company’s management.Our responsibility is to express an opinion on these financial statements and theschedule based on our audits.

We conducted our audits in accordance with auditing standards generally acceptedin the United States. Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements. An audit alsoincludes assessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation. Webelieve 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 consolidated financial position of Bally Total FitnessHolding Corporation at December 31, 1999 and 1998, and the consolidated resultsof its operations and its cash flows for each of the three years in the period endedDecember 31, 1999, in conformity with accounting principles generally accepted inthe United States. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic financial statements taken as a whole,presents fairly in all material respects the information set forth therein. As discussedin the Summary of Significant Accounting Policies footnote to the consolidatedfinancial statements, in 1999 the Company changed its method of accounting forstart-up costs. (Emphasis added).

184. The E&Y-referenced "Summary of Significant Accounting Policies footnote" which

discussed the "changed. . . method of accounting for start-up costs" stated:

In April 1998, the American Institute of Certified Public Accountants issuedStatement of Position ("SOP") 98-5, Reporting the Costs of Start-up Activities, andwas effective beginning on January 1, 1999. SOP 98-5 required that start-up costs,including organization costs capitalized prior to January 1, 1999, be written offand any future start-up costs be expensed as incurred. (Emphasis added). The


76

Company's unamortized start-up costs at January 1, 1999 were written off andreported as a cumulative effect of a change in accounting principle, net of tax.

185. On or about February 13, 2001 (except for a subsequent events note, as to which the

date was March 7, 2001), E&Y issued its unqualified audit opinion on the consolidated financial

statements of Bally as of December 31, 2000 and 1999, and for each of the three years in the period

ended December 31, 2000. This audit opinion, which was contained in E&Y's report as reproduced

in the Company's Form 10-K for the year ended December 31, 2000 which was filed with the SEC

on or about March 9, 2001 ("the 2000 Form 10-K") with the written consent of E&Y (which was

appended to the 2000 Form 10-K as exhibit 23), stated:

REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Bally Total Fitness Holding Corporation

We have audited the accompanying consolidated balance sheets of Bally TotalFitness Holding Corporation as of December 31, 2000 and 1999, and the relatedconsolidated statements of income, stockholders' equity and cash flows for each ofthe three years in the period ended December 31, 2000. Our audits also included thefinancial statement schedule listed in the Index at Item 14(a)2. These financialstatements and the schedule are the responsibility of the Company's management.Our responsibility is to express an opinion on these financial statements and theschedule based on our audits.


In our opinion, the consolidated financial statements referred to above present fairly,in all material respects, the consolidated financial position of Bally Total FitnessHolding Corporation at December 31, 2000 and 1999, and the consolidated resultsof its operations and its cash flows for each of the three years in the period endedDecember 31, 2000, in conformity with accounting principles generally accepted in


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the United States. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic financial statements taken as a whole,presents fairly in all material respects the information set forth therein.

As discussed in the Summary of Significant Accounting Policies footnote to theconsolidated financial statements, in 1999 the Company changed its method ofaccounting for start-up costs. (Emphasis added).


discussed the "changed. . . method of accounting for start-up costs" stated:

In April 1998, the American Institute of Certified Public Accountants issuedStatement of Position ("SOP") 98-5, Reporting the Costs of Start-up Activities, andwas effective beginning on January 1, 1999. SOP 98-5 required that start-up costs,including organization costs capitalized prior to January 1, 1999, be written offand any future start-up costs be expensed as incurred. The Company'sunamortized start-up costs at January 1, 1999 were written off and reported as acumulative effect of a change in accounting principle, net of tax. (Emphasis added).




E&Y's report as reproduced in the Company's Form 10-K for the year ended December 31, 2001,

filed with the SEC on or about March 27, 2002 ("the 2001 Form 10-K") with the written consent of

E&Y (which was appended to the 2001 Form 10-K as exhibit 23), stated:




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In our opinion, the consolidated financial statements referred to above present fairly,in all material respects, the consolidated financial position of Bally Total FitnessHolding Corporation at December 31, 2001 and 2000, and the consolidated resultsof its operations and its cash flows for each of the three years in the period endedDecember 31, 2001, in conformity with accounting principles generally accepted inthe United States. Also, in our opinion, the related financial statement schedule,when considered in relation to the basic financial statements taken as a whole,presents fairly in all material respects the information set forth therein.

As discussed in the Summary of Significant Accounting Policies footnote to theconsolidated financial statements, in 1999 the Company changed its method ofaccounting for start-up costs. (Emphasis added).


discussed the "changed. . . method of accounting for start-up costs" contained language which was

substantially identical to the discussion which appeared in the 1999 and 2000 Form 10-K as

particularized above.




E&Y's report as reproduced in the Company's Form 10-K for the year ended December 31, 2002

which was filed with the SEC on or about March 28, 2003 ("the 2002 Form 10-K") with the written

consent of E&Y (which was appended to the 2002 Form 10-K as exhibit 23), stated:


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As discussed in the Goodwill, trademarks and intangible assets note to theconsolidated financial statements, in 2002 the Company changed its method ofaccounting for goodwill and intangible assets.

190. The E&Y-referenced "Goodwill, trademarks and intangible assets note to the

consolidated financial statements" stated:

Prior to the implementation in the first quarter of 2002 of Statement of FinancialAccounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No.142), goodwill had been amortized on the straight-line method over periods rangingup to 40 years from dates of acquisition. Amounts assigned to acquired operatinglease rights, are being amortized on the straight-line method over the remaining lease


80

periods (six to 20 years). Also in 2000, we purchased certain marks, including the"Bally Total Fitness" service mark, from their owner. Prior to this purchase, themarks were used pursuant to a long-term trademark license agreement. At December31, 2002, these trademarks had a net book value of $6,969. Prior to theimplementation of SFAS No. 142 the Company annually evaluated whether thecarrying value of goodwill warranted revision, generally consideringexpectations of future profitability and cash flows (undiscounted and withoutinterest charges) on a consolidated basis. No revisions have been recorded. Asa result of the adoption of SFAS No. 142 the Company ceased amortization ofgoodwill and indefinite lived trademarks in 2002 in accordance with theprovisions of this standard. Upon adoption, the Company determined that thevalue of recorded goodwill was not impaired. Based on the decline in theCompany's common stock price below book value per share, the Companyperformed an assessment of business valuation and concluded that noimpairment of goodwill has occurred based on current projections of futurecash flows. (Emphasis added).

191. On or about March 11, 2004, E&Y issued its unqualified audit opinion on the

consolidated financial statements of Bally as of December 31, 2003 and, as restated, 2002 and 2001,

and for each of the three years in the period ended December 31, 2003. This audit opinion, which

was contained in E&Y's report as reproduced in the Company's Form 10-K for the year ended

December 31, 2003 which was filed with the SEC on or about March 30, 2004 ("the 2003 Form 10-

K") with the written consent of E&Y (which was appended to the 2003 Form 10-K as exhibit 23),

stated:


We have audited the accompanying consolidated balance sheets of Bally TotalFitness Holding Corporation as of December 31, 2003 and, as restated, 2002, and therelated consolidated statements of operations, stockholders' equity (deficit) and cashflows for the years ended December 31, 2003 and, as restated, 2002 and 2001. Ouraudits also included the financial statement schedule listed in the Index at Item15(a)2. These financial statements and the schedule are the responsibility of theCompany's management. Our responsibility is to express an opinion on thesefinancial statements and the schedule based on our audits.


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As discussed in the Changes in accounting Note to the consolidated financialstatements, in 2003, the Company changed its methods of accounting for recognitionof revenue from membership contracts, membership origination costs, and assetretirement obligations and, as discussed in the Goodwill, trademarks and intangibleassets Note, in 2002, the Company changed its method of accounting for goodwilland intangible assets.

192. The E&Y-referenced "Note to the consolidated financial statements" which described

the changes in Bally's methods of accounting for recognition of revenue from membership contracts,

membership origination costs, and asset retirement obligations stated:

In 2003, we changed our accounting for the recognition of financed initialmembership fees from our prior 22-month pool deferral method to a preferablemodified cash method of recognition and implemented EITF 00-21 "RevenueArrangements with Multiple Deliverables." We also changed our accounting for therecognition of recoveries of unpaid dues on inactive membership contracts fromaccrual-based estimations to a preferable cash basis of recognition. Concurrently withthe change in accounting for membership fees, we also changed our method ofaccounting in 2003 for initial membership origination costs from our prior methodwhere such costs were deferred and recognized over the same period used forrevenue recognition to a preferable method of expensing such costs as incurred.These accounting changes were all implemented as of the beginning of 2003 as acumulative effect of changes in accounting and as a result we recorded non-cashcharges of $441 million related to the change to the modified cash basis of


82

accounting for membership fees and adoption of EITF 00-21, $21 million related tothe change regarding unpaid dues on inactive membership contracts and $119 millionrelated to the change in accounting for initial membership fee origination costs.

As a result of the accounting changes described in the preceding paragraph and thelower level of proforma historical earnings under the new revenue recognitionpolicies, we additionally recorded a special tax provision of $50.5 million in 2003 toreduce previously recognized deferred tax assets.

In applying the new accounting for membership revenues as described above, it wasdetermined in consultation with our independent auditors that our previousmethodology of accounting for the deferral of prepayments of non-obligatorydues resulted in errors in calculating deferred revenue related to prepaid dues.As a result the Company has restated prior periods in accordance with therequirements of Accounting Principles Board Opinion No. 20 "Accounting Changes."The impact of the correction to previously reported net revenues and net income wasa reduction of $8.0 million ($.25 per diluted share), $10.6 million ($.36 per dilutedshare), and $4.9 million ($.18 per diluted share) in each of the years 2002, 2001 and1999, respectively, and an increase in reported net revenues and net income in 2000of $4.0 million ($.14 per diluted share). The impact of the correction to previouslyreported deferred revenue and stockholders' equity was an increase in deferredrevenue and a decrease in stockholders' equity of $43.0 million, $35.0 million, $24.4million and $28.4 million at the end of each of the years 2002 through 1999,respectively.

*****

We elected to change our accounting methods effective January 1, 2003 related to therecognition of revenue from membership contracts, initial membership originationcosts, and asset retirement obligations. The cumulative effect as of January 1, 2003of these changes in accounting principles has been charged to the 2003 statement ofoperations. These charges are discussed below.

As required, we adopted the provisions of EITF 00-21 "Revenue Arrangements withMultiple Deliverables" as it relates to revenues included in initial membershipcontracts. Under the previously acceptable method, revenues allocated to productsand services included in initial membership contracts, including financed contracts,were recognized upon delivery to the member. The new pronouncement limits theamount of revenue we can recognize upon delivery of the products and services tocash collected upon membership origination. Limiting early recognition to cashcollected resulted in a reversal of amounts previously recognized upon membershipsale, and an increase in amounts deferred to be recognized during future periods.


