IN THE UNITED STATES DISTRICT COUR TFOR THE EASTERN DISTRICT OF NORTH CAROLINA

WESTERN DIVISIONMaster File NO.5:04-CV-473 (1 )

IN RE RED HAT, INC . )SECURITIES LITIGATION )

CLASS ACTIONThis Document Relates To : )

ALL ACTIONS )

CONSOLIDATED A MENDED CLASS ACTION COMPLAINT

FILEDMAY 6 2005

6 0

TABLE OF CONTENTS

Page

1. NATURE OF THE ACTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

II . SUMMARY OF THE ACTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

III . JURISDICTION AND VENUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

IV. THE PARTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . 3A. Lead Plaintiffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . .3B. Defendants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

V. DEFENDANTS' FRAUDULENT SCHEME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6A. Red Hat's Business Model Allowed Defendants to Conceal Their Fraud . . . . . . . . . . . . . . . 6B . Defendants' Systematically Engaged in Prematurely Recognizing Revenue . . . . . . . . . . 8

(1) Defendants knew most contracts were signed near the end of th emonth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

C. Defendants' Desperation to Recognize Revenue Created a Culture o fAccounting Fraud . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10(1) Red Hat acquires companies just to recognize short term revenue . . . . . . . . . . .10(2) Defendants purposely inflated their subscriber contract renewals . . . . . . . . . . . .1 1(3) Defendant Thompson couldn't handle the truth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15(4) Defendants prematurely recognized revenue on consulting hours . . . . . . . . . . . .1 6(5) The Barking Dog : Defendants created an aura of fear and

intimidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 7(6) Defendants refuse to stop prematurely recognizing revenue eve n

after being personally confronted by a high level insider . . . . . . . . .. . . . . . . . . . . . . . . . .1 8D . PWC actively participated in the scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . .21E . PWC audit staff were intertwined with Red Hat's CFO and Financ e

Department . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22F. Barber is going to be replaced . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24G. The "firestorm" rapidly approaches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24H. PWC and the Defendants Know they Are in Imminent Danger of Bein g

Exposed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26I . The Individual Defendants Dump Their Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26J . The PWC Replacement Auditor Arrives at Red Hat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27

VI. THE TRUTH REGARDING RED HAT'S REVENUE RECOGNITIONSCHEME IS PARTIALLY REVEALED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28A . Monday, June 14, 2004 -- The CFO Bails Out . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28B . Tuesday, June 15, 2004 - Defendants' Continue to Panic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29C. Wednesday, June 16, 2004 -- The New Auditor "Drops the Bomb" . . . . . . . . . . . . . . . . . . . . .30D . Thursday, June 17, 2004 - Defendants' Announce Earnings Shortfall . . . . . . . . . . . . . . . . .30E. Barber's Tries to Cover His Tracks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

VII. THE TRUTH REGARDING RED HAT'S REVENUE RECOGNITIO NSCHEME IS FINALLY FULLY REVEALED . . . . . . . . 3 3A.

. . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .End Of Class Period: Defendants Announce Restatement And SEC

.

Inquiry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3

VIII . DEFENDANTS' FALSE AND MISLEADING STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38A. The Class Period Begins : Defendants Issue False Financial Results For

3Q03 (ended November 30, 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38B.

. . . . . . . . . . . . . . . . . . . . . . . . . .Reasons for Falsity: 3Q03 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

C . Defendants Release False Fiscal Year 2003 Year End Financial Results . . . . . . . . . . . . .43D. Reasons for Falsity : Fiscal Year 2003 (Ended February 28, 2003) . . . . . . . . . . . . . . . . . . . . . .46E. The Fraud Continues: First Quarter Fiscal Year 2004 (Ended May 31 ,

2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47F. Reasons for Falsity : 1 Q04 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49G. The Fraud Continues : Defendants Issue False 3Q04 Results . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . 50H. Reasons for Falsity: 3Q04 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 531. Defendants Issue False 4Q04 and Fiscal Year 2004 Results . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . 5 3J . Reasons for Falsity: 4Q and FY 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58K. Red Hat's June 17, 2004 False Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

(1) False statements regarding revenue recognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59(2) Defendant Szulik lies about the restatement and SEC investigation . . . . . . . . . 6 1

L. Reasons for Falsity of the June 17, 2004 Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62

IX. DEFENDANT'S OMISSIONS AND FAILURE TO REVEAL THE TRUTH . . . . . . . . . . . . . . . .63

X. DEFENDANTS' FALSE FINANCIAL REPORTING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63A. Defendants Violated GAAP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63B. Red Hat's Financial Restatement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .70C. Defendants ' Additional GAAP Violations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73

XI. PWC'S AUDITING VIOLATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74A. PWC and Barber's Violations of GAAS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79B. PWC Violated Section I OA(b)(1) of the Exchange Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85C. PWC Violated Its Own Accounting Guidelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86D. PWC and Barber Engaged in Improper Professional Conduct Within the

Meaning of Commission Rule of Practice 102(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86E. PWC's Lack of Independence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

XII. DEFENDANTS REAPED ENORMOUS FINANCIAL BENEFITS THROUG HTHEIR FRAUDULENT SCHEME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90A. Defendants Acted With Scienter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90B. Defendants' Insider Selling Was Unusual In Timing And Amount . . . . . . . . . . . . . . . . . . . . . .92C. The Defendants' Compensation, Bonuses, and Other Incentives were

Highly Dependent on Meeting Red Hat's Aggressive Financial Objective sand Estimates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .96(1) Defendant Szulik. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97

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(2) Defendant Thompson . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .98(3) Defendant Buckley. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99(4) Defendant Webbink . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99(5) Defendant Cormier. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

D . Defendants Were Motivated To Inflate Red Hat Stock In Order ToComplete Stock-Based Acquisitions During The Class Period . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

E . Defendants Propped Up the Company's Stock Price In Order to Completea Sale of $600 Million in Convertible Senior Debentures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1

F. Defendant's Had Access to an Enormous Amount of Detailed Financia lInformation at Their Fingertips . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1(1) Red Hat utilized accounting software . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 1(2) Regular internal reports were given directly to management . . . . . . . . . . . . . . . . . . 102(3) The Finance Department held regular meetings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

G. The Individual Defendants Controlled All Aspects of Red Hat . . . . . . . . . . . . . . . . . . . . . . . . . . 102(1) Defendant Szulik . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103(2) Defendant Thompson . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103(3) Defendant Webbink . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104(4) Defendant Buckley . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .104(5) Defendant Cormier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .104

H. Defendant PWC Had Signi ficant Financial Incentives to Appease Red Hat . . . . . . .105

XIII. CLASS ACTION ALLEGATIONS . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105

XIV. APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD ON THEMARKET DOCTRINE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107

COUNTI-VIOLATION OF SECTION 10(B) OF THE EXCHANGE ACT AND RULE 10B 5PROMULGATED THEREUNDER (AGAINST ALL DEFENDANTS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . .109

COUNT II -VIOLATION OF SECTION 20(A) OF THE EXCHANGE ACT (AGAINST SZULIK,THOMPSON, WEBBINK , BUCKLEY AND CORMIER) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 1

COUNT III - VIOLATION OF SECTION 304 OF SARBANES-OXLEY . . . . . . . . . . .

XV. REQUEST FOR RELIEF . . . .

XVI. JURY TRIAL DEMANDED . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . . . . . .112

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I. NATURE OF THE ACTION

1 . This securities class action is brought on behalf of purchasers of publicly traded

securities of Red Hat, Inc. ("Red Hat" or "the Company") between December 17, 2002 and July

12, 2004 inclusive, (the "Class Period"), seeking to recover damages caused by Defendants'

violations of federal securities laws and to pursue remedies under the Securities Exchange Act of

1934 and Section 304 of the Sarbanes-Oxley Act of 2002 .

H. SUMMARY OF THE ACTION

2. In order to falsify Red Hat's financial condition to the investing public,

Defendants, including Red Hat's senior management, and Red Hat's outside audito r

PricewaterhouseCoopers, knowingly and systematically booked revenue before it was actually

earned. Under their scheme, which was in direct violation of the rules that govern the accounting

profession, SEC rules, and the federal securities laws, Defendants secretly backdated Red Hat's

revenue, even though it was not actually earned until later, and then used that backdated revenue

to issue false financial reports to Red Hat investors.

3. As is often the case with a lie, the longer Defendants falsely booked revenue, th e

harder it became to stop . Increasingly desperate, they devised various techniques to falsely

recognize revenue in other ways, all of which have been confirmed by multiple former Red Hat

employees. These employees, many of whom had high-level positions or worked inside Red

Hat's finance department, revealed firsthand accounts of Red Hat's multi-faceted scheme, all of

which had a single goal - to prematurely recognize revenue .

4. The former Red Hat employees explained how even prior to the Class Period,

Defendants acquired companies in an effort to temporarily boost their short-term revenues . They

revealed how Defendants prematurely recognized revenue on consulting work, in blatant

violation of accounting rules . They revealed how Red Hat's management intimidated their

employees to falsify revenue reports -- or face the consequences. Indeed, at least one high-level

Red Hat employee who dared to confront Defendants about their improper scheme found out

quickly what that consequence was - instant termination .

5. In the midst of Defendants' accounting violations and fraudulent revenue

recognition scheme, an even darker cloud loomed . Defendants knew that a new outside audit

partner had been assigned to Red Hat, and he would soon be arriving on the scene . Unlike the

old auditor, he was unlikely to allow, let alone participate, in Defendants' ongoing fraud. So,

before they could be caught, Red Hat's executives began dumping their stock onto the

unsuspecting market, reaping a mind-bending personal windfall of more than $94 million

between the five of them, and shedding huge percentages of their holdings .

6. When the dust finally cleared, Red Hat was forced to revise over three years o f

financial information . Red Hat's stock price was devastated, and investors were left holding the

bag. Indeed, when the fraud was finally fully revealed, Defendants' lies caused Red Hat's stock

to suffer its largest loss ever, plummeting nearly 25% in a single day . All told, from the time the

truth began to leak to the market, it took nearly a month for Defendants' fraud to be full y

revealed, causing Red Hat's stock to sustain a total of three major blows . By the end of the final

day, investors had lost nearly $2 billion of their money, and Red Hat's stock, which had traded at

a high of $29.06 during the class period, has never recovered . Nearly a year later it still trades at

only $11 .00 per share .

III. JURISDICTION AND VENUE

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

Section 27 of the Exchange Act (15 U .S .C. § 78aa) and 28 U.S .C. §1331 . The claims asserted

herein arise under Sections 10(b), 20(a) of the Exchange Act (15 U .S .C. §§ 78j(b), 78t(a)), and

2

the rules and regulations promulgated thereunder by the SEC, including Rule I Ob-5 (17 C .F.R.

§ 240 .1 Ob-5) ; and Section 304 of the Sarbanes-Oxley Act of 2002 (15 U .S.C. § 7243) .

8 . 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 and transactions giving rise to the violations of law

complained of herein, including the preparation and dissemination to the investing public of false

and misleading information, occurred in this District . In addition, Red Hat maintains its

principal executive offices in this District .

9 . In connection with the acts, conduct and other wrongs complained of herein,

Defendants used the means and instrumentalities of interstate commerce, including the mails,

telephone communications and the facilities of national securities exchanges .

IV. THE PARTIES

A. Lead Plaintiffs

10. The Union Group ("Lead Plaintiffs"), consisting of United Food and Commercia l

Worker's Local 1262 and Employers Pension Fund ("UFCW Local 1262"), the Zhang Family

(Yile Zhuang and Zhijie Zhuang), Robert Piccurrio, Steve Salek and Eric Bushman, were

appointed Lead Plaintiffs on January 13, 2005 . Lead Plaintiffs purchased Red Hat common

stock and have suffered losses for the reasons stated in this Complaint .