83

Concurrent with the adoption of EITF 00-21, we elected to adopt a modified cashbasis of accounting for the recognition of membership fees effective January 1, 2003.Under the new method, membership revenue is recognized as income at the later ofwhen it is collected, or in the case of paid-in-full memberships or accelerated receiptsfrom financed memberships, when earned. This changes the pre-2003 22-month pooldeferral method that amortized revenues from financed initial membership fees onthe straight-line basis, after application of estimated uncollectible amounts. The useof the modified cash basis, which is viewed by us and by our independentauditors as a preferable accounting method, recognizes membership revenueover a longer period than the previous method. We have also applied the modifiedcash basis of recognition to our accounting for non-obligatory membership dues.Since monthly dues are collected in arrears, prior to 2003 we included in other assetsa receivable for uncollected dues at the end of each period. Under the modified cashbasis, the recognition of membership dues revenue has been changed to the later ofeither collected or earned consistent with our new policy for membership fees. As aresult, the receivable for earned but uncollected dues has been reversed and isincluded as a component of the cumulative effect adjustment.

Concurrent with our change to the modified cash basis of revenue recognition asdescribed above, in 2003 we additionally changed our accounting principle for initialmembership origination costs from the pre-2003 method whereby such costs weredeferred and recognized over the same period used for revenue recognition toexpensing such costs as incurred. This change has also been determined to be apreferable method when considered along with the modified cash basis adopted formembership fee recognition.

In the second quarter of 2003, we changed our accounting for the recognition ofrecoveries of unpaid dues on inactive membership contracts from accrual-basedestimations to a cash basis of recognition, which was considered a preferable methodof accounting for such past due amounts.

We believe these changes in accounting to recognize membership revenues at thelater of when collected or earned and to expense membership origination costs asincurred will result in financial reporting that is more understandable to the reader.The new methods also reduce the impact of estimations in the financial reportingprocess by eliminating the need to estimate the amount and timing of future membercollections for purposes of revenue and expense recognition.

We also implemented the provisions of Statement of Financial Accounting StandardsNo. 143, "Accounting for Asset Retirement Obligations," in the first quarter of 2003.It requires that we recognize the fair value of a liability for an asset retirementobligation in the period in which it is incurred if a reasonable estimate of fair valuecan be made. The associated asset retirement costs are then capitalized as part of thecarrying amount of the long-lived asset. As a result, a non-cash cumulative


84

adjustment of $.2 million was recorded to provide for estimated future restorationobligations on our leaseholds. (Emphasis added).

193. The 2003 Form 10-K contained the following management disclosure: "As of March

25, 2004, Ernst & Young LLP resigned as independent auditors for the Company effective no later

than the filing with the Commission of the Company's Quarterly Report on Form 10-Q for the

quarter ending March 31, 2004."

194. E&Y's unqualified audit opinions on the financial statements of the Company as of

and for the years ended December 31, 1999, December 31, 2000, December 31, 2001, December 31,

2002, and December 31, 2003, were materially false and misleading because these financial

statements were not presented in accordance with GAAP nor were they audited in accordance with

GAAS.

195. GAAS, as set forth in AICPA Professional Standards Volume 1, U.S. Auditing

Standards ("AU"), in section AU 411, describes "The Meaning of Present Fairly in Conformity With

Generally Accepted Accounting Principles in the Auditor's Report." It states:

The auditor's opinion that financial statements present fairly an entity's financialposition, results of operations, and cash flows in conformity with generally acceptedaccounting principles should be based on his judgement as to whether (a) theaccounting principles selected and applied have general acceptance; (b) theaccounting principles are appropriate in the circumstances; (c) the financialstatements, including the related notes, are informative of matters that may affecttheir use, understanding, and interpretation. . . ; (d) the information presented in thefinancial statements is classified and summarized in a reasonable manner, that is,neither too detailed nor too condensed. . . ; and (e) the financial statements reflect theunderlying events and transactions in a manner that presents the financial position,results of operations, and cash flows within a range of acceptable limits, that is, limitsthat are reasonable and practicable to attain in financial statements.


85

196. During the Class Period, the audited financial statements of the Company, which were

publicly disseminated, were not presented "fairly in conformity with generally accepted accounting

principles" because as subsequently admitted through Restatement, the:

a. Accounting principles selected and applied did not have general acceptance.

b. Accounting principles were not appropriate in the circumstances.

c. Financial statements, including the related notes, were not informative of matters thataffected their use, understanding, and interpretation.

d. Financial statements did not reflect the underlying events and transactions in amanner that presented the financial position and the results of operations within arange of acceptable limits that were reasonable and practicable to attain in financialstatements.

197. E&Y knew it was required to adhere to standards and principles of GAAS, including

the requirement that the financial statements comply in all material respects with GAAP. E&Y, in

issuing its unqualified audit opinions, as alleged herein, knew that by doing so it was engaging in

a gross departure from GAAS, or issued such certification with reckless disregard for whether or not

GAAS was being complied with.

198. In the introductory portion of Accounting Series Release 173, the SEC made the

following comments pertaining to economic substance:

Another problem. . . is the need for emphasizing the importance of substance overform in determining accounting principles to be applied to particular transactions andsituations. In addition to considering substance over form in particular transactions,it is important that the overall impression created by the financial statements beconsistent with the business realities of the company's financial position andoperations.

We believe that the auditor must stand back from his resolution of particularaccounting issues and assess the aggregate impact of the particular issues upon areasonable investor's perception of the economic substance of the enterprise forwhich the financial statements are being presented.


86

199. In opining on the fairness of the financial statements of the Company, E&Y failed to

assess the propriety of the accounting principles used by the Company and it failed to consider the

importance of substance over form in determining accounting principles to be applied.

200. As noted by the SEC in its Accounting And Auditing Enforcement Release No. 817

(September 19, 1996) "In the Matter of Cypress Bioscience Inc. and Alex P. De Soto, CPA": "It is

a well-established tenet of GAAP that transactions must be accounted for in accordance with their

substance rather than their form."

201. Due to the failure of the Company to account for transactions in accordance with their

substance rather than their form, the overall impression created by the financial statements was

inconsistent with the business realities of the Company's financial position and operations, and as

a result they were deceptive and materially misleading.

202. E&Y knew and recklessly disregarded, or was reckless in not knowing, the facts set

forth herein concerning the non-GAAP accounting and the materially false and misleading

disclosures which were contained in the Company's filings with the SEC during the Class Period.

E&Y further knew and disregarded, or was reckless in not knowing, that such non-GAAP accounting

and the materially false and misleading disclosures resulted in material misstatements of the

Company's financial position and results of operation.

203. E&Y's unqualified audit opinions, insofar as they state that E&Y's audits of the

Company's financial statements were conducted in accordance with GAAS, were false and

misleading because the following GAAS (AU 150) were knowingly or recklessly violated:

a. General Standard No. 1 was violated, which standard requires that the examinationis to be performed by a person or persons having adequate technical training andproficiency as an auditor.


87

b. General Standard No. 3 was violated, which standard requires that due professionalcare is to be exercised in the performance of the examination and in the preparationof the report.

c. Standard Of Field Work No. 1 was violated, which standard requires that the workis to be adequately planned and assistants, if any, are to be properly supervised.

d. Standard Of Field Work No. 2 was violated, which standard requires that a sufficientunderstanding of the internal control structure is to be obtained to plan the audit andto determine the nature, timing and extent of tests to be performed.

e. Standard Of Field Work No. 3 was violated, which standard requires that sufficientcompetent evidential matter is to be obtained through inspection, observation,inquiries, and confirmations to afford a reasonable basis for an opinion regarding thefinancial statements under examination.

f. Standard Of Reporting No. 1 was violated, which standard requires that the reportshall state whether the financial statements are presented in accordance withgenerally accepted accounting principles.

g. Standard Of Reporting No. 3 was violated, which standard requires that informativedisclosures in the financial statements are to be regarded as reasonably adequateunless otherwise stated in the report.

204. Bally restated its previously issued financial statements to correct its prior accounting.

As discussed above, these corrections were, in significant part, required to rectify improper

accounting for:

a. Membership Revenue

b. Membership Acquisition Expenses

c. Recoveries Of Unpaid Dues

d. Acquired Payment Obligations

e. Sales Of Future Receivables

f. Prepaid Personal Training Services

g. Multiple Element Arrangements


88

h. Self-Insurance Liabilities

i. Costs Incurred To Develop Internal-Use Computer Software

j. The Valuation Of Goodwill And Separately Identifiable Assets Apart From Goodwill

k. The Amortization Of Goodwill

l. Fixed Asset Impairment

m. Escheatment Obligations

n. Advertising Costs

o. Maintenance Costs

p. Start-Up Costs

q. Inventory

r. Accruals

s. Foreign Exchange Gains And Losses

t. Leases

u. Income Taxes

205. Although each of the above listed accounting issues was material to Bally's financial

statements, Bally's accounting policy with respect to certain of these issues was not disclosed during

the Class Period. For example, prior to effecting changes to Bally's previously issued financial

statements, Bally never disclosed the fact that it:

a. self-insured against risks arising from workers' compensation claims, health and lifeinsurance claims, and general liability claims.

b. capitalized all costs associated with endeavors to develop computer software,irrespective of whether such costs were properly capitalizable.

c. capitalized all advertising costs, irrespective of whether such costs were properlycapitalizable, and allocated these costs over the estimated life of the advertising.


89

d. recognized revenue by billing inactive members for dues, although such dues werenot paid by the inactive members.

e. did not account for foreign currency gains and losses.

f. did not account for escheatment obligations.

g. did not record all assets obtained and all liabilities assumed in businesscombinations.

206. Non-disclosure of the foregoing accounting policies violated GAAP (APB Opinion

No. 22) which states:

Disclosure of accounting policies should identify and describe the accountingprinciples followed by the reporting entity and the methods of applying thoseprinciples that materially affect the determination of financial position, changes infinancial position, or results of operations. In general, the disclosure shouldencompass important judgments as to appropriateness of principles relating torecognition of revenue and allocation of asset costs to current and future periods. . .Examples of disclosures by a business entity commonly required with respect toaccounting policies would include, among others, those relating to basis ofconsolidation, depreciation methods, amortization of intangibles, inventory pricing,accounting for research and development costs (including basis for amortization),translation of foreign currencies, recognition of profit on long-term construction-typecontracts, and recognition of revenue from franchising and leasing operations. Thislist of examples is not all-inclusive. (Emphasis added).

207. Although the foregoing accounting policies (including the "required" disclosure of

accounting policies governing translation of foreign currencies) were not disclosed, throughout the

Class Period E&Y falsely led the investment community to believe that all accounting policies which

materially affected the determination of Bally's financial position and results of operations had been

disclosed in notes to Bally's financial statements by issuing unqualified audit opinions which stated

that:

a. E&Y's "audit includes examining, on a test basis, evidence supporting the. . .disclosures in the financial statements"


90

b. "the consolidated financial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Bally Total Fitness HoldingCorporation. . . and the consolidated results of its operations"

208. As noted above, E&Y's February 9, 2000 unqualified audit opinion, E&Y's February

13, 2001 (except for a subsequent events note as to which the date was March 7, 2001) unqualified

audit opinion and E&Y's February 12, 2002 unqualified audit opinion each emphasized (in a separate

paragraph -- AU Section 508) the fact that (i) Bally had "changed its method of accounting for

start-up costs" and (ii) referred to a note to Bally's financial statements which stated that "beginning

on January 1, 1999" GAAP "required that start-up costs. . . be written off and any future start-up

costs be expensed as incurred." Accordingly, there is no question that both E&Y and the Bally

defendants understood the appropriate accounting for start-up costs.

209. Despite this fact, during the Class Period, the Bally defendants caused start-up costs

(particularly rental charges on new club facilities which were being readied for their grand opening)

to be capitalized, and E&Y failed to qualify its Class Period audit opinions as a result of this flagrant

violation of GAAP as required by GAAS (AU Section 508).

210. Upon Restatement, the Company admitted (in the 2004 Form 10-K) that correction

of the improper accounting required a $7,937,000 adjustment "as of January 1, 2002."

211. As noted above E&Y's February 12, 2003 unqualified audit opinion and E&Y's March

11, 2004 unqualified audit opinion each emphasized (in a separate paragraph -- AU Section 508) the

fact that (i) Bally had "changed its method of accounting for goodwill and intangible assets" and (ii)

referred to a note to Bally's financial statements which stated: "Prior to the implementation in the

first quarter of 2002. . . the Company annually evaluated whether the carrying value of goodwill


91

warranted revision" and determined that no revisions were required; that "no impairment of goodwill

has occurred."

212. Various narrative disclosures, including notes to the financial statements which

appeared in the 2002 Form 10-K and the 2003 Form 10-K, made it very clear that both E&Y and the

Bally defendants understood the determinants of goodwill impairment and the appropriate

accounting for such impairments.

213. Despite this fact, during the Class Period, the Bally defendants failed to recognize

obvious impairment charges for accounting purposes, and E&Y failed to qualify its Class Period

audit opinions as a result of this flagrant violation of GAAP as required by GAAS (AU Section 508).

214. Upon Restatement, the Company's financial statements (as reflected in the 2004

Form 10-K) reflected goodwill impairment charges of $54.5 million and $1.6 million in 2003 and

2002, respectively, and other impairment charges for periods prior thereto.

215. The "Goodwill, trademarks and intangible assets" note, which E&Y's February 12,

2003 audit opinion referred to, also stated: "Amounts assigned to acquired operating lease rights,

are being amortized on the straight-line method over the remaining lease periods (six to 20 years)."

(Emphasis added).

216. Accordingly, there is no question that both E&Y and the Bally defendants understood

that "acquired operating lease rights" were intangible assets that were required to be assigned a

value and recognized for accounting purposes.

217. Despite this fact, and despite the fact that both E&Y and the Bally defendants had

unrestricted access to one of the finest accounting research tools in the nation ("Other fees paid to

Ernst & Young LLP for 2003 included $2,500 for a subscription to EY On-line, an accounting


92

research tool." -- June 10, 2004 Form 14A), during the Class Period, the Bally defendants failed to

recognize "acquired operating lease rights" for accounting purposes, and E&Y failed to qualify its

Class Period audit opinions as a result of this flagrant violation of GAAP as required by GAAS (AU

Section 508). The admission of wrongdoing is unequivocal. Upon Restatement, the Company

stated:

. . . in applying APB 16, Business Combinations, we should have allocated a portionof the purchase price to certain separately identifiable intangible assets: a) "MembershipRelations" which represents the fair market value of relationships with existing members asof the acquisition date: b) "Non-compete Agreements" which represents the fair market valueof the non-competition agreement with the seller of the acquired company: c) "Trade name"which represents the fair value of the trade names associated with the acquired operations,and; d) "Leasehold Rights" which represents the estimate of the favorable andunfavorable lease agreements in place as of the acquisition date. The impact of thiscorrection resulted in a decrease of goodwill and non-compete agreements and an increasein membership relations, trade name and leasehold rights of $14,651, $29, $5,943, $1,600and $7,138, respectively, as of January 1, 2000. The impact of this correction resulted in adecrease in goodwill of $91,581 as of January 1, 2002. In addition, for the year endedDecember 31, 2003 and 2002, this correction resulted in an increase in depreciation andamortization of $6,404 and $8,435, respectively. (Emphasis added)

218. Other flagrant violations of GAAP during the Class Period, which were corrected

through Restatement, are discussed at paragraphs 128 through 173 above.

219. None of the Restatement adjustments was predicated upon judgmental determinations

which were subject to interpretative differences. Each adjustment was required to rectify

unquestionably wrong accounting as determined by PricewaterhouseCoopers LLP and KPMG LLP,

two of the nationally recognized "big four" accounting firms. Accordingly, the 2004 Form 10-K set

forth a plethora of accounting corrections and, in addition, contained the following representations

in addition to others discussed above:

In November 2004, the Audit Committee announced that based on the results of theinvestigation led by independent legal counsel at Bingham McCutchen LLP("Bingham") who consulted with accounting experts PricewaterhouseCoopers LLP


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("PwC") and Marshall Wallace, both retained by Bingham, and in consultation withKPMG, it had determined that:

o following the 1999 promulgation of Staff Accounting Bulletin No.101, "Revenue Recognition," beginning in the year ended December31, 2000, the Company should have changed its revenue recognitionpolicy for membership initiation fees. The Audit Committeedetermined that the Company should have recognized all membershipfees over the longer of the contractual life or the period over whichservices are expected to be provided, and concluded that the deferredpool method used by the Company did not meet this standard ofrecognition as the recognition period was in most cases shorter thanthe contract life. Additionally, the Audit Committee determined thatthe 2003 adoption of the modified cash basis method of accountingfor revenue recognition failed to defer initial membership fee revenuebeyond the initial contract period for certain members who areexpected to maintain their membership beyond the initial period ofmembership (36 months in most markets) and therefore requiredchanges to extend recognition over such renewal periods;

o prior to the second quarter of 2003, the Company's recognition ofrevenue associated with recoveries of unpaid dues on inactivemember contracts was in error (See Restatement - 2003 Changes inAccounting and Restatement);

o Bally's allowance for doubtful accounts was inadequate for yearsprior to and including 2003; and

o a liability related to repayment obligations of approximately $22million due in 2015 or later with respect to membership contractssold by a subsidiary before Bally acquired it in the late 1980s had notbeen reflected in the Company's financial statements since 1995.

*****

The Board of Directors and Stockholders Bally Total Fitness Holding Corporation:

We have audited management's assessment, included in the accompanyingManagement's Report on Internal Control Over Financial Reporting (Item 9A(b)),that Bally Total Fitness Holding Corporation (the Company) did not maintaineffective internal control over financial reporting as of December 31, 2004, becauseof the effects of material weaknesses identified in management's assessment, basedon criteria established in Internal Control - Integrated Framework issued by the


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Committee of Sponsoring Organizations of the Treadway Commission (COSO).Bally Total Fitness Holding Corporation's management is responsible for maintainingeffective internal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibility is toexpress an opinion on management's assessment and an opinion on the effectivenessof the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we planand perform the audit to obtain reasonable assurance about whether effective internalcontrol over financial reporting was maintained in all material respects. Our auditincluded obtaining an understanding of internal control over financial reporting,evaluating management's assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion.

A company's internal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance with generallyaccepted accounting principles. A company's internal control over financial reportingincludes those policies and procedures that (1) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financial statementsin accordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance with authorizationsof management and directors of the company; and (3) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, ordisposition of the company's assets that could have a material effect on the financialstatements.

Because of its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

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 theannual or interim financial statements will not be prevented or detected. Thefollowing material weaknesses have been identified and included in management'sassessment as of December 31, 2004:


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1. Deficiencies in the Company's control environment. The Company did notmaintain an effective control environment as defined in the InternalControl-Integrated Framework published by the Committee of SponsoringOrganizations of the Treadway Commission. Specifically, the following controldeficiencies were identified:

o The Company's finance and accounting resources were insufficient innumber, insufficiently trained, and authority and responsibility werenot properly delegated as of December 31, 2004. Accordingly, incertain circumstances, accounting control activities were notperformed consistently, accurately, and timely, and an effectivereview of technical accounting matters was not performed;

o Management did not have acceptable and clearly communicatedpolicies reflecting an appropriate management attitude towardsfinancial reporting and the financial reporting function and did nothave sufficient controls in place to ensure the appropriate selection ofand modifications to accounting policies;

o The Company did not establish effective controls to address the riskof management override in the financial reporting process; and

o Management did not have effective processes to ensure that relevantinformation was communicated in a timely manner from theCompany's regional service center, property management department,information technology group, human resources, sales and marketing,and legal department to the Company's corporate accountingdepartment.

These deficiencies resulted in a more than remote likelihood that a materialmisstatement of the Company's annual or interim financial statements would not beprevented or detected, and contributed to the development of other materialweaknesses described below.

2. Deficiencies in end-user computing controls. The Company did not maintainadequate controls over end-user computing. Specifically, controls over the access to,and completeness, accuracy, validity, and review of, certain spreadsheet informationthat supports the financial reporting process were either not designed appropriatelyor did not operate as designed.

This deficiency resulted in material errors in accounting, which required restatementof the Company's consolidated financial statements as of and for the years endedDecember 31, 2003 and 2002, and for interim periods in 2003 and the first quarterof 2004, to reflect the correction of these errors in accounting. These deficiencies also


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resulted in material errors in accounting that required correction in the Company'sconsolidated financial statements as of and for the year ended December 31, 2004prior to their issuance.

3. Inadequate controls associated with accounting for revenue. The Companydid not maintain effective policies and procedures related to its accounting forrevenue and did not employ personnel with the appropriate level of technicalknowledge and experience to prepare, document and review its accounting forrevenue to ensure that such accounting complied with U.S. generally acceptedaccounting principles. This lack of effective policies and procedures and lack ofknowledge and experience contributed to the Company's failure to:

o Select and implement membership revenue accounting policies inaccordance with U.S. generally accepted accounting principles;

o Effectively perform and document a periodic evaluation of thereasonableness of assumptions with respect to the deferral of revenueassociated with personal training services;

o Establish procedures to identify and periodically assess promotionaloffers to ensure that they were accounted for in accordance with U.S.generally accepted accounting principles;

o Establish procedures to identify and periodically assess changes to theCompany's principal member offers to ensure that they wereaccounted for in accordance with U.S. generally accepted accountingprinciples; and

o Execute policies and procedures to ensure that the financial reportingand disclosure obligations related to revenue recognition wereappropriately understood and considered.

These deficiencies resulted in material errors in accounting, which requiredrestatement of the Company's consolidated financial statements as of and for theyears ended December 31, 2003 and 2002, and for interim periods in 2003 and thefirst quarter of 2004, to reflect the correction of these errors in accounting. Thesedeficiencies also resulted in material errors in accounting that required correction inthe Company's consolidated financial statements as of and for the year endedDecember 31, 2004 prior to their issuance.