B. Defendants

Red Hat, Ina

11 . Defendant Red Hat, Inc . ("Red Hat") is a Delaware corporation with its principa l

o ffices at 1801 Varsity Drive, Raleigh, North Carolina 27606 . The relevan t background and

details of Red Hat 's business is contained in Section V.A. of this Complaint . Red Hat ' s fiscal

year begins on March 1 of each year, and ends on February 28 of the following year. For

example, March 1 , 2003 to February 28, 2004 is Red Hat 's fiscal year 2004 (FY `04), and the

3

fiscal quarterly periods contained within FY '04 are March 1, 2003 to May 31, 2003 (1Q '04),

June 1 , 2003 to August 31, 2003 (2Q '04), September 1, 2003 to November 30, 2003 (3Q '04),

and December 1, 2003 to February 28, 2004 (4Q '04) .

Matthew J. Szulik

12. Defendant Matthew J. Szulik has been Red Hat's Chief Executive Officer since

November of 1999, was elected Chairman of the Board of Directors in Apri l of 2002, served as

President since November of 1998 and as a director since April of 1999 . Defendant Szulik also

served as Chief Operating Officer from November of 1998 to April of 1999 . Defendant Szulik

signed Red Hat's Forms 10-K for fiscal years ending February 28, 2003 and February 29, 2004,

in addition to all Forms 10-Q for those fiscal years . Defendant Szulik also certified Forms 10-K

for fiscal years ended February 28, 2003 and February 29, 2004, in addition to Forms 10-Q for

the fiscal quarters ending August 31, 2002, November 30, 2002, and May 31, 2003 . In addition,

Defendant Szulik participated in several conference calls with analysts throughout the Class

Period, including calls on December 17, 2002, March 25, 2003, June 17, 2003, September 18,

2003, December 18, 2003, March 23, 2004 and June 17, 2004 .

Kevin B. Thompson

13. Defendant Kevin B . Thompson is a certified public accountant and served as

Executive Vice President of Red Hat from February of 2001 and Chief Financial Officer fro m

November of 2000, until he resigned on June 14, 2004 and subsequently left sometime in

September of 2004 when the new CFO, Charles Peters, Jr ., took over. Defendant Thompson also

served as Senior Vice President of Red Hat from November of 2000 to February of 2001, and

Vice President of Operations from September of 2000 to November of 2000 . Prior to joining

Red Hat, Defendant Thompson was a Technology Partner with PricewaterhouseCoopers, LL P

4

from June of 2000 until September of 2000, having joined the accounting firm in January of

1998. Prior to this, Defendant Thompson was a Senior Manager with the accounting firm of

Andersen, LLP, formerly known as Arthur Andersen . Defendant Thompson signed Red Hat's

Forms 10-K for fiscal years ending February 28, 2003 and February 29, 2004, in addition to al l

Forms 10-Q of those fiscal years . Defendant Thompson also certified Forms 10-K for fiscal

years ended February 28, 2003 and February 29, 2004, in addition to Forms 10-Q for the fiscal

quarters ending August 31, 2002, November 30, 2002, and May 31, 2003 . In addition,

Defendant Thompson participated in several conference calls with analysts during the Class

Period, including calls on December 17, 2002, March 25, 2003, June 17, 2003, September 18,

2003, December 18, 2003, and March 23, 2004 .

Mark H. Webbink

14. Defendant Mark H . Webbink has served as General Counsel of Red Hat since

May of 2000, Secretary since July of 2000, Senior Vice President since February of 2001, and

Deputy General Counsel for intellectual p roperty and public po licy since June of 2004 . Prior to

joining Red Hat, Defendant Webbink practiced licensing, intellectual proper ty transactions,

general corporate law and trademarks at the law firm Moore & Van Allen, PLLC, where he

represented numerous technology companies . Defendant Webbink participated in a June 17,

2003 conference call with an alysts .

Timothy J. Buckley

15 . Defendant Timothy J . Buckley served as Executive Vice President since February

of 2001 , Chief Operating Officer since April of 1999, until his retirement in December of 2003 .

Defendant Buckley also served as Senior Vice President from Apri l of 1999 to February of 2001 .

Prior to joining Red Hat , from October of 1997 until April of 1999 , Defendant Buckley was

5

Senior Vice President of Worldwide Sales at Visio Corp ., a business software company .

Defendant Buckley participated in several conference calls with analysts throughout the Clas s

Period, including calls on December 17, 2002, March 25, 2003, June 17, 2003 , and Septembe r

18, 2003 .

Paul J. Cormier

16. Defendant Paul J . Cormier has served as Red Hat's Executive Vice President o f

Engineering since May 2001 . Prior to joining Red Hat, from March of 1999 to May of 2001 ,

Defendant Cormier served as Senior Vice President, Research and Development at BindView

Development Corporation, a network management software company .

PricewaterhouseCoopers LLP

17. Defendant PricewaterhouseCoopers LLP ("PWC") is a limited liability

partnership of certified public accountants, auditors and consultants that provides audit and

assurance services, advisory services and tax and human resource services . It maintains its

headquarters at 300 Madison Avenue, New York, NY 10017 . Defendant PWC served as Red

Hat's auditor and principal accounting firm throughout the Class Period .

References to Red Hat Management Defendants

18. Defendants Szulik, Thompson, Webbink, Buckley, and Connier are collectivel y

referred to in this Complaint as the "Individual Defendants ."

V. DEFENDANTS' FRAUDULENT SCHE ME

A. Red Hat's Business Model Allowed Defendants to Conceal Their Frau d

19. Red Hat is one of the largest companies in the world that is dedicated to ope n

source software . Basically, open source software represents a shift in how computer software is

created. Unlike most proprietary software (such as Microsoft's Windows), the code that make s

6

up open source software is available to anyone free of charge, and developers who use the

software are allowed to freely make improvements to it .

. 20. One of the most recognized open source software programs ever created is called

Linux. Like Microsoft Windows, Linux is a computer operating system . An operating system is

a software program that enables the computer hardware to communicate and operate with the

computer software . Without an operating system, a computer would be useless . Originally

developed by a Finnish student named Linus Torvalds in 1991 for free distribution to all, Red

Hat used Linux to create its own variant so it could profit from the free program . Red Hat began

selling their version of the Linux, which they called Red Hat Linux, in 1994 .

21 . Today, Red Hat sells one of the most recognized Linux brands available, Re d

Hat's Enterprise Linux . Like the original Linux, this program is also an operating system .

However, Enterprise Linux is designed for larger users such as businesses, academic institutions,

and government entities to operate multiple computers on a single network (similar to

Microsoft's Windows 2000) . Red Hat also markets what it calls the Red Hat Enterprise

Network, which is a system that makes updates, patches, and bug fixes available to users of Red

Hat Linux and Red Hat Enterprise Linux .

22. Red Hat sells Enterprise Linux and the Red Hat Enterprise Network through what

it calls a subscription model . This simply means that these technologies and services are sold in

the form of annual subscriptions on a per-computer basis (generally meaning the more computers

a customer is operating, the more subscriptions it will need to purchase) .

23. When Red Hat sells a subscription agreement, it receives revenue, which as a

public company it is required to report to investors pursuant to the federal securities laws . These

laws, as well as accounting regulations, sensibly require that a company may not tell investor s

7

(who have no access to the company's internal books, records, or subscription agreements) it has

earned revenue until that revenue has actually been earned .

24. Red Hat purposely decided to ignore these rules, and with the help of its auditor

PriceWaterhouseCoopers, it booked millions of dollars of revenue before it was actually earned,

thus lying to investors and issuing false financial reports in violation of the federal securities law .

Red Hat was able to accomplish its premature revenue recognition scheme by setting up a system

whereby it shifted revenue it earned at the end of the month to the beginning of the month . Of

course, this only worked until they were caught, and when they were, it had a devastating effect

on Red Hat's stock price and on investors who rightfully expected Red Hat's management to tell

the truth about its financial condition .

B. Defendants ' Systematically Engaged in Prematurely Recognizing Revenue

25. The Former Treasurer' explained how Defendants' scheme worked . If Red Hat

received a signed contract to provide a customer with certain services on May 31, and if it was a

one year contract (as the majority of them were), 1/12th of the revenue associated with that

contract would be recorded by Red Hat in May on that day even though Red Hat had not

provided any services to the customer for that month .

26. Another example would be when a Red Hat customer purchased a subscription t o

Linux Enterprise on August 28, rather than Red Hat recognizing 4 days of revenue (August 28-

31), the Company would instead improperly book 31 days of revenue as if it had been earned on

August 1 . Since Red Hat's second fiscal quarter ends on August 31, this had the effect o f

prematurely recognizing the quarterly revenue that was reported to investors . When thousands

1 To protect their identity, all former Red Hat employees are referred to in the masculineregardless of their actual gender . In addition, all witnesses described in this Complaint identifiedas "Former" are former employees of Defendant Red Hat unless otherwise noted .

8

of sales are booked this way, as they were at Red Hat, this had the effect of shifting large

amounts of revenue into prior quarters (and years), so when Red Hat told investors how much

revenue it earned in a particular financial period, that amount was false .

27. As former Red Hat employees have confirmed, Defendants knew what they were

doing was wrong. For example, the Former Director of Professional Services confirmed that

there was no reason for this scheme other than a desire to accelerate revenues that Red Ha t

should have been recognizing on a monthly versus a daily basis . He said that Red Hat's

revenues and costs were generally fixed, the contracts were in place, and it would not have been

any more expensive for the Company to have "pushed a button" and thereby tallied the

accounting figures on a daily basis as opposed to a monthly basis .

28 . Indeed, he confirmed that all that was necessary in order for Red Hat to determin e

where it stood from an accounting and financial standpoint on a daily basis was to input the

quantifications of a transaction within a standard Excel spreadsheet . In terms of the actual

accounting figures, he said all that would have changed was the divisor, meaning that the incom e

less the costs would have been divided by 365, instead of 12 . He explained that it would not

have been any more time consuming or cost prohibitive to calculate the numbers on a daily

versus a monthly basis.

(1) Defendants knew most contracts were signed near the end of themonth

29. Defendants orchestrated the premature revenue recognition scheme because the y

knew that many of their sales were made at the end of the month (and hence at the end of the

quarter and year end). The Former Director of Professional Services confirmed that the "real

reason" the Company recognized revenues on a monthly basis was "clear" -- they wanted to be

able to recognize a full month of revenue for contracts that were signed on or towards the end of

9

the month, as many contracts were . Another former Red Hat employee, the Former Treasurer,

corroborated this, stating that a significant quantity of Red Hat's contracts were signed towards

the end of any given month .

30. The Former Managing Consultant/Director of Professional Services2 also

confirmed that it was very, very common for Red Hat to experience a large "spike" in business

during the last month of each Quarter. The Former Director of Business Intelligence recalled

that the pressure exerted upon Red Hat's upper management to achieve the Company's financial

objectives intensified significantly at the end of every quarter .

C. Defendants ' Desperation to Recognize Revenue Created a Culture ofAccounting Fraud

(1) Red Hat acquires companies just to recognize short term revenue

31 . Company insiders have revealed that Defendants, even before the Class Period

began, did whatever they could to artificially boost short term revenues, as well as to disguise the

problems they were experiencing in generating revenue. One way they accomplished this was

by acquiring other companies just to recognize their revenue stream .

32. The Former Director of Professional Services explained that Red Hat acquire d

other businesses with the "100% purpose" of assuming the revenues of the acquired companies

in order to smooth over dips in income experienced by Red Hat . By doing this, he said, Red

Hat's shareholders were appeased with a one-time injection of revenue. He said that after

enjoying the one-time revenue infusions from the acquired companies, the acquired companies

were then left to "die on the vine ." The Former Regional Account Manager also confirmed

Defendants' improper acquisition strategy, saying the company's management was onl y

2 The Former Managing Consultant/Director of Professional Services and The Former Director

of Professional Services are two different witnesses .

10

interested in realizing short term revenues in order to drive up the stock price as high as possible

in the fastest time frame possible .

33. In the meantime, Red Hat's management did not tell investors the real reason

behind these acquisitions, which was to simply boost short term revenue. In addition, the truth

was that nearly all the acquisitions had been complete failures . The Former Financial Analyst in

the Accounting Department spoke directly with Defendant Szulik around June or July 2004

about Red Hat's history of what he considered unsuccessful acquisitions . Defendant Szulik told

the Analyst "point blank" that Red Hat had completed 16 acquisitions, and that he considered 15

of these acquisitions to have been "total failures ."

34. Other high-level former insiders corroborate both the content of Defendan t

Szulik's private admission, and Red Hat's improper acquisition strategy. The Former Regional

Account Manager confirmed that "every" acquisition that the Company made was a total failure .

In addition, the Former Managing Consultant/Director of Professional Services heard it said

many times during his Red Hat employment that Red Hat would buy companies solely for the

purpose of acquiring the companies' revenue streams . He also claimed that it was Red Hat's

intention to provide itself a temporary "injection" of money to cover shortfalls of revenue .

Finally, he confirmed that after assuming the acquired companies' revenue streams, Red Hat

thereafter allowed the companies to "wither away ."

(2) Defendants purposely inflated their subscriber contract renewals

35 . During the Class Period, Defendants also knowingly inflated the percentage o f

customers who were going to renew their subscriptions . This is an important metric that outside

analysts and investors look to, because as the Former Director of Business Intelligence

explained, a company will find itself in a compromised situation when it has prematurely

recognized at least some of the revenue in association with its subscriptions, and the customer s

I1

then fail to renew . The Former Director of Business Intelligence also said that it was imperative

that Red Hat have consistently high renewal rates in order to keep the Company's business in

line with projections, and, as such, Red Hat's renewal rates were paramount to the Company's

financial well being .

36. But as Defendants became increasingly desperate as time went on, they chose to

falsify their accounting, lie to investors, and withhold the truth regarding the true nature of the

Company's finances, including the actual number of subscription renewals . Numerous high-

level former insiders confirmed that Defendants were basing their reports on false numbers

because, as the Former Financial Analyst in the Accounting Department put it, Red Hat's

executives, including Defendant Szulik, were becoming increasingly afraid of being unable to

keep the projections close to actual results because the market was consistently expecting the

company to deliver growth quarter after quarter, year after year . The Former Managing

Consultant/Director of Professional Services said that Red Hat's attempt to "sell stuff that we

couldn't deliver" created the shortfall.

37. The Former Managing Consultant/Director of Professional Services bluntl y

explained how it is a well known fact that within any sales organization, there will always be

sales staff who "are going to come in and blow smoke ." He stated that because it was well

known that the Red Hat executives never wanted to receive or acknowledge bad news, the

submission of highly inflated sales forecasts was relatively a well known problem at Red Hat .

No one at Red Hat either reviewed or reduced the forecasts in order to make them more realistic,

nor was any verification of the forecasting numbers conducted .

38. The Former Managing Consultant/Director of Professional Services also

explained that "normal companies" hold regular forecasting meetings in which the pipelin e

12

forecasts are reviewed with the sales staff. Typically, management will hold the "feet [of the

sales reps] to the fire" to determine the true prospects for particular deals . He said that the

managers leave these meetings wi th an adjusted, but much more realistic , sales forecast, which is

then disseminated to the public and the SEC. However, he claimed these kinds of in-depth and

critical forecasting meetings were not done at Red Hat .

39. The Former Regional Account Manager corroborated this , and presented an even

more detailed account of Defendant's forecasting activities . He confirmed that there was a very

significant difference between the Company's internal forecasts regarding subscriber contract

renewal rates and those that were reported to the public. According to this witness, the

forecasted renewals reported to the public were "much higher" than the actual/internal subscriber

contract renewal forecasts . He stated that Red Hat's publicly reported subscriber contract

renewal rates were comprised of "lies" and "bullshit" which were intended to make the Company

"look good to Wall Street . "

40. The Regional Account Manager explained that one duty of the sales personne l

was to provide forecasts of which existing customers they expected to renew their subscriptions

with Red Hat. These subscription renewal forecasts were ultimately consolidated and forwarded

to the CFO, who then used them as supposedly the basis for what Red Hat publicly stated were

the company's anticipated renewal rates . However, the witness asserted that Red Hat's publicly

reported forecasts were never actually attained at any time during his tenure . He recalled that

throughout his tenure at the Company, Red Hat reported forecasted subscriber contract renewal

rates well over 75%, when, in reality, the actual subscriber contract renewal rates never exceeded

50%.

13

41. The Regional Account Manager said that the sales staff were well aware that their

subscriber contract renewal forecasts were going to be submitted directly to the CFO, and that it

was known that these forecasts had a direct effect upon how these individuals were perceived by

upper management. The members of Red Hat's sales staff who submitted accurate, but therefore

lower, subscriber contract renewal forecasts were not well regarded, were actively chastised by

management, including Alex Sanchez, Vice President of Sales, and accused of having poor or

deficient sales skills . The witness stated that although the subscriber contract renewal forecasts

were not verified or validated (nor was there any consequence imposed upon the sales staff for

submitting inaccurately high subscriber contract renewal forecasts), the ramifications for

submitting accurate and therefore lower subscriber contract renewal forecast percentages were

significant .

42. He recalled that whenever a Red Hat sales representative made the mistake of

being too accurate and included too many "no's" (i .e., customers who indicated that they did not

intend to renew their Red Hat subscriber contracts) within a subscription renewal forecast, the

sales representative would invariably receive a "visit" from the sales manager reminding him/her

that these forecasts were submitted directly to Defendant Thompson. The sales rep would

typically be asked something like, "are you really sure" about the given forecast results .

However, the sales reps never received visits of this nature when very high subscription contract

renewal forecasts were submitted, even after those forecasts proved to have been overstated. As

a result, Red Hat's inside sales staff, as a matter of course, positively skewed their subscriber

contract renewal forecasts .

43. The witness remembered that one of the ways by which the Company's sales staff

achieved artificially high subscriber contract renewal forecasts was by only contacting customer s

14

that they were relatively certain were going to renew. The witness reiterated that Red Hat did

nothing to confirm and/or verify that the sales staff was contacting a representative sample of

their customers, much less verify whether the reported renewal forecasts were based on

representations about anticipated contract renewals actually made by the customers to the Red

Hat sales staff. These forecasts from the sales reps were put into Excel spreadsheets, which

included information as to whether the customer was expected to renew, and if not, why not, and

if so, the dollar value of anticipated revenue associated with the given contract renewal . The

witness indicated that the subscription contract renewal forecasts were combined, or rolled up by

the sales managers, who thereafter submitted the rolled up reports to the CFO.

(3) Defendant Thompson couldn 't handle the truth

44. Red Hat's CFO, Defendant Kevin Thompson, also knowingly assisted i n

disseminating false subscription information to investors . According to the Former Director of

Professional Services, anyone within the Company, himself included, who had the audacity to

present Defendant Thompson with any "bad news," especially about unfavorable sales o r

revenue numbers, risked immediate termination. Even those who attempted to address the idea

of incorporating a "normalizing force" to establish a more reliable revenue and /or contract

renewal target for Red Hat were met with severe disapproval by Red Hat Director of Operations

Mandeep Chaddha, Red Hat Senior Director of Operations Tim Lucas, and/or Defendant

Thompson .

45 . As the Former Director of Professional Services put it, "[Defendant] Thompson

couldn't handle the truth ." The witness added that Red Hat's sales projections were also

exaggerated because if members of Red Hat's sales team did not have what was internally

referenced as a "full pipe," and if the sales staff wished to remain employed, the sales personnel

resorted to pulling their weekly sales figures out "of their asses" in order to appease Defendan t

15

Thompson. The Former Director of Professional Services stated that he knew, without any

doubt, that sales staff who did not produce the rosy sales forecasts that Defendant Thompson

demanded were "out of a job, on the spot," and this, he said, was a reality he witnessed, not a

rumor he heard, as "I ran the team, I know what happened . "

(4) Defendants prematurely recognized revenue on consulting hours

46. Consistent with their pattern of premature revenue recognition and imprope r

accounting, Defendants also engaged in revenue recognition manipulations with respect to the

consulting services that Red Hat offered to its customers . The Former Director of Professional

Services confirmed that Defendants were recognizing a large quantity of revenues in association

with consulting hours that had not actually been worked . He explained that in association with

its billable consulting hours, Red Hat had a "nasty habit" of billing the customer, in th is case,

Lawrence Livermore National Laboratory (LLNL) (which the witness described as a multi-

million dollar Red Hat account) many, many more consulting hours than had actually been

worked, for the purpose of pulling future revenues into current quarters to ensure that the

Company made its revenue targets for that current period .

47. Referring to Defendants' practice as "selling out his next quarter," he said that the

primary problem with pulling revenues back from future quarters, in addition to the fact that it

was unethical, is that once the future time periods are reached, the manager in charge of the

consultants is "stuck" with a "bunch of work" for the consultants to do and no budget with which

to compensate the consultants, as the associated revenues had been realized prematurely by Red

Hat . Another Former Director of Professional Services also confirmed that this was akin to

going "into the next quarter with nothing . . .no billable revenue," as it had already been

prematurely recognized .

16

(5) The Barking Dog: Defendants created an aura of fear andintimidation

48. In order to artificially achieve short term revenue goals, and to keep the stock

price inflated, the standard method of operation by the Individual Defendants was to maintain an

atmosphere of fear and intimidation among Red Hat's staff and employees . This directly

contributed to the improper activities described in this Complaint, such as the premature revenu e

recognition, and the false sales forecasts handed in by the sales staff. One "wrong move" at Red

Hat, which could include submitting low (yet accurate) renewal forecasts, questioning

management's revenue recognition policies, or even reporting accounting fraud, would be met

with swift and strong retribution from the Individual Defendants who controlled Red Hat .

49. For example, the Former Regional Account Manager stated the Company' s

excessively high employee turn-over rates were due, at least in part, to the fact that Defendant

Szulik frequently threatened to fire people over relatively minor issues, often during large,

office-wide meetings . Another former employee, the Former Financial Analyst in the

Accounting Department said that Defendant Szulik could be very abrasive, and likened him to a

"barking dog." The witness said that when Defendant Szulik wanted "the numbers" on his desk,

he wanted them "NOW!" He also said that Defendant Szulik put the "fear of God" into

everyone who worked for Red Hat . The Former Director of Professional Services also stated

that Defendant Szulik often "barked" at people during meetings, and intimated, if not openly

stated, that he intended to terminate certain individuals .

50. The Former Inside Account Executive also recalled that during large employee

meetings, Defendant Szulik would threaten employees by saying "You'd better do this or you're

fired," which created an environment of hostility and intimidation within the Company . The

Former Project Manager & Senior Business Analyst characterized the Red Hat work

17

environment as hostile, and he said that everyone was always "walking on glass," afraid of being

terminated. Finally, the Former Managing Consultant/Director of Professional Services said that

Red Hat's executive staff did not want to "hear bad news, ever ." The witness explained that if

anyone questioned anything Defendants Szulik and/or Thompson did in any way, "that person

disappeared, fast."