4. Inadequate controls associated with accounting for fixed assets. The Companydid not maintain effective policies and procedures related to its accounting for fixedassets and did not employ personnel with the appropriate level of knowledge andexperience to prepare, document and review its accounting for fixed assets to ensure


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that such accounting complied with U.S. generally accepted accounting principles.This lack of effective policies and procedures and lack of knowledge and experiencecontributed to the Company's failure to:

o Select and implement fixed asset accounting policies in accordancewith U.S. generally accepted accounting principles;

o Effectively perform and document procedures to periodically reviewthe valuation of capitalized costs incurred prior to the opening of afitness center;

o Effectively perform and document a review of fixed assetdepreciation;

o Effectively perform and document procedures to review capitalizablelabor costs;

o Effectively reconcile the subsidiary fixed asset ledger to consolidatedfixed asset information; and

o Execute policies and procedures to ensure that the financial reportingand disclosure obligations related to fixed assets were appropriatelyunderstood and considered.


5. Inadequate controls associated with accounting for goodwill and otherintangible assets. The Company did not maintain effective policies and proceduresrelated to its accounting for goodwill and other intangible assets and did not employpersonnel with the appropriate level of knowledge and experience to prepare,document and review its accounting for goodwill and other intangible assets toensure that such accounting complied with U.S. generally accepted accountingprinciples. This lack of effective policies and procedures and lack of knowledge andexperience contributed to the Company's failure to:

o Select and implement accounting policies in accordance with U.S.generally accepted accounting principles;


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o Effectively identify, and allocate an appropriate portion of the cost ofan acquisition to, identifiable intangible assets in conjunction with itspurchase business combinations;

o Effectively perform and document procedures to periodically reassessthe valuation of goodwill; and

o Execute policies and procedures to ensure that the financial reportingand disclosure obligations related to goodwill and other intangibleassets were appropriately understood and considered.


6. Inadequate controls associated with accounting for leases. The Company didnot maintain effective policies and procedures related to its accounting for leases anddid not employ personnel with the appropriate level of knowledge and experience toprepare, document and review its accounting for leases to ensure that such accountingcomplied with U.S. generally accepted accounting principles.

This lack of effective policies and procedures and lack of knowledge and experiencecontributed to the Company's failure to:

o Perform and document procedures to record rent expense on astraight-line basis over the lease term, when appropriate, and torecord a related deferred rent obligation, in accordance with U.S.generally accepted accounting principles;

o Perform and document procedures to ensure that leaseholdimprovements were properly depreciated over the lesser of theeconomic useful life or the lease term;

o Perform and document procedures to ensure leases were appropriatelyaccounted for as capital or operating leases;

o Perform procedures to periodically review the accounting for landlordincentives; and


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o Execute policies and procedures to ensure that the financial reportingand disclosure obligations related to leases were appropriatelyunderstood and considered.


7. Inadequate controls associated with accounting for accrued liabilities. TheCompany did not maintain effective policies and procedures related to its accountingfor accrued liabilities and did not employ personnel with the appropriate level ofknowledge and experience to prepare, document and review its accounting foraccrued liabilities to ensure that such accounting complied with U.S. generallyaccepted accounting principles. This lack of effective policies and procedures andlack of knowledge and experience contributed to the Company's failure to:

o Effectively perform and document procedures to periodically evaluatethe reasonableness of assumptions used to estimate liabilitiesassociated with workers compensation, health care, and other insuredarrangements with retained risk exposures;

o Perform and document procedures to periodically evaluate items thatmay meet the definition of unclaimed property, in order to properlyvalue the Company's escheatment liability;

o Perform and document procedures to periodically evaluate liabilitiesrelated to the Company's obligation to former members to refundinitial member fees in a future period;

o Perform and document a periodic assessment of the Company's risksharing obligation associated with its transfers of obligatory memberpayments to third parties;

o Effectively perform and document procedures to reconcilecommission and other payroll related liabilities to supporting detail;

o Effectively perform and document a review of expenses incurred inone period and paid in subsequent periods to ensure that the relatedaccounting is reflected in the appropriate period; and


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o Execute policies and procedures to ensure that the financial reportingand disclosure obligations related to accrued liabilities wereappropriately understood and considered.


8. Inadequate controls associated with accounting for computer software. TheCompany did not maintain adequate policies and procedures or employ sufficientlyknowledgeable and experienced personnel to ensure appropriate application ofStatement of Position (SOP) 98-1, Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use. This lack of effective policies andprocedures and lack of knowledge and experience contributed to the Company'sfailure to select and implement software accounting policies in accordance with U.S.generally accepted accounting principles, and effectively perform and documentprocedures to periodically reassess their valuation.

This deficiency resulted in material errors in accounting, which required restatementof the Company's consolidated financial statements as of and for the years endedDecember 31, 2003 and 2002, and for interim periods in 2003 and the first quarterof 2004, to reflect the correction of these errors in accounting. These deficiencies alsoresulted in material errors in accounting that required correction in the Company'sconsolidated financial statements as of and for the year ended December 31, 2004prior to their issuance.

9. Inadequate financial statement preparation and review procedures. TheCompany did not maintain effective policies and procedures related to its financialstatement preparation and review procedures and did not employ personnel with theappropriate level of knowledge and experience to ensure that accurate and reliableinterim and annual consolidated financial statements were prepared and reviewed ona timely basis. Specifically, the Company did not have:

o Effective reconciliation of significant balance sheet accounts;

o Effective reconciliation of subsidiaries' accounts to consolidatingfinancial information;

o Effective reconciliation and conversion of foreign financialstatements to consolidated financial information;


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o Policies and procedures relating to the origination and maintenanceof contemporaneous documentation to support key judgments madein connection with the selection of significant accounting policies orthe application of judgments within its financial reporting process;

o Policies and procedures related to the identification and disclosure ofsubsequent events;

o Policies and procedures related to the review of complex or unusualtransactions;

o Adequate policies and procedures related to the review and approvalof accounting entries;

o Sufficient retention policies with respect to historical documentationthat formed the basis of prior accounting judgments that havecontinuing relevance; and

o Effective review of financial statement information, and relatedpresentation and disclosure requirements.


We also have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets of BallyTotal Fitness Holding Corporation and subsidiaries as of December 31, 2004 and2003, and the related consolidated statements of operations, stockholders' equity(deficit) and comprehensive income, and cash flows for each of the years in thethree-year period ended December 31, 2004. The aforementioned materialweaknesses were considered in determining the nature, timing, and extent of audittests applied in our audit of the 2004 consolidated financial statements, and thisreport does not affect our report dated November 29, 2005, which expressed anunqualified opinion on those consolidated financial statements.

In our opinion, management's assessment that Bally Total Fitness HoldingCorporation did not maintain effective internal control over financial reporting as ofDecember 31, 2004, is fairly stated, in all material respects, based on criteriaestablished in Internal Control - Integrated Framework issued by the Committee of


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Sponsoring Organizations of the Treadway Commission (COSO). Also, in ouropinion, because of the effect of the material weaknesses described above on theachievement of the objectives of the control criteria, Bally Total Fitness HoldingCorporation has not maintained effective internal control over financial reporting asof December 31, 2004, based on criteria established in Internal Control - IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (COSO).

/s/ KPMG LLP Chicago, Illinois November 29, 2005

220. Each and every audit opinion which E&Y expressed during the Class Period stated

that its audit "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." This representation was materially false and

misleading because E&Y either failed to assess the propriety of the accounting principles used by

the Company and to consider the Company's use of non-GAAP accounting as specified above, or

did so in an egregiously reckless manner.

221. In auditing Bally's financial statements as of and for the years ending December 31,

1999, December 31, 2000, December 31, 2001, December 31, 2002, and December 31, 2003, E&Y

either identified and ignored, or recklessly failed to investigate extremely questionable transactions,

and made audit judgments that no reasonable auditor would have made if confronted with the same

facts. Accordingly, E&Y's audits were so deficient that they amounted to no audit at all.

222. Had E&Y undertaken the performance of those audit procedures which were required

by GAAS, and with the due professional care which was required by GAAS, it would have known

that the Company's 1999, 2000, 2001, 2002, and 2003 financial statements were materially false and

misleading because these financial statements were not presented in accordance with GAAP.


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223. Given the woefully deficient state of Bally's internal controls, E&Y was required by

GAAS (AU Section 312) to expand the scope of its substantive audit procedures and use more

experienced staff:

Whenever the auditor has concluded that there is significant risk of materialmisstatement of the financial statements, the auditor should consider this conclusionin determining the nature, timing, or extent of procedures; assigning staff; orrequiring appropriate levels of supervision. The knowledge, skill, and ability ofpersonnel assigned significant engagement responsibilities should be commensuratewith the auditor's assessment of the level of risk for the engagement. Ordinarily,higher risk requires more experienced personnel or more extensive supervision by theauditor with final responsibility for the engagement during both the planning and theconduct of the engagement. Higher risk may cause the auditor to expand the extentof procedures applied, apply procedures closer to or as of year end, particularly incritical audit areas, or modify the nature of procedures to obtain more persuasiveevidence.

224. Indeed, E&Y represented that it had complied with the foregoing GAAS. In a May

10, 2004 letter to the SEC (Exhibit 16 to Bally's March 31, 2004 Form 10-Q), E&Y stated:

"Regarding the registrant's statement concerning the material weakness in internal accounting control

related to accounting for the deferral of revenue related to prepayments of non-obligatory dues

revenue, included in the fourth paragraph of Item 5, we had considered such matter in determining

the nature, timing and extent of procedures performed in our audit of the registrant's financial

statements for each of the three years in the period ended December 31, 2003."

225. Accordingly, E&Y either expanded its substantive audit procedures to determine

whether Bally's accounting for membership revenue, membership acquisition expense, recoveries

of unpaid dues and bad debts, acquired payment obligations, sales of future receivables, prepaid

personal training services, multiple element arrangements, self-insurance, development of

internal-use computer software, goodwill and other intangibles, amortization, asset impairment,

escheatment obligations, advertising costs, maintenance costs, start-up costs, inventory, accruals,


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foreign exchange gains and losses, leases, and income taxes was appropriate or E&Y failed to

expand substantive audit procedures of Bally's financial data and audited them in a manner which

was so deficient that it amounted to no audit at all, while making audit judgments that no reasonable

auditor would have made if confronted with the same facts.

226. E&Y knew and ignored or recklessly failed to know the facts which indicated that the

Company's financial statements were materially false and misleading and were presented in a manner

which violated the principles of fair financial reporting and the GAAP specified herein.

227. As particularized above, E&Y failed to comply with GAAS in that it failed to perform

its audits of the Company's financial statements with a proper degree of professional skepticism (AU

Section 316). In this regard, E&Y either identified and ignored evidence that the Company's

financial statements were materially misstated via fraudulent accounting or recklessly failed to

identify such fraudulent accounting.

228. Further, as particularized herein, E&Y either identified and ignored, or recklessly

failed to investigate extremely questionable transactions, and made audit judgments that no

reasonable auditor would have made if confronted with the same facts. Accordingly, E&Y audits

were so deficient that they amounted to no audit at all.

229. Had E&Y undertaken the performance of those audit procedures which were required

by GAAS, and with the due professional care which was required by GAAS, it would have known

that the Company's financial statements were materially false and misleading because these financial

statements were not presented in accordance with GAAP. In reckless disregard of professional

standards, E&Y failed to audit the Company's financial statements in conformity with GAAS.