(6) Defendants refuse to stop prematurely recognizing revenue even afterbeing personally confronted by a high level inside r

51 . Defendants knew the proper methods and controls they should have implemented ,

and were even personally told by high-level employees that they needed to stop their current

improper activity. However, instead of changing their ways, the Individual Defendants met any

challenge with responses that ranged from indignation (at the least) to immediate termination of

any employee (no matter what level) who either refused to participate, or dared to challenge their

fraudulent methods .

52. The Former Managing Consultant/Director of Professional Services explaine d

how consulting revenue is normally recognized . He said that when a consulting company enters

into a new consulting contract, the company is supposed to conduct a detailed assessment of the

consulting project in order to develop a Statement of Work, or "SOW," which basically contains

a breakdown of what the company is going to do, what the company is going to deliver, and the

date of delivery. He stated that stages of this plan become "milestones," or points of delivery,

and, once the points of delivery are reached, the consulting company can bill against the contract

total and recognize a certain portion of the revenue associated with the consulting contract .

53. He recalled that other consulting companies typically utilize MS Project 4 or a

similar spreadsheet program in order to track the achievement of milestones . The witness

explained that he was well versed in the conduct of these kinds of project assessments and i n

18

determining the appropriate milestone plan . However, Red Hat's executive management

consistently would "not agree" to implement this measure of control over the projects or revenue

recognition process . Instead, the Red Hat executive management staff informed him that "you

can't do it that way, that's not the way we do it here [at Red Hat] ."

54. The situation was even more severe for the Former Director of Professiona l

Services, who explained that because he knew his head was going to be on the chopping block in

either the previous quarter (if he failed to go along with the Company's program of stealing

revenue from future quarters) or in the following quarter (for being unable to achieve revenue

targets as explained), he figured that he had "nothing to lose" by confronting Red Hat Director of

Operations Mandeep Chaddha and Senior Director of Operations Tim Lucas about his objections

in writing .

55 . So, in October 2002, he began a process of confronting the "higher ups," to whom

he directly and/or indirectly reported, including Chaddha and Lucas, with regard to the means

and manner in which Red Hat had been recognizing revenue . He wrote an email (the subject line

of which read "LLNL billing number vs . recognize number + actual hours worked") asking

Chaddha to explain the logic behind the revenue recognition number he calculated in association

with two projects called DMX and Chromium. In essence, the email pointed out that in the

following quarter, he was expected to execute $780,000 of work, but "show no revenue," as it

had all already been recognized in the previous quarter .

56. In response, Chaddha wrote that "we can perhaps recognize only 200K in the

current quarter ." The Former Director of Professional Services responded to Chaddha saying "I

don't know what kind of math or logic constitute the `perhaps 200k' you are speaking of," "you

have not yet explained the logic behind your revenue recognition number? Is there any?", and " I

19

do not want some arbitrary recognition number to be some kind of indicator of resource s

required."

57. Chaddha responded "I believe we have already had the discussion about th e

LLNL revenue recognition numbers ." Again, the Former Director of Professional Service s

attempted to get Red Hat management to listen, saying "I am reporting what I will be billing,

[but] you are telling me I can't report that," "I do not know what to report because the logi c

behind our revenue recognition policy has never been explained," and "[w]hat is the rational e

behind the 'perhaps 200K ' That does not sound like it comes from the GAAP binder."

58. However, his follow-up e-mails fell on deaf ears. The former Red Hat employee

stated that the bottom line was that Red Hat was allotting "many, many" more man hours a s

having been already worked, at least in association with the LLNL account, in order to accelerate

the revenue associated with the LLNL projects, but the work still needed to be done in order to

complete the project.

59. After sending his email, the former Red Hat employee confronted Red Hat's Vic e

President of Operations Tony Moretto with the same information . When he did, Moretto

attempted to intimidate him by threatening his continued employment with Red Hat if he did no t

keep quiet, telling him that if he "couldn't handle it," he would "lose his job ."

60. The former Red Hat employee responded to Moretto's threats by stating that

when he was not able to achieve revenue goals in future quarters because the Company had

already prematurely recognized all of the associated revenues in previous quarters, he probably

would not be looking at a very bright future at Red Hat at that point either . To this, Moretto did

not offer any response . However, soon thereafter the former Red Hat employee's internal

employee rating previously allocated to him by Red Hat's employees (and which had ranked him

20

in the top 10% of Red Hat employees ) was lowered . Morretto had "re-ranked " him down to the

50th percentile .

61 . That same month , still having convinced no one in Red Hat m anagement that they

must stop recognizing revenue prematurely, the Former Director of Professional Services met in

person with Defendant Thompson to discuss his concerns that Red Hat had been prematurely

recognizing consulting revenue associated with the LLNL project . The former Red Hat

employee said he "sat down" in Defendant Thompson's office and con fronted Defendan t

Thompson with the fact that he was being put in the position to report numbers in association

with work that had not yet been completed , and he wanted an explanation from Defendant

Thompson as to how he could possibly be expected to go along with this, when he was clearly

not going to be able to achieve his revenue goals in future quarters since revenue was being

prematurely recognized .

62. The Former Director of Professional Services said Defendant Thompso n

dismissed his concerns about the premature revenue recognition, telling him "you don't have to

worry about next quarter . . .I'll take care of you .-This is what we have got to do." The former

employee recalled that the implication of Defendant Thompson's statements to him was "go

along with it, don't make noise" and he would not have any problems . Shortly thereafter,

Defendant Thompson escorted the former employee out of his office with a smile and a pat on

the back. Almost immediately after this meeting, the Former Director of Professional Services

received word that his employment with Red Hat had been terminated .

D. PWC actively Participated in the scheme

63. PWC actively assisted and participated, both directly and knowingly, in Red Hat's

ongoing revenue recognition fraud. As detailed below, Red Hat's chief audit partner from PWC

directly assisted Red Hat in its plan, knew what he was doing was wrong and in violation of th e

21

rules governing accounting, and even tried to cover up the fraud when his active participation

was exposed .

E. PWC audit staff were intertwined with Red Hat 's CFO and FinanceDepartment

64. PWC has been Red Hat's auditor during Red Hat 's entire existence as a public

company (since Red Hat's IPO on August 11, 1999). This is further confirmed by the Former

Treasurer, who said that PWC initially entered into the Red Hat engagement even prior to the

IPO, beginning in 1998 . Both the Treasurer and the Former Senior Staff Accountant revealed

that for the five year period prior to the restatement , a PWC Audit Partner named Jeff Barber had

been the PWC Audit Engagement Partner assigned to the Red Hat account .

65. The Treasurer also revealed that Barber and Red Hat's CFO, Defendant

Thompson, had previously worked toge ther at PWC, as did several other individuals who

worked closely with Defendant Thompson at Red Hat . The Former Director of Business

Intelligence said that prior to Defend ant Thompson 's tenure as Red Hat 's CFO, Defendant

Thompson worked for PWC. This was further con firmed by the Former Senior Staff

Accountant, who stated that Red Hat 's accounting department employed "a lot of people" who

were formerly employed by PWC, and as a result, there was "a lot" of PWC accounting literature

to be found within the Red Hat Corporate Office accounting department . He reiterated that

Defendant Thompson had been employed by PWC for "a while" before he became Red Hat's

CFO, and that in addition to Defendant Thompson, Senior Vice President of Revenue

Recognition William Tendel , as well as current Senior Finance Manager Bart Kalsu and Jason

Savod , both of whom repo rted to Defendant Thompson, were also previously employed by

PWC .

22

66. The Former Treasurer said that it was well known within Red Hat that Defendant

Thompson used to work at PWC's Raleigh office, and that Barber was Defendant Thompson's

boss throughout his tenure at PWC . He said that Barber "runs" the Raleigh PWC office, and,

that all of the PWC employees who work out of Raleigh technically report to Barber. He said

that while Defendant Thompson was working at PWC, Defendant Thompson brought Red Hat in

as a client .

67. The Former Financial Analyst in the Accounting Department stated that PW C

"pretty much always had bodies" at Red Hat . This made sense, as the Former Treasurer

explained that Red Hat did not have any internal audit staff whatsoever . The Former Financial

Analyst in the Accounting Department said that these PWC personnel were typically involved in

conducting some form of auditing function within the Red Hat premises, and that Defendant

Thompson and Senior Finance Manager Bart Kalsu both interacted with the PWC auditors on a

regular basis. A Former Senior Staff Accountant indicated that Red Hat had worked with the

same PWC audit staff for many years prior to June 2004, and that during his Red Hat

employment, he worked closely with three or four Red Hat employees who had previously been

employed by PWC .

68. The Treasurer also confirmed that the PWC auditors were usually working on

"one thing or another" at the Red Hat Corporate Office . He explained that because Red Hat is a

publicly-traded Company, and is required to file a quarterly lOQ and earnings release, PWC was

required to be at the Red Hat premises on at least a quarterly basis to do the necessary audit

review. In the course of a typical year, he said that PWC conducted auditing work at the Red

Hat premises at least 5 times a year, and on each occasion, they were never at the Red Hat

premises for less than one week, and were usually there longer . He recalled that during the year

23

end audits, when there was more work to be done, PWC auditors were on the Red Hat site for

approximately two weeks .

69. The Treasurer said that after every Red Hat annual audit was completed, PWC

met with Red Hat's Board of Directors and Audit Committee, usually in March or April, in order

to inform them of the results of the audit and the auditors associated opinion . Many of the

attendees participated by telephone . He said that Barber and his staff led the discussion on these

calls, and that Defendant Thompson also participated in these conference calls . He also said that

PWC had a hard copy format of these presentations, and that Defendant Thompson and the Red

Hat Audit Committee would have received a copy of this .

F. Barber is going to be replaced

70. In July 2002, which was then approximately three years into Barber's tenure a t

Red Hat, the Sarbanes-Oxley Act was enacted. As part of the new Act, and in recognition of the

paramount importance of having an independent auditor, Congress required that no accounting

firm could have an lead auditor responsible for a particular company for longer than five years .

See Sarbanes-Oxley Act of 2002, Pub . L. No.107-204, Title II, § 203, 116 Stat. 772 (2002),

codified at 15 U .S.C. 78j-1(j) .

71 . In Red Hat's case , PWC was now required to replace Barber with a new audit

partner beginning in the first quarter of Red Hat's fiscal 2005, which would begin on March 1,

2004 and end on June 1, 2004. Indeed, the Former Director of Business Intelligence confirmed

that the auditor rotation would be the factor that precipitated the "shit hitting the fan" in terms of

Red Hat's earnings restatements .

G. The "firestorm" rapidly approaches

72. Barber and the Defendants were growing increasingly tense and uneasy as the

auditor rotation approached, because they knew that the new auditor would not be entrenched

24

wi th management , and therefore would likely not continue to go along with the premature

revenue recognition scheme . Even worse , they knew that the new auditor would probably

discover the scheme on his own, thus forcing Defendants to reveal their lies and omissions,

restate the comp any's financials, and general ly triggering what the Former Treasurer referred to

as a "firestorm . "

73 . The Former Treasurer detailed the exact events leading up to the accounting storm

that actually did occur. On March 1, 2004, Red Hat's Accounting and Finance Departments

began the annual process of closing the books and generating the required financial statements .