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230. As particularized herein, E&Y either knew and ignored, or recklessly failed to know

that the Company's audited financial statements which were disseminated to the investing public

during the Class Period improperly reported revenues, expenses, earnings, assets, liabilities and

shareholders' equity, and failed to disclose material facts that were necessary in order to make these

financial statements, in light of the circumstances, not misleading.

231. GAAS (AU Section 311) states that:

The auditor should obtain a level of knowledge of the entity's business that willenable him to plan and perform his audit in accordance with generally acceptedauditing standards. That level of knowledge should enable him to obtain anunderstanding of the events, transactions, and practices that, in his judgment, mayhave a significant effect on the financial statements. . .Knowledge of the entity'sbusiness helps the auditor in:

a. Identifying areas that may need special consideration.

b. Assessing conditions under which accounting data are produced, processed,reviewed, and accumulated within the organization.

c. Evaluating the reasonableness of estimates.

d. Evaluating the reasonableness of management representations.

e. Making judgments about the appropriateness of the accounting principles applied andthe adequacy of disclosures.

232. E&Y audited the Company's financial statements prior to the Class Period and,

therefore, it had a thorough knowledge of the Company's financial history, accounting practices,

internal controls, and business operations. Accordingly, E&Y either failed to:

a. Identify areas that needed special consideration (such as the Company's accountingfor membership revenue, membership acquisition expense, recoveries of unpaid duesand bad debts, acquired payment obligations, sales of future receivables, prepaidpersonal training services, multiple element arrangements, self-insurance,development of internal-use computer software, goodwill and other intangibles,amortization, asset impairment, escheatment obligations, advertising costs,maintenance costs, start-up costs, inventory, accruals, foreign exchange gains and


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losses, leases, and income taxes) or identified such areas and audited them in amanner which was so deficient that it amounted to no audit at all, while making auditjudgements that no reasonable auditor would have made if confronted with the samefacts.

b. Assess the conditions under which accounting data (such as accounting data relatedto membership revenue, membership acquisition expense, recoveries of unpaid duesand bad debts, acquired payment obligations, sales of future receivables, prepaidpersonal training services, multiple element arrangements, self-insurance,development of internal-use computer software, goodwill and other intangibles,amortization, asset impairment, escheatment obligations, advertising costs,maintenance costs, start-up costs, inventory, accruals, foreign exchange gains andlosses, leases, and income taxes) was produced, processed, reviewed, andaccumulated within the organization or assessed such conditions and made auditjudgements based upon said assessment that no reasonable auditor would have madeif confronted with the same facts.

c. Evaluate the reasonableness of management's representations (such as itsrepresentations regarding the recovery of the carrying value of goodwill throughfuture operations, or the fact that Bally was "subject to minimal foreign exchange andcommodity risk" ) or evaluated them in a manner which was so deficient that itamounted to no evaluation at all.

d. Judge the appropriateness of the accounting principles applied (such as the principlethat disclosure of accounting policies should identify and describe the accountingprinciples followed by the reporting entity and the methods of applying thoseprinciples that materially affect the financial statements) and the adequacy ofdisclosures in the Company's financial statements (such as disclosure of the fact thatthere existed retained risk exposures associated with workers compensation, healthcare, and other self-insurance arrangements), or did so and arrived at judgements thatno reasonable auditor would have arrived at if confronted with the same facts.

233. GAAS (AU Section 331) states that the observation of inventories is a generally

accepted auditing procedure, and that an auditor who issues an opinion without having observed

inventory "has the burden of justifying the opinion expressed." Accordingly, E&Y observed the

inventories in conjunction with each of its audits. In connection therewith, E&Y learned that there

were differences between the inventory that was reflected in the Company's ledger and the inventory

that physically existed and was counted. These shrinkage shortfalls were required to have been


107

recorded as an expense in the period of loss (in compliance with GAAP (Accounting Research

Bulletin No. 43)).

234. E&Y either knew and ignored, or recklessly failed to know that the shrinkage losses

which it had identified and documented in its working papers (AU Section 339) were required to

have been recorded as an expense in the period of loss, and E&Y failed to issue a qualified opinion

and disclose the material facts (regarding the Company's non-recognition of shrinkage losses) that

were necessary in order to make these financial statements, in light of the circumstances, not

misleading. The Company, not E&Y, ultimately disclosed in the Form 10-K what E&Y was

required to have disclosed during the Class Period:

. . . the recorded value of retail inventories were overstated, primarily as a result ofdifferences in physical count and as a result of incorrect accounting for cost of goodssold. The impact of these adjustments is an increase in accumulated deficit and adecrease in other current assets of $2,231 as of January 1, 2002. In addition, theseadjustments resulted in an increase in retail products expenses of $594 for the yearended December 31, 2003, and a decrease in retail products expenses of $538 for theyear ended December 31, 2002.

235. Similarly, during its audits, E&Y either knew and ignored, or recklessly failed to

know that the Company's accounting for and disclosures concerning membership revenue,

membership acquisition expense, recoveries of unpaid dues and bad debts, acquired payment

obligations, sales of future receivables, prepaid personal training services, multiple element

arrangements, self-insurance, development of internal-use computer software, goodwill and other

intangibles, amortization, asset impairment, escheatment obligations, advertising costs, maintenance

costs, start-up costs, inventory, accruals, foreign exchange gains and losses, leases, and income taxes

was woefully deficient and E&Y failed to issue a qualified opinion and disclose the material facts


108

that were necessary in order to make these financial statements, in light of the circumstances, not

misleading.

236. The Company, not E&Y, ultimately disclosed what E&Y was required to have

disclosed regarding the Company's accounting for and disclosures concerning membership revenue,

membership acquisition expense, recoveries of unpaid dues and bad debts, acquired payment

obligations, sales of future receivables, prepaid personal training services, multiple element

arrangements, self-insurance, development of internal-use computer software, goodwill and other

intangibles, amortization, asset impairment, escheatment obligations, advertising costs, maintenance

costs, start-up costs, inventory, accruals, foreign exchange gains and losses, leases, and income taxes,

as particularized above.

237. It was no secret that Bally's growth was predicated upon the acquisition of existing

clubs from third parties and the opening of new clubs by Bally. Each of Bally's Forms 10-K which

were filed with the SEC during the Class Period discussed Bally's "expansion and acquisition"

history and strategy. Accordingly, during its audits, E&Y reviewed numerous acquisition

agreements which required Bally to pay for specified assets (including Membership Relations,

Non-compete Agreements, Trade names, and Leasehold Rights) and numerous agreements

associated with the leasing of new facilities and the developments of new clubs.

238. During its audits, E&Y either knew and ignored, or recklessly failed to know of the

Company's acquisition and non-recordation of Membership Relations, Non-compete Agreements,

Trade names, and Leasehold Rights, and E&Y failed to issue a qualified opinion and disclose the

material facts (regarding the Company's non-recordations) that were necessary in order to make these

financial statements, in light of the circumstances, not misleading. The Company, not E&Y,


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ultimately disclosed what E&Y was required to have disclosed during the Class Period as specified

above.

239. During its audits, E&Y either knew and ignored, or recklessly failed to know of the

Company's acquisition of new facility sites through the assumption of existing leases or through the

signing of new leases, and E&Y failed to issue a qualified opinion and disclose the material facts

(regarding the Company's improper accounting for acquired operating lease rights and lease rentals

associated with start-up operations) that were necessary in order to make these financial statements,

in light of the circumstances, not misleading. The Company, not E&Y, ultimately disclosed what

E&Y was required to have disclosed during the Class Period as specified above.

240. In order to assure itself that significant risks and uncertainties were properly disclosed

(Statement Of Position 94-6), and that contingencies were properly accounted for in Bally's financial

statements (FASB Statement No.5), E&Y was required to determine whether Bally was materially

uninsured. Accordingly, during its audits, E&Y either examined the nature and extent of Bally's

insurance coverage and knew and ignored that Bally self-insured for numerous risks and that its

financial statements materially understated expenses and liabilities arising from its self-insurance,

or E&Y failed to examine the nature and extent of Bally's insurance coverage and recklessly failed

to know.

241. As a result, during the Class Period, the Bally defendants failed to disclose the fact

that Bally self-insured against certain risks and that Bally's financial statements materially

understated expenses associated with Bally's self-insurance, and E&Y failed to qualify its Class

Period audit opinions as a result of this flagrant violation of GAAP as required by GAAS (AU

Section 508).


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242. Upon Restatement, the Bally defendants stated: "We concluded that our previous

methodologies for estimating our self-insured workers' compensation, health and life and general

insurance claims resulted in an understatement of our self-insured liabilities. The impact of this

adjustment was a decrease in accrued liabilities of $3,365 and increase in other inabilities and

accumulated deficit of $4,312 and $947, respectively, as of January 1, 2002."

243. Similarly, there were repayment obligations associated with certain membership

contracts sold. E&Y never audited these obligations. Accordingly, E&Y never knew that Bally's

liabilities were materially understated. This financial reporting deficiency was cured when the

Company's "Audit Committee identified that the Company had improperly accounted for $22,000

[,000] of face amount repayment obligations due in 2015 or later on membership contracts sold by

a subsidiary before its acquisition in the late 1980s" and caused corrections to be made to Bally's

previously issued financial statements ("The impact of this correction resulted in an increase in

accumulated deficit and other liabilities of $4,335[,000] as of January 1, 2002 and an increase in

interest expense of $589[,000] and $526[,000] for the years ended December 31, 2003 and 2002,

respectively." -- 2004 Form 10-K).

244. E&Y addressed several of the accounting issues discussed in paragraphs 128 through

173 above during its audit of Bally's 2003 financial statements as evidenced by notes to these

financial statements which stated:

We elected to change our accounting methods effective January 1, 2003 related to therecognition of revenue from membership contracts, initial membership originationcosts, and asset retirement obligations. The cumulative effect as of January 1, 2003of these changes in accounting principles has been charged to the 2003 statement ofoperations. These charges are discussed below.

As required, we adopted the provisions of EITF 00-21 "Revenue Arrangements withMultiple Deliverables" as it relates to revenues included in initial membership


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contracts. Under the previously acceptable method, revenues allocated to productsand services included in initial membership contracts, including financed contracts,were recognized upon delivery to the member. The new pronouncement limits theamount of revenue we can recognize upon delivery of the products and services tocash collected upon membership origination. Limiting early recognition to cashcollected resulted in a reversal of amounts previously recognized upon membershipsale, and an increase in amounts deferred to be recognized during future periods.

Concurrent with the adoption of EITF 00-21, we elected to adopt a modified cashbasis of accounting for the recognition of membership fees effective January 1, 2003.Under the new method, membership revenue is recognized as income at the later ofwhen it is collected, or in the case of paid-in-full memberships or accelerated receiptsfrom financed memberships, when earned. This changes the pre-2003 22-month pooldeferral method that amortized revenues from financed initial membership fees onthe straight-line basis, after application of estimated uncollectible amounts. The useof the modified cash basis, which is viewed by us and by our independent auditorsas a preferable accounting method, recognizes membership revenue over a longerperiod than the previous method. We have also applied the modified cash basis ofrecognition to our accounting for non-obligatory membership dues. Since monthlydues are collected in arrears, prior to 2003 we included in other assets a receivablefor uncollected dues at the end of each period. Under the modified cash basis, therecognition of membership dues revenue has been changed to the later of eithercollected or earned consistent with our new policy for membership fees. As a result,the receivable for earned but uncollected dues has been reversed and is included asa component of the cumulative effect adjustment.

Concurrent with our change to the modified cash basis of revenue recognition asdescribed above, in 2003 we additionally changed our accounting principle for initialmembership origination costs from the pre-2003 method whereby such costs weredeferred and recognized over the same period used for revenue recognition toexpensing such costs as incurred. This change has also been determined to be apreferable method when considered along with the modified cash basis adopted formembership fee recognition.

In the second quarter of 2003, we changed our accounting for the recognition ofrecoveries of unpaid dues on inactive membership contracts from accrual-basedestimations to a cash basis of recognition, which was considered a preferable methodof accounting for such past due amounts.

We believe these changes in accounting to recognize membership revenues at thelater of when collected or earned and to expense membership origination costs asincurred will result in financial reporting that is more understandable to the reader.The new methods also reduce the impact of estimations in the financial reporting


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process by eliminating the need to estimate the amount and timing of future membercollections for purposes of revenue and expense recognition.

245. Given the nature and magnitude of the audit issues, E&Y would have been required

to have significantly expanded the scope of its audit and the nature of its procedures in observance

of GAAS (AU Section 311).

246. Having specifically addressed the foregoing issues during its 2003 audit, it is

remarkable that the 2004 Form 10-K, which contained restated 2003 financial statements, attested

to the deficiency in E&Y's audit by stating that, after investigation, the Company's Audit Committee

determined that the Company:

a. "improperly applied Staff Accounting Bulletin No. 101 ("SAB 101") in a priorperiod. Specifically, after the Company's adoption of SAB 101, revenue wasrecognized over the average contractual life of twenty-two months. As a part of thisrestatement, the Company has modified its membership revenue recognitionmethodology such that membership revenue is earned on a straight-line basis overthe longer of the initial membership term or the estimated membership life. Theimpact of this correction resulted in an increase in deferred revenue and an increasein accumulated deficit of $997,837 as of January 1, 2002, a decrease in installmentaccounts receivable, net of $493,236 and $522,605 for the years ended December 31,2003 and 2002, respectively, and an increase in membership services revenue of$9,269 and $54,233 for the years ended December 31, 2003 and 2002, respectively."

b. "improperly accounted for membership acquisition costs by improperly deferringcertain costs in 2002 and prior. The impact of this correction resulted in an increasein accumulated deficit and a decrease in deferred membership origination costs of$113,959 as of January 1, 2002 and a decrease in membership services expenses andcumulative effect of changes in accounting principle of $1,000 and $119,484,respectively, for the year ended December 31, 2003 and an increase in membershipservices expense of $6,525 in the year ended December 31, 2002."

c. "should have adopted the cash basis for recoveries of unpaid dues on inactivememberships prior to 2003. The impact of this correction resulted in an increase inaccumulated deficit and a decrease in accounts receivable of $21,821 as of January1, 2002, and a decrease in cumulative effect of change in accounting principle of$20,335 for the year ended December 31, 2003."


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d. "improperly separated. . . multiple element arrangements into multiple units ofaccounting resulting in premature recognition of early delivered nutritional productsand personal training services. As a part of this restatement, the Company hasmodified its membership revenue recognition policy to treat these arrangements assingle units of accounting and recognize revenue for these arrangements on astraight-line basis over the later of when collected or earned. The impact of thischange resulted in an increase in deferred revenue and an increase in accumulateddeficit of $105,467 as of January 1, 2002, and a decrease in membership servicesrevenue of $33,013 and $86,499 for the years ended December 31, 2003 and 2002,respectively."

247. GAAS (AU Section 230) states that "Auditors should be assigned to tasks and

supervised commensurate with their level of knowledge, skill, and ability so that they can evaluate

the audit evidence they are examining. The auditor with final responsibility for the engagement. . .

should be knowledgeable about the client"

248. E&Y either possessed the requisite level of knowledge to understand and evaluate

the above discussed accounting changes and knew and ignored that they were inappropriately

applied, or E&Y failed to possess the requisite level of knowledge and understanding and failed to

know this fact.

249. GAAS (AU Section 326) notes that underlying accounting data and all corroborating

information available to the auditor (including books of original entry, the general and subsidiary

ledgers, related accounting manuals, and records such as work sheets and spreadsheets supporting

cost allocations, computations, checks, purchase orders, bills of lading, invoices, records of

electronic fund transfers, invoices, contracts, minutes of meetings, and reconciliations) constitute

evidence that should be subjected to inquiry, observation, inspection, confirmation, and physical

examination. It is inconceivable that E&Y could have inquired about, observed, inspected,

confirmed and physically examined the available documentation and failed to detect Bally's improper

accounting for membership revenue, membership acquisition expense, recoveries of unpaid dues and


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bad debts, acquired payment obligations, sales of future receivables, prepaid personal training

services, multiple element arrangements, self-insurance, development of internal-use computer

software, goodwill and other intangibles, amortization, asset impairment, escheatment obligations,

advertising costs, maintenance costs, start-up costs, inventory, accruals, foreign exchange gains and

losses, leases, and income taxes. Accordingly, E&Y either performed audits which were so deficient

that they amounted to no audit at all, or it identified and ignored, or recklessly failed to investigate

extremely questionable transactions, and made audit judgments that no reasonable auditor would

have made if confronted with the same facts.

250. For example, in this regard, notes to the audited financial statements which appeared

in the 1999 Form 10-K, the 2000 Form 10-K, the 2001 Form 10-K, the 2002 Form 10-K, and the

2003 Form 10-K each articulated Bally's leasehold improvement amortization accounting policy as

follows: "Amortization of leasehold improvements is provided on the straight-line method over the

lesser of the estimated useful lives of the improvements or the lease periods." This statement was,

at all relevant times, wholly false.

251. As admitted by the Bally defendants after the Class Period, throughout the Class

Period, Bally violated not only GAAP in accounting for amortization of leasehold improvements,

it violated its own stated accounting policy.

Historically, we depreciated leasehold improvements over the contractual termof the lease. We also depreciated leasehold improvements acquired subsequentto store opening, such as remodels, over the contractual term of the lease. Inboth instances, optional renewal periods were included in the contractual termof the lease. We have concluded that such leasehold improvements should bedepreciated over the lesser of the asset's economic life, with a maximum offifteen years, or the contractual term of the lease, excluding all renewal options.The Company's club leases generally have a term of ten to fifteen years and provideoptions to renew for between five to fifteen additional years." (2004 Form 10-K) (Emphasis added).


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252. Had E&Y performed even the most perfunctory audit of Bally's amortization of

leasehold improvements, it could not have avoided knowing that in contravention of GAAP Bally

amortized leasehold improvements over "extended" lease periods which assumed the exercise of

lease options (thereby significantly decreasing reported amortization expense); not over the lesser

of the estimated useful lives of the improvements or the lease periods as stated in Bally's financial

statements.

253. E&Y either examined Bally's accounting for the amortization of leasehold

improvements and knew and ignored that Bally's accounting violated GAAP and Bally's own stated

accounting policy, or E&Y failed to examine Bally's accounting for the amortization of leasehold

improvements and recklessly failed to know. Accordingly, E&Y performed audits which were so

deficient that they amounted to no audit at all.

254. Notes to Bally's audited 2003 financial statements articulated its accounting policy

with regard to the impairment of long-lived assets as follows:

Long-lived assets are reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not be recoverable.Recoverability of long-lived assets held for use are assessed by a comparison of thecarrying amount of the asset to the estimated future undiscounted net cash flowsexpected to be generated by the asset. If estimated future undiscounted net cash flowsare less than the carrying amount of the asset, the asset is considered impaired andexpense is recorded in an amount required to reduce the carrying amount of the assetto its fair value.

255. As admitted by the Bally defendants after the Class Period, Bally violated not only

GAAP in accounting for the impairment of long-lived assets, it violated its own stated accounting

policy.

. . . we determined conditions at various dates which indicated the carryingamounts of fixed assets were impaired, but determined that impairmentanalyses had not been performed even though trigger events were present. As


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a result, we performed the impairment analyses not previously completed for theperiods being restated and recorded impairment adjustments as applicable. . . Wedetermined that the Company did not properly apply the guidance in FASB StatementNo. 121 and in FASB Statement No. 144, "Accounting for the Impairment orDisposal of Long-Lived Assets", to either identify the existence of relevant triggeringevents or to measure the related impairment charges. As a result, we performed theimpairment analyses and recorded impairment charges as applicable. . . TheCompany recorded impairment losses of $14,772, $19,605, and $18,258 in the yearsended December 31, 2004, 2003, and 2002, respectively.

The 2004 and 2003 charges related to club locations with operating performance thatdeteriorated subsequent to the 2001 review or which had additions during thesubsequent period that were found to additionally be impaired. The 2003 chargerelated primarily to the Crunch Fitness International acquisition in 2001, which wasfound to perform at a level below expectations during 2002 and 2003. Theimpairment charges in 2004, 2003, and 2002 related primarily to the carrying valuesof land, buildings and leasehold improvements that will, with the possible exceptionof Crunch (See Note 21 of Notes to Consolidated Financial Statements), continue tobe operated by the Company. (2004 Form 10-K) (Emphasis added).

256. Had E&Y performed even the most perfunctory audit of long-lived asset impairment

it could not have avoided knowing that, in contravention of GAAP and the Company's own stated

accounting policy, Bally failed to account for obvious impairments of long-lived assets.

257. E&Y either audited Bally's accounting for long-lived asset impairment and knew and

ignored that Bally's accounting violated GAAP and Bally's own stated accounting policy, or E&Y

failed to audit Bally's accounting for long-lived asset impairment and recklessly failed to know.

Accordingly, E&Y performed audits which were so deficient that they amounted to no audit at all.

258. The Bally defendants were required to cause the Company to disclose, in its financial

statements, the existence of the material facts described herein and to appropriately recognize and

report revenues and expenses in conformity with GAAP. The Company failed to make such

disclosures and to account for and to report revenue and expenses in conformity with GAAP.


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259. Due to the pervasive mosaic of non-disclosures, deceptive disclosures and improper

accounting, the Company's financial statements which were disseminated to the investing public

during the Class Period (including those which were audited by E&Y as specified above) were

materially false and misleading.

260. The defendants knew and ignored, or were reckless in not knowing, the facts which

indicated that the Company's financial statements (and the various press releases and public

statements which referred to them which were disseminated to the investing public during the Class

Period (including those which were audited by E&Y as specified above) were materially false and

misleading for the reasons set forth herein above.