He explained that although Red Hat closed its books every month, the quarterly process was

more involved. The witness said that throughout the first 10 to 14 days of March 2004, Red

Hat's accounting department was in the process of closing its books for the quarter and

generating financial statements for that period . He said that at the end of the first 14 days of

March, the PWC audit team came out to audit Red Hat's financials associated with FQ1 . Once

the numbers are approved by the Board, the audit partner can release the earnings results . He

stated that by the time this process is completed, it is usually late March .

74. The Former Treasurer went on to explain that generally a Company has 90 days

from its year end to file its 10K/Annual Report with the SEC (pursuant to General Instruction

A(2) to Form 10-K), which, in Red Hat's case, was May 31, so the Company has to have these

reports finalized by approximately mid-May, allowing the audit team ample time to review them .

75. He said that during the months of March, April, and May 2004, Barber was still

involved on the Red Hat engagement, as PWC's audit team conducted the process of completing

the audit for the year ending February 29, 2004 . By May 31, 2004, the PWC auditors had

completed their work, and Barber was rotated off of the Red Hat engagement . He said that on

25

May 31, 2004, Red Hat had come to the end of its first fiscal quarter for 2005, at which point the

Company again began the same process - i .e., for the next 10 - 14 days, the accounting

department closed the books and generated and reviewed the requisite financial statements, after

which time the PWC auditors began their audit .

H. PWC and the Defendants Know they Are in Imminent Dancer of BeingExposed

76. The Defendants had strong reasons to believe that the new auditor who woul d

soon arrive at Red Hat would be a stranger to them, and would likely be unwilling to continue

their fraud. The Former Treasurer explained that the offices of the four large accounting firms in

Raleigh are "relatively small ." He stated that when Barber had to be rotated off of the Red Hat

engagement, there were only two other Audit Partners within the Raleigh PWC office from

which to choose. He indicated that because the Raleigh office was so small, it was unlikely that

the other two audit partners based there would have had the necessary technology expertise .

77. He pointed out that within North Carolina, there was a substantial amount o f

manufacturing, banking and finance companies, and it is reasonable for one to deduce that the

remaining audit partners in the Raleigh PWC office had expertise in these and/or related areas, as

opposed to technology. He said that Barber was well known as a local technology partner, and

since Barber had to be rotated off of the Red Hat engagement, it was logical to conclude that the

new partner would be someone from outside the area .

I . The Individual Defendants Dump Their Stock

78. Faced with the impending prospect of having their fraud revealed to the market,

and knowing that the new auditor would be reviewing Red Hat's financial statements for fiscal

year 2005, which was to begin on March 1, 2004, the Individual Defendants began to illegally

sell millions of dollars worth of their personal stock, with a staggering amount of sales taking

26

place in February 2004 and continuing through May 2004, all of which encompassed the quarter

which the new auditor would be addressing .

79. The details of Defendants' insider trading are addressed in full in Section XII .B .

of this Complaint, but it is worth noting here that CFO Thompson sold 135,000 shares for $2 .9

million between January and April 2004, while CEO Szulik dumped 1 .2 million shares for

proceeds of approximately $22 million in February 2004 alone . For two men with salaries of

$350,000 and $250,000 per year in fiscal year 2004, this represented an enormous profit .

J. The PWC Replacement Auditor Arrives at Red Hat

80. The Former Treasurer recalled that when Barber "rolled off' the Red Ha t

engagement in the fiscal year ending February 29, 2004, Victor Petri, who was based in PWC's

Boston office, replaced Barber as Red Hat's audit partner . He explained that Barber signed off

on the opinions for the audit ending on February 29, 2004, and Petri was assigned as Red Hat's

new audit partner for the Red Hat fiscal year beginning March 1, 2004 . The witness maintained

that Petri did not really "get into" reviewing Red Hat's financials until June of 2004, when Petri

and his audit team were in the process of reviewing the Company's financial statements for the

quarter ending May 31, 2004.

81 . The witness stated that the first time Petri was asked to look at or review Red

Hat's financials in his role as Red Hat audit partner was when the Company completed its first

fiscal quarter ending May 31, 2004, so the beginning of June 2004 was the first time that Petri

went to Red Hat's Corporate Office to begin the auditing process for the first quarter of the new

fiscal year. So, on May 31, 2004, Red Hat's accounting department closed its books for the

quarter ending May 31, 2004, at which time the PWC engagement team "came out" to the Red

Hat premises to review the Company's books.

27

VI. THE TRUTH REGARDING RED HAT'S REVENUE RECOGNITION SCHEMEIS PARTIALLY REVEALE D

A. Monday, June 14, 2004 -- The CFO Bails Ou t

82. Less than two weeks after Petri and his team began their initial review of Re d

Hat's books, on Monday, June 14, 2004, after the market closed at 4 :00 p.m. EST, Red Hat

suddenly and unexpectedly announced in a prepared statement that CFO Thompson would be

resigning "to pursue other interests ." Red Hat added that Defendant Thompson was expected to

continue as CFO until the search for his successor was completed .

83 . TheStreet.com, a highly respected investment advisor and leading provider of

investment commentary, advice, research and news, reacted on June 14, 2004, stating that "[t]he

abrupt resignation, coming just three days before the company is scheduled to report fiscal 2005

first-quarter earnings, puzzled Wall Street ." The article further quoted an analyst's comments,

stating "[e]veryone hates uncertainty. Why wouldn't they wait until earnings? This puts even

more of a spotlight on Thursday's report . "

84. Inside the company, the Former Inside Account Executive confirmed that th e

CFO's resignation was "highly unexpected," and that "nobody saw that coming ," while the

Former Regional Account Manager , who held a higher position at Red Hat, said that he and the

other sales personnel at the corporate office believed that the timing of the two events and

Defendant Thompson 's stated reason for his resignation were "tot al bullshit." He and his fellow

sales personnel believed that Defendant Thompson had resigned because he was aware of the

impending earnings restatement announcement and the negative impact th is would invariably

have on Red Hat 's stock price . The witness recalled that as soon as the earnings restatement was

announced, the internal sales staffcollectively exclaimed, "Oh, that's why he [Defendant

Thompson] left ."

28

85. Adding further evidence that Defendant Thompson's departure was fallout from

the revenue recognition scheme is Defendant Thompson's separate statement, reported by the

Associated Press Worldstream that same evening (June 14, 2004), that the reason he was leaving

was to spend "some additional time with my family ." However, Defendant Thompson's famil y

excuse has now been exposed as manufactured . The News & Observer followed up on

Defendant Thompson's excuse on December 26, 2004, making the following observation in its

Christmas "gifts" to the "naughty and nice" : "To Kevin Thompson, who left his position as chief

financial officer at Red Hat, a Raleigh software company, to spend more time with his family

and yet ended up becoming CFO at SAS, a Cary software company: a two-week vacation with

the wife and kids ."

86. As a consequence of the June 14, 2004 announcement of the CFO's unexpecte d

resignation, which was directly related to the premature revenue recognition scheme employed

by Defendants, Red Hat's stock, which was inflated throughout the Class Period due to

Defendants' fraudulent scheme, dropped 12 .55% in after hours trading on June 14, 2004 from a

close of $24 .30 to an after-hours low of $21 .25, causing damages and economic loss to Lead

Plaintiffs and the other members of the Class .

B. Tuesday, June 15, 2004 - Defendants' Continue to Panic

87. Under enormous pressure, and with their scheme rapidly unraveling, Red Ha t

panicked the following day, releasing, just minutes prior to the market's opening on Tuesday,

June 15, 2004, an unexpected "preview" of earnings and subscriptions volumes for the first

quarter of fiscal 2005 ended May 31, 2004, announcing that the Company expected to report net

income of over $10.0 million, or $0 .05 per share, for the first fiscal quarter 2005, and operating

income in the range of $4 .7 million.

29

C. Wednesday, June 16, 2004 - The New Auditor " Drops the Bomb"

88 . Meanwhile, back at Red Hat's corporate headquarters, Defendants and Barber's

worst fears about the new auditor were about to come to fruition . The Former Treasurer recalled

that after Petri's arrival in early June 2004, Petri was not at the Red Hat premises every day, but

was shuttling back and forth between Boston and Raleigh during the Quarterly Review audit .

But even with Petri not working on site at Red Hat's headquarters full time, it didn't take long

for him to discover Defendants' scheme .

89. The Former Financial Analyst in the Accounting Department and the Forme r

Treasurer both explained that on the morning of June 16, 2004 Petri informed Red Hat

management, including Defendant Thompson and Senior Finance Manager Bart Kalsu, that he

wanted Red Hat to change the Company's revenue recognition practice from a monthly basis to a

daily basis . The Treasurer, who referred to this as Petri "dropping the bomb," said Petri stated

that he had to cover himself, and that Barber may have been comfortable signing off on the audit

opinions, but that he (Petri) was not .

90. The Treasurer said that after the "bomb" was dropped, he (the Treasurer),

Defendant Thompson, and several other individuals worked overnight on June 16, 2004

manually running the financials on a daily revenue recognition method. According to this

witness, just one business day later, on June 17, 2004, the final decision was made by Petri to

change Red Hat's revenue recognition method . Once Petri determined that Red Hat was going to

have to restate its financials, Petri said that "if the shit is going to hit the fan and the SEC is down

on us and there are law suits, they will come after me . . . .I am not comfortable with this ."

D. Thursday, June 17, 2004 - Defendants' Announce Earnings Shortfall

91 . On Thursday, June 17, 2004, just three days after announcing the CFO's

resignation, and two days after its "preview," Red Hat announced its first quarter results for th e

30

fiscal quarter ended May 31, 2004, revealing that its revenues of $41 .6 million fell short of the

Company's guidance of $42 .5-43.5 million and consensus expectations of $43 million .

92. As a consequence of this unanticipated revenue miss on June 17, 2004, which was

directly related to the premature revenue recognition scheme employed by Defendants, Red

Hat's stock, which was inflated throughout the Class Period due to Defendants' fraudulent

scheme, dropped 10 .23% from a close of $22 .39 on June 17, 2004 to close at $20.10 on June 18 ,

2004, causing damages and economic loss to Lead Plaintiffs and the other members of the Class .

93. Red Hat made the number 2 spot on TheStreet.com's June 18, 2004 "The Five

Dumbest Things on Wall Street This Week." In response to the strange actions of Red Hat in

unexpectedly issuing a preview of earnings one day after announcing the CFO's resignation and

two days before releasing actual earnings, TheStreet.com reported: "Some companies aren't

distracted by the vicissitudes of the market . They key their eye on the operational big picture,

not the tiny ups and downs of their stock price. They take the long view. Red Hat, we learned

this week, is not one of those companies ."

94. Also on June 17, 2004, an interview of Defendant Szulik by Bloomberg reporter

Dina Bass ("Bass") was broadcast on Bloomberg. During the interview, Bass asked Defendant

Szulik why the Company announced Defendant Thompson's resignation and pre-announced its

financials results for the first quarter of fiscal year 2005 just days before the Company formally

announced its first quarter financial results on June 17, 2004. Defendant Szulik responded to

Bass by first representing that Red Hat "prides itself on transparency not only in its software

code, but as part of its overall corporate governance strategy." Defendant Szulik went on to state

that many analysts believed that Defendant Thompson's resignation was a precursor to further

"negative news, i .e ., a financial restatement or SEC investigation," and therefore, the Company

31

wanted to "reassure investors that that was not happening and more importantly that the health

of the business was strong ."

E. Barber's Tries to Cover His Tracks

95 . Again, back at Red Hat, Barber and the Defendants had now been caught red-

handed, and Barber scrambled to protect himself. Of course, as the Former Treasurer explained,

Barber knew that revising the fraudulent revenue recognition policy during his tenure as the

Audit Engagement Partner would have "raised flags," and would have caused "a ruckus ." But

now the "ruckus" was here, and the firestorm was in full play.