261. SEC Regulations require that financial statements filed with the SEC conform with

GAAP. Financial statements filed with the SEC which are not prepared in conformity with GAAP

are presumed to be misleading or inaccurate, despite footnote or other disclosure [17 C.F.R.

§210.401 (a)(1)]. The Company's financial statements referred to above were false and misleading

for the reasons alleged herein and because they constituted an extreme departure from GAAP as

particularized herein above.

262. Pursuant to GAAS, E&Y was required to express a qualified opinion on the

Company's 1999, 2000, 2001, 2002, and 2003 financial statements (AU Section 508) because they

were not prepared in conformity with GAAP. In so doing, E&Y was required (AU Section 508) to

disclose to the investing public the nature and extent of the Company's false and misleading

accounting and to provide those disclosures which the Company's financial statements failed to

provide. E&Y either knew and ignored or recklessly failed to know these facts and, therefore, failed


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to express a qualified opinion on the Company's financial statements and make those required

disclosures. As a result, Lead Plaintiff and members of the Class sustained damages.

ADDITIONAL SCIENTER ALLEGATIONS

263. In addition to the allegations set forth above, all defendants acted with scienter in that

defendants knew or recklessly disregarded that the public documents and statements issued or

disseminated in the name of the Company were materially false and misleading; knew or recklessly

disregarded 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. As set forth

elsewhere herein in detail, defendants, by virtue of their receipt of information reflecting the true

facts regarding Bally, their control over, and/or receipt and/or modification of Bally’s allegedly

materially misleading misstatements and/or their associations with the Company which made them

privy to confidential proprietary information concerning Bally, participated in the fraudulent scheme

alleged herein.

264. As alleged herein, the Company and the Individual Defendants disseminated to the

investing public false and misleading press releases and filed false and misleading quarterly and

annual reports with the SEC. The statements made in these documents described Bally's positive

financial performance, but failed to disclose and/or misrepresented adverse material facts.

265. Furthermore, as illustrated by the Individual Defendants' positions with the Company,

they had and used their influence and control to further the scheme alleged herein. The Individual

Defendants had broad responsibilities that included communicating with the financial markets and

providing the markets with financial results. The Individual Defendants were privy to and directed


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the making of financial projections and results. By making the misleading statements contained

herein, the Individual Defendants knew that they would artificially inflate the value of the Company's

securities. Defendants' actions in doing so resulted in damage to Lead Plaintiff and the Class.

266. As Chief Financial Officer of Bally, defendant Dwyer, in conjunction with his direct

supervisors, defendants Toback and Hillman, were responsible for the preparation of Bally's financial

statements and for ensuring that the periodic reports filed with the SEC containing such financial

statements complied fully with the disclosure requirements of the federal securities laws. The

Individual Defendants signed and/or reviewed Bally's SEC filings containing the Company's falsely

reported financial results, as alleged herein, were the persons responsible for the preparation and

filing of Bally's financial statements, and had the responsibility to verify the underlying facts of any

publicly released financial statements.

267. In addition, given the fact that certain of the accounting irregularities involved

accounting for the revenues of the Company's core business – club memberships – the Individual

Defendants as senior executive officers and directors of the Company, approved, knew of, or

recklessly ignored the improper conduct complained of herein.

268. Moreover, each of the Individual Defendants was a CPA – each having worked for

E&Y prior to joining Bally – such that they knew or should have known that the improper and

aggressive accounting techniques being employed at Bally did not comply with GAAP.

269. Defendant Dwyer, as CFO, should have known of the basic principles of revenue and

expense recognition. Defendants Toback and Hillman, as experienced executives, also should have

known that revenue should not be recognized before it was earned and realized or realizable, and that

expenses were required to be recognized when incurred. Said defendants were involved in drafting,


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producing, reviewing and/or disseminating the false and misleading statements and information

alleged herein, were aware, or recklessly disregarded, that the false and misleading statements were

being issued regarding the Company, and approved or ratified these statements.

270. Defendants were motivated, in part, to materially misrepresent Bally's results in order

to cause and maintain artificial inflation in the price of Bally common stock, in order to secure for

themselves lucrative performance-based bonuses from the Company, pursuant to their employment

agreements with the Company, in addition to substantial stock awards pursuant to incentive plans.

271. For instance, in 2003, Toback was paid $775,00 in salary and bonus compensation,

$1,206,000 in restricted stock awards and $200,000 in stock options. That same year, Dwyer

received a salary of $375,000, $603,000 in restricted stock options and $160,000 in securities

underlying stock options. In 2002, Hillman received $638,654 in salary, $1,641,750 worth of

restricted stock awards and $4,863,600 in cash payments pursuant to a separation agreement with

Bally, which included $926,100 for vesting of restricted stock previously awarded to Hillman.

272. Defendants were further motivated to materially misrepresent Bally's results in order

to cause and maintain artificial inflation in the price of Bally common stock. Defendants took

advantage of that artificial inflation by raising additional cash proceeds for the Company during the

Class Period through a secondary offering of common stock. Defendants also took advantage of the

Company's false financial results and inflated stock price to obtain financing, refinance outstanding

debt, and effect acquisitions using inflated Bally stock as partial payment, as follows:

a. On February 7, 2001, defendants took advantage of the Company's inflated stockprice and made a public offering of 4,000,000 shares of its common stock, of whichthe proceeds from 1,408,821 shares went directly to Bally, for approximate proceedsof $50.6 million.


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b. On October 15, 2001, Bally announced via press release that it had signed a mergeragreement with Crunch Fitness. The companies reached an agreement whereby Ballywould acquire Crunch, a privately-held concern of 19 health clubs in five states, ina cash and stock-for-stock merger. The terms of the agreement required Bally to issueapproximately three million shares of its common stock, plus a payment of cash andother consideration. The total purchase price was valued at approximately $90million.

c. On April 23, 2002, Bally issued a press release announcing that it had expanded itspresence in the New England area with the acquisition of seven health clubs operatedby Planet Fitness. The agreement included the payment of 383,000 shares of Bally'scommon stock.

d. On June 27, 2003, Bally announced that it had priced $200 million of senior notesdue 2011 at 10.5 percent in a private offering to qualified institutional buyers underRule 144A and Regulation S under the Securities Act of 1933, as amended.

e. On June 27, 2003, Bally also announced that it intended to enter into a new $90million dollar senior secured revolving credit facility with its existing group of banksconcurrently with the closing of the note offering. Bally planned to use the netproceeds from the issuance of the senior notes, and, if required, borrowings under thenew credit facility to repay all outstanding borrowings under its existing creditfacility.

f. On June 27, 2003, Bally further announced that it had completed the refinancing of$100 million of its outstanding $155 million Securitization Series 2001-1, which hadbeen scheduled to start amortizing in December 2003. The refinancing extended thematurity of the $100 million of the Securitization Series to July 2005, and requiredthat the remaining balance begin amortizing in October 2003.

g. On July 15, 2003, Bally announced that it had secured an additional $35 million ina private offering to institutional buyers. The additional senior notes were priced at101% plus accrued interest from July 2, 2003.

273. In sum, all defendants acted with scienter in that they knew or recklessly disregarded

that the public documents and statements issued or disseminated in the name of the Company were

materially false and misleading when made; knew or recklessly disregarded that such statements or

documents would be issued or disseminated to the investing public; and knowingly or recklessly and

substantially participated or acquiesced in the issuance or dissemination of such statements or


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documents as primary violations of the federal securities laws. As set forth herein, defendants acted

with a knowing or reckless disregard for the falsity of Bally's financial statements.

UNDISCLOSED ADVERSE INFORMATION

274. The market for Bally’s securities was open, well-developed and efficient at all

relevant times. As a result of these materially false and misleading statements and failures to

disclose, Bally’s securities traded at artificially inflated prices during the Class Period. The artificial

inflation continued until at least April 28, 2004. Lead Plaintiff and other members of the Class

purchased or otherwise acquired Bally securities relying upon the integrity of the market price of

Bally’s securities and market information relating to Bally, and have been damaged by the disclosure

of the truth.

275. During the Class Period, defendants materially misled the investing public, thereby

inflating the price of Bally’s securities, by publicly issuing false and misleading statements and

omitting to disclose material facts necessary to make defendants’ statements, as set forth herein, not

false and misleading. Said statements and omissions were materially false and misleading in that

they failed to disclose material adverse information and misrepresented the truth about the Company,

its business and operations, including, inter alia:

(a) that the Company’s financial statements were not prepared in accordance with GAAP

and/or in accordance with the federal securities laws and SEC regulations concerning fair reporting;

and

(b) that the Company’s seeming growth was, in material part, the result of improper

accounting.


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276. At all relevant times, the material misrepresentations and omissions particularized

in this Complaint directly or proximately caused or were a substantial contributing cause of the

damages sustained by Lead Plaintiff and other members of the Class. As described herein, during

the Class Period, defendants made or caused to be made a series of materially false or misleading

statements about Bally’s business, prospects and operations. These material misstatements and

omissions had the cause and effect of creating in the market an unrealistically positive assessment

of Bally and its business, prospects and operations, thus causing the Company’s securities to be

overvalued and artificially inflated at all relevant times. Defendants’ materially false and misleading

statements during the Class Period resulted in Lead Plaintiff and other members of the Class

purchasing the Company’s securities at artificially inflated prices, causing the damages complained

of herein upon disclosure of the truth.

LOSS CAUSATION

277. During the Class Period, as detailed herein, defendants engaged in a scheme to

deceive the market and a course of conduct that artificially inflated the price of Bally’s securities and

operated as a fraud or deceit on Class Period purchasers of Bally securities by misrepresenting the

Company’s financial results, business success and future business prospects. Defendants achieved

this facade of success, growth and strong future business prospects via improper accounting

(prematurely recognizing revenue and delaying the recordation of expenses) in violation of GAAP.

278. The false financial statements caused and maintained the artificial inflation in Bally’s

stock price throughout the Class Period.


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279. Defendants’ false and misleading statements had the intended effect and caused Bally

securities to trade at artificially inflated levels throughout the Class Period, reaching as high as $34

per share.

280. Over at least four and 1/2 years, defendants improperly inflated Bally’s reported

earnings. On April 28, 2004, however, when defendants’ prior misrepresentations and fraudulent

conduct were first disclosed and became apparent to the market, Bally stock fell precipitously as the

prior artificial inflation came out of Bally’s stock price. As a result of their purchases of Bally

securities during the Class Period, and the diminution in value attributable to disclosure of the truth,

Lead Plaintiff and other members of the Class suffered economic loss, i.e., damages under the federal

securities laws.

281. As a direct result of defendants’ admissions (later set forth with detail in the

Restatement) and the public revelations regarding the truth about Bally’s previously reported

financial results and its actual business prospects going forward, Bally’s stock price plummeted from

$5.40 on April 28, 2004 to $4.50 per share the following day, or over 16%. This drop removed the

inflation from Bally’s stock price, causing real economic loss to investors who had purchased the

stock during the Class Period. In sum, as the truth about defendants’ fraud and Bally’s business

performance was revealed, the Company’s stock price plummeted, the artificial inflation came out

of the stock and Lead Plaintiff and other members of the Class were damaged.

282. The timing and magnitude of Bally’s stock price decline negates any inference that

the loss suffered by Lead Plaintiff and other Class members was caused by changed market

conditions, macroeconomic or industry factors or Company-specific facts unrelated to the

defendants’ fraudulent conduct. During the same period in which Bally’s stock price fell


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approximately 16.6%, the Standard & Poor’s 500 securities index was down less than 1%. The

economic loss, i.e., damages, suffered by Lead Plaintiff and other members of the Class was a direct

result of and was proximately caused by defendants’ fraudulent scheme to artificially inflate Bally’s

stock price and the subsequent significant decline in the price of Bally’s stock when defendants’

prior misrepresentations and other fraudulent conduct were revealed.

APPLICABILITY OF PRESUMPTION OF RELIANCE:FRAUD-ON-THE-MARKET DOCTRINE

283. At all relevant times, the market for Bally’s securities was an efficient market for the

following reasons, among others:

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

the NYSE, a highly efficient and automated market;

(b) As a regulated issuer, Bally filed periodic public reports with the SEC and the NYSE;

(c) Bally regularly communicated with public investors via established market

communication mechanisms, including through regular disseminations of press releases on the

national circuits of major newswire services and through other wide-ranging public disclosures, such

as communications with the financial press and other similar reporting services; and

(d) Bally was followed by several securities analysts employed by major brokerage firms

who wrote reports which were distributed to the sales force and certain customers of their respective

brokerage firms. Each of these reports was publicly available and entered the public marketplace.

284. As a result of the foregoing, the market for Bally’s securities promptly digested

current information regarding Bally from all publicly available sources and reflected such

information in Bally’s stock price. Under these circumstances, all purchasers of Bally’s securities


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during the Class Period suffered similar injury through their purchase of Bally’s securities at

artificially inflated prices and a presumption of reliance applies.

NO SAFE HARBOR

285. The statutory safe harbor provided for forward-looking statements under certain

circumstances does not apply to the false statements pleaded in this complaint, which consist

primarily of materially false and misleading statements of Bally’s historical performance. Moreover,

many of the specific statements pleaded herein were not identified as “forward-looking statements”

when made. To the extent there were any forward-looking statements, there was no meaningful

cautionary statement identifying important factors that could cause actual results to differ materially

from those in the purportedly forward-looking statements. Alternatively, to the extent that the

statutory safe harbor does apply to any forward-looking statements pleaded herein, defendants are

liable for those false forward-looking statements because at the time each of those forward-looking

statements was made, the particular speaker knew that the particular forward-looking statement was

false, and/or the forward-looking statement was authorized and/or approved by an executive officer

of Bally who knew that those statements were false when made.

FIRST CLAIM

VIOLATION OF SECTION 10(b) OF THE EXCHANGE ACT AND RULE 10b-5PROMULGATED THEREUNDER AGAINST ALL DEFENDANTS

286. Lead Plaintiff repeats and realleges each and every allegation contained above as if

fully set forth herein.

287. During the Class Period, Bally, E&Y, and the Individual Defendants, and each of

them, carried out a plan, scheme and course of conduct which was intended to and, throughout the

Class Period, did: (i) deceive the investing public, including Lead Plaintiff and other Class members,


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as alleged herein; (ii) artificially inflate and maintain the market price of Bally’s securities; and (iii)

cause Lead Plaintiff and other members of the Class to purchase Bally’s securities at artificially

inflated prices. In furtherance of this unlawful scheme, plan and course of conduct, defendants, and

each of them, took the actions set forth herein.

288. Defendants (i) employed devices, schemes, and artifices to defraud; (ii) made untrue

statements of material fact and/or omitted to state material facts necessary to make the statements

not misleading; and (iii) engaged in acts, practices, and a course of business which operated as a

fraud and deceit upon the purchasers of the Company’s securities in an effort to maintain artificially

high market prices for Bally’s securities in violation of Section 10(b) of the Exchange Act and Rule

10b-5. All defendants are sued as primary participants in the wrongful and illegal conduct charged

herein.

289. In addition to the duties of full disclosure imposed on defendants as a result of their

making of affirmative statements and reports, or participation in the making of affirmative

statements and reports to the investing public, defendants had a duty to promptly disseminate truthful

information that would be material to investors in compliance with the integrated disclosure

provisions of the SEC as embodied in SEC Regulation S-X (17 C.F.R. Sections 210.01 et seq.) and

Regulation S-K (17 C.F.R. Sections 229.10 et seq.) and other SEC regulations, including accurate

and truthful information with respect to the Company’s operations, financial condition and earnings

so that the market price of the Company’s securities would be based on truthful, complete and

accurate information.

290. Bally, E&Y, and the Individual Defendants, individually and in concert, directly and

indirectly, by the use, means or instrumentalities of interstate commerce and/or of the mails, engaged


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and participated in a continuous course of conduct to conceal adverse material information about the

business, operations and future prospects of Bally as specified herein.

291. These defendants employed devices, schemes and artifices to defraud, while in

possession of material adverse non-public information and engaged in acts, practices, and a course

of conduct as alleged herein in an effort to assure investors of Bally’s value and performance and

continued substantial growth, which included the making of, or the participation in the making of,

untrue statements of material facts and omitting to state material facts necessary in order to make the

statements made about Bally and its business operations and future prospects in the light of the

circumstances under which they were made, not misleading, as set forth more particularly herein,

and engaged in transactions, practices and a course of business which operated as a fraud and deceit

upon the purchasers of Bally’s securities during the Class Period.

292. Each of the Individual Defendants’ primary liability, and controlling person liability,

arises from the following facts: (i) the Individual Defendants were high-level executives (CEOs and

CFO) and directors at the Company during the Class Period and members of the Company’s

management team and had control thereof; (ii) each of these defendants, by virtue of his

responsibilities and activities as a senior officer and director of the Company was privy to and

participated in the creation, development and reporting of the Company’s internal budgets, plans,

projections and/or reports; (iii) each of these defendants enjoyed significant personal contact and

familiarity with the other defendants and was advised of and had access to other members of the

Company’s management team, internal reports and other data and information about the Company’s

finances, operations, sales, and internal controls at all relevant times; and (iv) each of these


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defendants was aware of the Company’s dissemination of information to the investing public which

they knew or recklessly disregarded was materially false and misleading.

293. The defendants had actual knowledge of the misrepresentations and omissions of

material facts set forth herein, or acted with reckless disregard for the truth in that they failed to

ascertain and to disclose such facts, even though such facts were available to them. Such defendants’

material misrepresentations and/or omissions were done knowingly or recklessly and for the purpose

and effect of concealing Bally’s operating condition and future business prospects from the investing

public and supporting the artificially inflated prices of its securities. As demonstrated by defendants’

overstatements and misstatements of the Company’s business, operations and earnings throughout

the Class Period, defendants, if they did not have actual knowledge of the misrepresentations and

omissions alleged, were reckless in failing to obtain such knowledge by deliberately refraining from

taking those steps necessary to discover whether those statements were false or misleading.

294. As a result of the dissemination of the materially false and misleading information

and failure to disclose material facts, as set forth above, the market price of Bally’s securities was

artificially inflated during the Class Period. In ignorance of the fact that market prices of Bally’s

publicly-traded securities were artificially inflated, and relying directly or indirectly on the false and

misleading statements made by defendants, or upon the integrity of the market in which the securities

trade, and/or on the absence of material adverse information that was known to or recklessly

disregarded by defendants but not disclosed in public statements by defendants during the Class

Period, Lead Plaintiff and the other members of the Class acquired Bally securities during the Class

Period at artificially high prices and were damaged by disclosure of the truth.


130

295. At the time of said misrepresentations and omissions, Lead Plaintiff and other

members of the Class were ignorant of their falsity, and believed them to be true. Had Lead Plaintiff

and the other members of the Class and the marketplace known of the true financial condition and

business prospects of Bally, which were not disclosed by defendants, Lead Plaintiff and other

members of the Class would not have purchased or otherwise acquired their Bally securities, or, if

they had acquired such securities during the Class Period, they would not have done so at the

artificially inflated prices which they paid.

296. By virtue of the foregoing, defendants have violated Section 10(b) of the Exchange

Act, and Rule 10b-5 promulgated thereunder.

297. As a direct and proximate result of defendants’ wrongful conduct, Lead Plaintiff and

the other members of the Class suffered damages in connection with their respective purchases and

sales of the Company’s securities during the Class Period.

SECOND CLAIM

VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT AGAINST THEINDIVIDUAL DEFENDANTS

298. Lead Plaintiff repeats and realleges each and every allegation contained above as if

fully set forth herein.

299. The Individual Defendants acted as controlling persons of Bally 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


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the Company, including the content and dissemination of the various statements which Lead Plaintiff

contends are false and misleading. The Individual Defendants were provided with and/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.

300. 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.

301. As set forth above, Bally and the Individual Defendants each violated Section 10(b)

and Rule 10b-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. As a direct and proximate result of defendants’ wrongful conduct, Lead Plaintiff and

other members of the Class suffered damages in connection with their purchases of the Company’s

securities during the Class Period.

WHEREFORE, Lead Plaintiff prays for relief and judgment, as follows:

(a) Determining that this action is a proper class action under Rule 23 of

the Federal Rules of Civil Procedure;

(b) Awarding compensatory damages in favor of Lead Plaintiff and the

other Class members against all defendants, jointly and severally, for all damages sustained as a

result of defendants’ wrongdoing, in an amount to be proven at trial, including interest thereon;


CERTIFICATE OF SERVICE

I, Carol V.Gilden, an attorney, certify that on December 30, 2005, I served the

Consolidated Class Action Complaint on the parties set forth on the Service List below through

the CM/ECF system.

/s/ Carol V. Gilden Carol V.Gilden

SERVICE LIST Sherrie R. Savett Douglas M. Risen Berger & Montague 1622 Locust Street Philadelphia, PA 19103 Tel: (215) 875-3000 Fax: (215) 875-4604 Erin S. Shaw Amanda Jean Hollis Robert Brian Tanner Robert Walter Tarun Latham & Watkins LLP 233 South Wacker Drive 5800 Sear Tower Chicago, IL 60606 Tel: (312) 876-7700 Fax: (312) 993-9767 Laurie B. Smilan Latham & Watkins, LLP TwoFreedom Square 11955 Freedom Drive Reston, VA 20190 Tel: (703) 456-1000


Howard S. Suskin Ross M. Rosenberg Shyni R. Varghese William D. Heinz Jenner & Block, LLP One IBM Plaza 330 N. Wabash Chicago, IL 60611 Tel: (312) 222-9350 Fax: (312) 840-7604 Gregory A. Markel Gregory G. Ballard Cadwalader Wickersham & Taft, LLP One World Financial Center New York, NY 10281 Tel: (212) 504-6000 Steven Bashwiner Mary Ellen Hennessy Dawn M. Canty Katten Muchin Zavis Rosenman 525 W. Monroe Chicago, IL 60661 Tel: (312) 902-5200 Fax: (312) 902-1061


in re: bally total fitness holding corporation securities litigation

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