96. Increasingly desperate, and engaged in a futile effort to cover his tracks, Barbe r

was determined to try and fix the problem if he could. As the Former Treasurer explained, there

was approximately a 21-day period during the last half of June 2004 and the first part of July

2004, during which Petri and his staff were in the process of analyzing the previous quarters

(which were subsequently restated). Amazingly, as the Former Treasurer revealed, even though

Petri had taken over as Red Hat's engagement partner and Barber was no longer assigned to

work on the Red Hat account, Barber continued to travel "back and forth" to the Red Hat

premises during this 21-day time frame.

97. The witness said that Barber's interest in returning to the Red Hat premises durin g

this 21-day time frame was that he did not want Petri to make him "look bad," and, more

importantly, Barber did not want to be susceptible to litigation and liability . The Former

Treasurer distinctly remembered being informed by the PWC audit staff members that

throughout this 21-day timeframe, upon each return visit to the Red Hat premises, it was clear to

them that Barber was losing approximately 10 pounds a week and reportedly was not sleeping

much, if at all . Barber had reportedly informed the audit team members that he was "nauseous"

and unable to sleep .

32

98 . The witness understood that PWC was "also looking out for itself' and its own

possible exposure to liability and litigation, and that at some point during this time, PWC

recognized that Barber's continued presence during the 21-day analysis of the previous quarters

represented a possible conflict of interest, in that Barber may have been pressuring the audit

team, several of whom used to report to Barber during his tenure as Red Hat's engagement

partner . Finally, at one point during this 21-day time frame, senior PWC personnel admonished

Barber for continually returning to the Red Hat premises even though he was no longer on the

engagement, telling Barber in no uncertain terms "don't go back [to the Red Hat premises] ."

VII. THE TRUTH REGARDING RED HAT'S REVENUE RECOGNITION SCHEMEIS FINALLY FULLY REVEALED

A. End Of Class Period : Defendants Announce Restatement And SEC Inquiry

99. One month later, on July 13, 2004, before the opening bell, the Company stunned

the market again . This time, and in a complete 180° turn from Red Hat's June 17, 2004

reassurance that a restatement "was not happening," Red Hat revealed to the public that i t

planned to restate its audited financial statements for the fiscal years ended February 28, 2002 ,

February 28, 2003, and February 29, 2004, and its unaudited financial statements for the fiscal

quarter ended May 31, 2004 . The company said that the restatement was due to the correction in

the manner in which the Company recognizes revenue for certain subscription agreements. The

press release stated :

Red Hat today announced that it had corrected the manner in which it recognizesrevenues for certain of its subscription agreements and, as a result, will restate itsaudited financial statements for the fiscal years ended February 29, 2004,February 28, 2003, and February 28, 2002, and its unaudited financial statementsfor the fiscal quarter ended May 31, 2004 .

The decision results from recent discussions between the Company and theCompany's independent auditors PricewaterhouseCoopers, following the normal

rotation of audit partners required by the accounting profession's rotation rules .

As a result of these discussions, the Company determined it would be appropriate

33

to stop recognizing revenue for subscription agreements on a monthly basis - amethod it has consistently applied for the last five years - and start recognizingrevenue on a daily basis over the particular contract term .

The restatement is due entirely to the correction in the Company's method ofrecognizing revenue for subscription agreements. The effect of using the newmethod is to defer a portion of the revenue that had been previously recognized inthe month of commencement of a subscription to the month in which thesubscription ends.

100. In the same July 13, 2004 press release , Red Hat also disclosed that th e

restatement "is expected to result in significant percentage differences in certain items such as

quarterly operating profit and net income."

101 . The Company also said in the press release that PWC had informed them of the

change in revenue recognition a month earlier on June 16, 2004 :

On June 16, 2004, the Company's independent auditors informed the Companythat it should consider recognizing revenue from a subscription over the term ofthe subscription (for example, the number of days in the subscription period),which ultimately resulted in the Company deciding to change to this method . Theresulting change will now mean that the Company will begin to recognize revenueon the date of commencement of a subscription and ratably over the remainingterm of the subscription. The effect of the Company's decision is to defer aportion of the subscription revenues that would have been recognized in themonth of the commencement of the subscription to the last month of thesubscription term.

102. Trying desperately to spin the restatement as a non-event, Defendant Szulik state d

"[t]he restatement is not expected to reflect any material difference in the meaningful historical

trends of our business, nor will it adversely affect our business outlook, which remains strong ."

The Company also revealed in its July 13, 2004 press release that it would not file its Form 10-Q

for the first fiscal quarter 2004 on time. Rather, the Company anticipated filing its Form 10-Q

on or before July 19, 2004 .

103. However, analysts knew how serious a situation this really was, and they

peppered Defendant Szulik with questions during an analyst conference call that same day (July

34

13, 2004) . For example, a Prudential analyst asked Defendant Szulik, "why did it take the

auditor 5 years to raise this issue, I guess, why wasn't this raised earlier and what triggered them

to raise this now versus few years ago . . ., - which seemed like the way that it should be done?"

Defendant Szulik replied "as we have discussed in the call that the discussion that resulted in our

decision to make the restatement began on June 16, 2004 . And while prior discussions about

the method had occurred early on, it has only been since the discussions that commenced from

the 16th that we understood the need to make this correction."

104. But the bad news was not over yet . Defendants also revealed to the market in the

July 13, 2004, press release that Red Hat was "in the process of responding to prior comments

and questions from the SEC regarding its Annual Report on Form 10-K ." Because of Red Hat's

earlier reassurances on June 17, 2004 that an SEC investigation "vas not happening," it was

again revealed that Defendants omitted to tell the public the full truth regarding the SEC inquiry .

105. Indeed, according to the Former Treasurer, the SEC inquiry began in April o f

2004, months before the release, when the SEC informed Red Hat that it had reviewed one of the

Company's filings and had questions. Red Hat was asked to provide certain information to the

SEC in order to address those questions, and the Company was forced to file a response with the

SEC. However, when Red Hat provided this additional information, it reportedly gave rise to

more questions. According to the Former Treasurer, when Defendant Thompson initially

received the SEC inquiry letter, he shared the correspondence with a PWC auditor, who shared

the letter with the then-audit partner, Jeff Barber . However, Defendant Thompson waited to

focus on the SEC inquiry until after Red Hat announced results for the first fiscal quarter ended

May 31, 2004 .

35

106. As a consequence of the news of the morning of July 13, 2004, which was

directly related to the premature revenue recognition scheme employed by Defendants, Red Hat

stock, which was inflated throughout the Class Period due to Defendants' fraudulent scheme,

plunged 22 .7% from $20.35 per share to $15 .73 per share on July 13, 2004, on unusually high

volume of 55,783,888 shares, far greater than the Company's average daily trading volume

during the Class Period of 3,518,357 shares, causing damages and economic loss to Lead

Plaintiffs and the other members of the Class . In fact, it was the largest one day drop Red Hat's

stock had ever suffered .

107 . News of Red Hat's restatement was met with much dismay in the financia l

markets. The timing of the announcement, coupled with other bad news, called Red Hat's

credibility into question . As eWeek.com stated in a July 13, 2004, article, "[t]he market []

doesn't like this change one bit . . . The shorts and longs battled it out on the frantic Red Hat

financial message boards at Yahoo . Some shorts asked, `why didn't management say anything

during the June conference call?' Others suggested that Red Hat's previous chief financial

officer resigned two weeks before the last earnings call because he knew `the books were

cooked." '

108. In fact, on July 16, 2004, TheStreet.com ranked the Red Hat restatement

announcement as one of "The Five Dumbest Things on Wall Street This Week ." As the article

reported, "[a]t Red Hat, the hits just keep on coming . Or more accurately, the body blows . []

More alarming than the revelation of the now-discredited policy - after all, who among us hasn't

slid revenue forward 20 days every now and then? - are some other disclosures the company

made in the course of explaining the revenue problem to analysts . First, though the Company

36

started out saying that PWC brought the revenue problem to its attention on June 16, Red Hat

said on the call that in fact, the problem had previously surfaced at some time in the distant past . "

109 . Client Server News, in a July 19, 2004 article, also considered the restatement to

be a credibility issue . In addition, as reported in the same article, Prudential stated that the June

and July 2004 events and assertions from Red Hat "call into question the timing and judgment of

Red Hat management," leading investors to question whether Red Hat was completely up front

on these issues . The article also said that "stockholders are wondering why, i f

PricewaterhouseCoopers raised the recognition issue on June 16, like Red Hat CEO Matthew

Szulik said, and if Red Hat had its Q1 recalculations in hand by June 17 when it reported its QI

results, again like Defendant Szulik said, why the heck it didn't say it was using a different

revenue recognition policy then since the switch lowered revenues to $41 .6 million, below the

$42 .5 million to $43 million it guide[d] towards . "

110. Analysts now began to raise numerous serious questions about Red Hat' s

credibility . For example, Red Hat analyst FTN Midwest Research commented on July 15, 2004,

"when you look at the timeline, the timing is so bizarre, there are some concerns about

management credibility." In fact, during a July 13, 2004 conference call, FTN Midwest

Research told Defendant Szulik and Defendant Thompson that it was "quite disconcerting" and

that "all the timing [ ] doesn't seem to be quite in sync ." During this conference call, FTN

Midwest also stated that it was "quite amazed," questioning whether this was "the start of more

accounting issues, or is it the end?" Another Red Hat analyst, the John Hancock Technology

Fund, was reported by TheStreet.com on July 13, 2004, as saying "[y]ou have some credibility

issues there ." John Hancock also suggested that Red Hat management's credibility has been

37

called into question because the Company didn't disclose the change when it announced it s

quarterly results on June 17, 2004 .

111 . In fact, as the Defendants knew, the timing of the restatement was not bizarre a t

all, but rather a calculated effort to withhold information from investors for as long as they could,

in order to maximize their own personal profits through insider sales, as detailed in I¶ 272-28 3

of this Complaint .

112. Several analysts also lowered their valuation ranges for Red Hat . For instance,

Wachovia Securities lowered their valuation range for Red Hat from $21-$25 to $15-$17 .25, due

to heightened business uncertainty and risk relating to Defendant Thompson's resignation an d

the accounting-related disclosures.

113. These questions and concerns lingered with analysts long after the dust had

settled. For example, in an August 27, 2004, article by The News & Observer, Red Hat analyst

Canis & Company was quoted as saying "[w]e lost a whole lot of belief that everything was

under control as they shot themselves in various feet and other appendages . The market is really

waiting for management changes or other events that would boost people's confidence."

VIII . DEFENDANTS' FALSE AND MISLEADING STATEMENT S

A. The Class Period Begins: Defendants Issue False Financial Results For 3003(ended November 30, 2002)

114. On December 17, 2002, the Company released its results for the third fiscal

quarter ended November 30, 2002, in a press release entitled, "Double-Digit Sequential

Revenue Growth, Positive Cash Flows from Operations Highlight Red Hat's Third Quarter

Results : Enterprise subscription revenues grow 29% sequentially, operating cash flows reach

$1 million ." Specifically, the Company reported in part :

38

Red Hat achieved revenue of $24.3 million, a sequential increase of 14% compared to$21 .2 million in the second quarter of fiscal 2003 , and a year-over-year increase of21% .

For the third quarter of fiscal 2003 the company reported a net income of $305,000,3 orbreak-even per share. This compares to a net loss of $2 .0 million, or $0.01 per share, inthe prior quarter, and a net loss of $15 .1 million, or $0.09 per share in the same quartera year ago .

115. The Company summarized third qua rter fiscal highlights as follows :

• Enterprise revenues, which account for 93% of Red Hat's totalrevenues, grew 15% to $22 .5 million .

• Enterprise subscription revenues jumped 29% and generated grossmargins of 82% .

• Sales of Advanced Server increased to 12,000 subscriptions, a 50%increase compared to the prior quarter .

116. Defendant Thompson commented : "Accelerating growth of our enterpris e

subscription revenues and positive operating cash flows are evidence of Red Hat's scalabl e

business model . "

117. Defendants hosted a conference call with analysts on December 17, 2002, after

the earnings release, in which Defendants Szulik, Thompson and Buckley participated . During

the call, Defendants repeated the results for the third fiscal quarter 2003 announced the same

day .

118. The financial results announced on December 17, 2002 were repeated and

incorporated into the Form 10-Q filed with the SEC on January 10, 2003, for the third quarter of

fiscal year 2003 . The Form 10-Q was signed by Defendants Szulik and Thompson .

119. The Form 10-Q included certifications from Defendants Szulik and Thompson, a s

required by Section 9 .06 of the Sarb anes-Oxley Act of 2002 , that to their best knowledge, the

quarterly report "fully complies with the requirements of Section 13(a) or 15(d) of the Exchang e

3 The 3Q03 Form 10-Q shows net income of $214,000. See 1121 below.)

39

Act of 1934" and "the information contained in the Quarterly Report [] fairly presents, in al l

material respects, the financial condition and results of operations of Red Hat, Inc ."

120. Defendants Szulik and Thompson also certified the internal controls of the

Company, stating:

The registrant's other certifying officer and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange Act Rules13a-14 and 15d-14) for the registrant and we have :

a) designed such disclosure controls and procedures to ensure that materialinformation relating to the registrant, including its consolidated subsidiaries, ismade 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 and proceduresas 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 the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate .

121 . The 3Q03 Form 10-Q reported results as follows :

3 04 ReportedTotal Revenue $24,278,000Gross Profit $16,090,00 0Income (loss) fromoperations

($2,894,000)

Net Income (loss) $214,000

122. The Form 10-Q explained the Company' s revenue recognition policy as follows :

We recognize revenue in accordance with Statement of Position No . 97-2,"Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-4 andSOP 98-9, and SEC Staff Accounting Bulleting No . 101 ("SAB 101"). Revenuerecognition in accordance with these pronouncements can be complex due to thenature and variability of our sales transactions 4

4 This policy is repeated in Form 10-K for FY2003 and the Forms 10-Q for 1Q04, 2Q04 and

3Q04 filed by the Company during the Class Period . The language of the policy changes slightly

thereafter. See ¶175.

40

123. The Form 1O-Q explained that enterp rise subscription revenue is recognized as

follows:

In accordance with the provisions of SOP 97-2, we recognize all of the revenuefrom the sale of our subscription based products ratably over the period that thesubscription services are provided. Revenues from sales of Advanced Server isrecognized over the twelve month period that subscription services are provided .

Direct software sales are recognized over the period that subscription services areprovided beginning when shipped, as these customers purchase on the Company'son-line web store . Revenue from our OEM arrangements are recognized over thesubscription period beginning on the date we are notified that sales have beenmade.

Subscription relationships with large enterprise customers typically involvecontracts with multiple elements (i .e ., delivered and undelivered products,maintenance and other services) . The Company allocates revenue to eachcomponent of the contract based on objective evidence of its fair value, which isspecific to the Company . The fair value of each element is based on the price ifsold separately. The Company recognizes revenue allocated to undeliveredproducts when the criteria for product revenue set forth above have been met.Subscription revenue also includes revenue from large Unix to Linux migrationarrangements . Revenue from these arrangements has historically been recognizedratably over the term of the arrangement as no other pattern of performance isdiscernible, none of the elements are essential to the functionality of the softwareand specific evidence of the fair value of the elements has not been established .

Revenue from technical support and maintenance services is recognized ratablyover the term of the related technical support and maintenance agreement .

** *

RHN is sold in the form of a monthly subscription and revenue is recognizedratably over the subscription period .

124. The Form 1O-Q explained that embedded subscriptions revenue is recognized as

follows :

Revenue is deferred and recognized ratably over the term of the agreement, which

is typically twelve months.

41

B. Reasons for Falsity: 3003

125 . The statements contained in 11114-124 above were materially false an d

misleading because, as revealed in Red Hat's Form 10-K/A filed with the SEC on August 4 ,

2004:

a) total revenues for the third fiscal quarter 2003 were actually $23,655,000, not the

$24,278,000 reported;

b) gross profit for the third fiscal quarter 2003 was actually $15,018 ,000, not the

$16,090,000 reported, a decrease of 6 .66%;

c) loss from operations for the third fiscal quarter 2003 was actually $3,897,000, not

the loss of $2,894,000 reported , a decrease of 34.66%; and

d) net loss for the third fiscal quarter 2003 was actually $789,000, not the income of

$214,000 reported, a decrease of 468 .69%.

126. The statements described above in IN 114-124 were also materially false and

misleading for the reasons stated in this Complaint, including because :

a) Defendants materially inflated and falsified Red Hat's reported revenues, ne t

income, operating profit, forecasts, general financial condition, and other financial informatio n

by prematurely recognizing revenue from subscription contracts that had not yet been earned .

b) Defendants misled investors by repeatedly informing them Red Hat was deferrin g

revenue ratably over the period of the subscription (or term of the agreement), when in fact Red

Hat was secretly recognizing revenue before the subscription had begun.

c) Defendants failed to disclose that Red Hat's definition of recognizing revenu e

ratably over the period of the subscription (or term of the agreement) meant that it was back-

dating revenue to the beginning of each monthly period, and thereby materially inflating an d

42

falsifying its quarterly, yearly, and other financial reports and information it provided to

investors .

d) Defendants failed to disclose to investors that Red Hat's financial statements

failed to comply with GAAP and GAAS, including Defendants ' false assurance that its financia l

statements were in compli ance with SAB 101 and SOP 97 -2 as described in this Complaint .

C. Defendants Release False Fiscal Year 2003 Year End Financial Result s

127. On March 25, 2003, the Company announced results for fourth quarter and fisca l

year ended February 28, 2003 . Regarding the Company's fiscal year 2003 ended February 28 ,

2003, the March 25 press release stated in relevant part :

The company reported revenues of $90 .9 million, an increase of 15% as compared tofiscal 2002 revenues of $78.9 million . The company reported a net loss of $6 .4 millionfor fiscal 2003, or $0.04 per share, compared to a net loss of $140 .2 million, or $0 .83per share, for fiscal 2002.

128. Defendant Thompson stated in the press release that "[t]hrough stron g

performance of all our enterprise technologies, Red Hat was able to achieve steady, consisten t

growth in fiscal 2003 ."

129. Defendants also hosted a conference call on March 25, 2003, after the earning s

release, in which Defendants Szulik, Thompson and Buckley participated . Defendant Szulik

opened the conference call repeating the results for fiscal year 2003 .

130. Defendant Thompson also summarized the results for fiscal year 2003 and further

stated :

For the current fiscal year, we had a GAAP net loss of $6 .4 million or a net loss of 4

cents per share as compared to a GAAP net loss of $140 .2 million, or a loss of 83

cents per share for the prior fiscal year .

131 . Defendant Thompson explained the importance of subscriptions on revenu e

growth:

43

There are several factors that are important to understand to properly project theimpact of these subscriptions on our future Enterprise subscription revenue growth .First, approximately 30% of our sales of Red Hat Enterprise Linux to date representmigration of existing customers off of a prior Red Hat operating system to the RedHat Enterprise Linux platform . These migration subscriptions initially create arelatively small amount of incremental revenues or on a quarterly basis . However,are strategically important as we continue to successfully convert our customers to arecurring per-service subscription model based on Enterprise Linux from theEnterprise relationship model that they were on previously . Second, approximately4,000 subscriptions of the Advanced Server subscriptions sold in Q4 will be deployedlate in calendar 2003, and, therefore, we will not begin to recognize revenue on thesesubscriptions until such time as the technology is deployed.

132 . Defendant Thompson forecasted for 1Q04 that another quarter of strong

sequential revenue growth in 1 Q04 "will be led by sales of subscriptions to Red Hat Enterprise

Linux AS, ES and WS ." Defendant Thompson predicted for 1Q04 that "[t]otal revenues will b e

in the range of [$]27 million to $27.5 million, which represents a growth rate of 4 to 6% over

Q4."

133. In discussing the Company' s revenue recognition policy with an analyst,

Defendant Thompson stated :

as you look at our balance sheet and our deferred revenue balance, our revenues arerecognized monthly, and our deferred revenues are driven by the payment terms andbilling terms we have with our customers, so the growth in deferred revenue relates toboth the timing of the bookings of subscriptions during the quarter and how much thecustomers agree to pay up front versus what they decide to pay quarterly .

134. On May 29, 2003, the Company filed its Form 10-K Annual Report . The Form

10-K repeated in substantial part the results for fiscal year 2003 provided in the Company's

March 25 press release, as well as the results for third quarter 2003 announced December 17,

2002. The Form 10-K is signed by, among others, Defendants Szulik and Thompson and

contains the same certifications of Defendants Szulik and Thompson as in the 3Q03 Form 10-Q .

(See In119-120 above) .

44

135. The Form 10-K repeated the general revenue recognition policy quoted above i n

¶122. The Form 10-K further explains recogni tion of enterprise subscription revenue as

follows :

We recognize revenue from the sale of our enterprise offerings ratably over theperiod of the subscription. Our subscription relationships with our large enterprisecustomers typically have contracts with multiple elements (i .e ., delivered andundelivered products, maintenance and other services) . We allocate revenue toeach component of the contract based on objective evidence of its fair value,which is specific to us. The fair value of each element is based on the price if soldseparately. Enterprise subscription revenue also includes revenue from severallarge Unix to Linux migration arrangements which were sold prior to the releaseof Red Hat Enterprise Linux in May 2002 . Revenue from these arrangements hasbeen recognized ratably over the term of the arrangement, as no other pattern ofperformance has been discernible nor has there been specific evidence of the fairvalue of the elements of these arrangements .

*~ s

We sell Red Hat Linux subscription solutions through four channels: directsales, original equipment manufacturers ("OEMs"), value-added resellers andthe Internet . Revenue recognition periods for each channel are based on thesubscription period with Red Hat that the end purchasers of the subscriptionsfrom these channels receive, which is generally one year .

Red Hat Enterprise Network is sold in the form of a monthly or annualsubscription . Revenue is recognized ratably over the subscription period .

136. The Form 10-K explains recognition of retail revenue as follows :

Through our retail distributors, we sell Red Hat Linux Consumer products . . . .We recognize all of the revenue from the sale of Red Hat Linux ratably overthe period that the subscription services are provided .

137. The Form 10-K explains recognition of embedded subscription revenue as

follows:

Embedded subscription revenue consists of revenue for technical support andmaintenance services provided pursuant to software compiling, debugging, and

45

optimization agreements . Revenue is recognized ratably over the term of theagreement, which is typically 12 months . 5

138 . In addition, contained in the Company's Fonn 10-K was a Report of Independen t

Accountants by PWC, dated March 25, 2003 . In this Report, PWC assured investors that the

Company conformed with GAAP and stated the following:

In our opinion, the accompanying consolidated balance sheets and the relatedconsolidated statements of operations, of stockholders' equity, and of cash flows presentfairly, in all material respects, the financial position of Red Hat, Inc . and its subsidiariesat February 28, 2003 and 2002, and the results of their operations and their cash flowsfor each of the three years in the period ended February 28, 2003 in conformity withaccounting principles generally accepted in the United States of America . Thesefinancial statements are the responsibility of the Company's management ; ourresponsibility is to express an opinion on these financial statements based on our audits .We conducted our audits of these statements in accordance with auditing standardsgenerally accepted in the United States of America, which require that we plan andperform the audit to obtain reasonable assurance about whether the financial statementsare free of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation . We believe that our auditsprovide a reasonable basis for our opinion .

D . Reasons for Falsity : Fiscal Year 2003 (Ended February 28, 2003 )

139. Defendants' statements detailed above in ¶1127-131 and 133-138 were materially

false and misleading , because, as revealed in Red Hat's Form 10-K/A filed with the SEC on

August 4, 2004 :

a) Total revenues for fiscal year 2003 were actually $90,275,000, not the

$90,926,000 reported ;

b) Gross profit was actually $59,256,000, not the $59,464,000 reported ; and

c) Third fiscal quarter 2003 results were actually as detailed in ¶125 above ;

5 The Company's revenue recognition policies appear twice in the Form 10-K: First, in

Management's Discussion and Analysis, and also in the Notes to the Consolidated Financial

Statements .

46

140. The statements described in ¶1127-138 above, including PWC's Report o f

Independent Accountants, are also materially false and misleading for the reasons stated in ¶12 6

above.

141 . Defendant Thompson 's forecasts for 1Q04 detailed in 1132 above were materiall y

false and misleading , because , as revealed in Red Hat's Form 10-K/A filed with the SEC on

August 4, 2004, the total revenues for first fiscal quarter 2004 were actually $26,124,000 .

E. The Fraud Continues : First Ouarter Fiscal Year 2004 (Ended May 31, 2003 )

142. On June 17, 2003, the Company announced its first quarter results for fiscal yea r

2004, which ended on May 31, 2003. The Company's press release reported in pa rt :

Red Hat achieved revenue of $27 .2 million, a sequential increase of 5% comparedto $25 .9 million in the fourth quarter of fiscal 2003, and a year-over-year increaseof 39%.

143 . The Company summarized highlights for the first quarter as follows :

• First quarter sales of annual subscriptions for the Red HatEnterprise Linux family of technologies increased sequentially by2,000, or 10%, to 23,500 subscriptions .

• Subscription revenues from Enterprise Technologies grew 14%sequentially and 104% year-over-year .

• Blended gross margins remained strong at 68%, while grossmargins of Enterprise subscription technologies, including retailrevenues, also remained strong at 82% .

• Continued scaling of the business model, as the sequential reductionin the company's operating loss of $1 .3 million equated to thesequential increase in revenues .

144. Defendant Thompson commented on the results : "Red Hat continues to sho w

strong operating performance, including sold growth in cash flows, deferred revenues, and net

income, which translates into continued leverage of our business model ."

145 . In a conference call with analysts after the earnings release on June 17, 2003, in

which Defendants Szulik, Thompson, Buckley, and Webbink participated, Defendant Szuli k

47

reiterated the strong financial performance results . Defendant Thompson then continued with an

assessment of subscription revenues :

we experienced our third sequential quarter of increases in option and sales of ourRed Hat Enterprise Linux technologies with sales of subscriptions to Red HatEnterprise Linux reaching 23,700 units in the first quarter, a sequential increase of10% as compared to sales of 21,500 subscriptions in the fourth quarter of fiscal2003 .

Third, in Q1, enterprise technology subsc ription revenues increased by $1 .5million or 14% to $12.3 million as compared to the fourth quarter of fiscal 2003,and increased by $6.3 million or 104% as compared to the same p rior yearquarter.

Q1 continued to show significant growth in our enterprise technology subscriptionrevenues, which increased by $1 .5 million or 14% as compared to the fourthquarter of fiscal 2003 and $6 .2 million or 104% as compared to the same prioryear quarter . The significant increase in enterprise technology subscriptionrevenues are being driven by the recognition of revenues from the sales ofsubscriptions to Red Hat enterprise Linux, which increased to 23,700subscriptions in the first quarter from 21,500 subscriptions in the precedingquarter .

146. Defendant Thompson reiterated that the Company's "revenue recognition practic e

is that we recognize revenues from the sales of subscriptions to Red Hat Enterprise Linux ratably

over the period of the subscription, which is generally one year."

147. The first quarter fiscal year 2004 financial results announced on June 17, 2003

were repeated and incorporated into the Form 10-Q filed with the SEC on June 27, 2003 . The

Form 10-Q was signed by Defendants Szulik and Thompson and contained the sam e

certifications of Defendants Szulik and Thompson as in the 3Q03 Form 10-Q . See ¶¶119-120

above) .

148 . The Form 10-Q reported total revenues for 1 Q04 of $27,182,000 ; gross profit o f

$18,430,000; and net income of $1,506,000 . The Company said that in 1Q04, the Company sol d

48

approximately 36,500 subscriptions to its Red Hat Enterprise Linux platform, stating : "This

significantly exceeded management's expectations of the number of subscriptions to be sold in

the initial year of the release of the Red Hat Enterprise Linux technologies . . . . Our ability to

continue to increase market penetration and maintain competitive pricing for our enterpris e

technology subscriptions are critical to our success ."

149. The 10-Q also states :

Enterprise technologies revenue increased 103 .8% to $12 .3 million for the threemonths ended May 31, 2003 from $6 .0 million for the three months ended May31, 2002 . The increase is directly related to the units of Red Hat Enterprise Linuxsold in previous quarters . These Enterprise offerings are important as they aresold with renewable subscriptions and all have twelve month revenue recognitionperiods to match the related support obligation . As a result of our twelve monthrevenue recognition policy, for each unit sold in a given quarter, we recognize aportion of the revenue related to that unit in the current quarter, based on theperiod of time between the date of the sale and the end of the quarter, and theremainder in subsequent quarters . For the three month period ended May 31,2003, we sold approximately 23,700 subscriptions to our Red Hat Linux AS, ESand WS platforms .

150. Defendants repeated that the Company recognizes revenue ratably over the period

of the subscription, repeating the revenue recognition policy summarized in the 3Q03 Form 10-Q

see ¶122 above) and revenue recognition policies for enterprise, retail and embedded revenues

outlined in the FY03 Form 10-K see ¶¶135-137 above) .

F. Reasons for Falsity: 1004

151 . Defendants' statements detailed above in ¶1142-150 were materially false and

misleading, because, as revealed in Red Hat's Form 10-K/A filed with the SEC on August 4 ,

2004:

a) Total revenues for first fiscal quarter 2004 were actually $26,124,000, not the

$27,182,000 reported ;

49

b) Enterprise technologies subscription revenues were actually $11,872,000, not the

$12,289,000 reported;

c) Gross profits for the first fiscal quarter 2004 were actually $17,742 ,000, not the

$18,430,000 reported; and

d) Net income for the first fiscal quarter 2004 was actually $1,047,000, 30.48%

lower than the $1,506,000 reported .

152 . The statements described above in ¶¶142-150 are also materially false an d

misleading, for the reasons stated in ¶126 .

G. The Fraud Continues : Defendants Issue False 3004 Results

153. On December 18, 2003, the Company issued its earnings release for the third

quarter of fiscal year 2004 (ended November 30, 2003) after the close of trading . In a press

release title, "Red Hat Delivers Record Revenue, Cash Flows From Operations, and Operatin g

Income in Third Quarter" the Company announced:

Red Hat reported revenue of $33.1 million, a sequential increase of 15%compared to $28 .8 million in the second quarter of fiscal 2004, and a year-over-year increase of 36% .

154. The release highlighted the following achievements for the quarter:

Third quarter sales of annual subscriptions for the Red Hat EnterpriseLinux family of technologies increased sequentially by 7,000subscriptions, or 27%, to approximately 33,000 subscriptions . Renewalrates for Red Hat Enterprise Linux approximated 90% for the secondconsecutive quarter . Deferred revenue increased 40% sequentially, to$42.3 million. Gross margins remained strong, with blended gross marginsat 72%, and gross margins of Enterprise subscriptions remaining constantat 88% .

155 . Defendant Thompson, commenting on the results, stated, "Our revenue growt h

accelerated in the third quarter, which translated to increased operating income and cash flows

50

from operations . The subscription revenue model has developed sufficient maturity to enable u s

to drive consistent sequential increases in quarterly revenue . "

156. Defendants also hosted a conference call with analysts on December 18, 2003, i n

which Defendants Szulik and Thompson participated . Gabriel Szulik, Red Hat's Director o f

Investor Relations and Defendant Szulik's brother, and Defendant Thompson summarized th e

quarterly results .

157. Defendant Thompson reiterated the Company's revenue recognition policy:

As a reminder to all those on the call, our revenue recognition practice is that werecognize revenues from the sales of subscription to Red Hat Enterprise Linux, Red HatEnterprise Network, and Red Hat Enterprise Application ratably over the period ofsubscriptions which is generally one year .

158. Defendant Thompson again touted the Company's subscription model for revenue

growth :

Our confidence continues to grow in our ability to drive strong sequential quarterlygrowth in our Enterprise system. Sequential revenue growth will be led by recognition ofrevenues from sales of cumulative subscriptions to Red Hat Enterprise Linux, which totalapproximately 141,000 subscriptions at November 30, 2003 . And continued growth inour Enterprise Services revenue. Our subscription business model already providessignificant visibility into the source of our revenue growth. As our model continues tomature, this visibility will continue to improve.

159. Defendant Thompson stated that he anticipated the Company's future financial

performance would be as follows :

Full GAAP net income will be in the range of $5 .5 million to $5 .8 million or 3 cents per

share. For purposes of earnings per share we have assumed that our fully diluted shares

outstanding are 186 million shares . Subscription volume from the Red Hat Enterprise

Linux subscription in 2004 will be at least 40,000 new subsc riptions .

160. The market reacted favorably to this announcement . Red Hat shares ro se $3 .2 1

per share, or 22 .48%, from its previous close of $14 .28, to close at $17.49 per share on

December 19, 2003 . Trading volume was unusually heavy at 32 .34 million shares .

51

161 . The financial results announced on December 18, 2003 were repeated and

incorporated into the Form 10-Q filed with the SEC on January 6, 2004 for the third quarter o f

fiscal year 2004. The Form 10-Q was signed by Defendants Szulik and Thompson and containe d

the same certifications of Defendants Szulik and Thompson as in the 3Q03 Form 10-Q . (See

¶¶119-120 above).

162. Defendants repeated that the Company recognizes revenue ratably over the perio d

of the subsc ription , repeating the revenue recognition policy summarized in the 3Q03 Form 10-Q

see ¶122 above) and revenue recognition policies for enterprise, retail and embedded revenue s

outlined in the FY03 Form 10 -K see ¶¶135 - 137 above) .

163. Defendants indicated in the Form 10-Q that subscription revenue increased to

$22.0 million from $13 .2 million for prior-year same quarter and that enterprise technologies

revenue increased 158 .0% to $17 .8 million from $6.9 million for prior-year same quarter.

Defendants explained :

The increase is directly related to the subscriptions of Red Hat Enterprise Linux sold inprevious quarters . These Enterprise offerings are important as they are sold withrenewable subscriptions and generally have twelve month revenue recognition periods tomatch the related support obligation . As a result of our twelve month revenue recognitionpolicy, for each unit sold in a given quarter, we recognize a portion of the revenue relatedto that unit in the current quarter, based on the period of time between the date of the saleand the end of the quarter, and the remainder in subsequent quarters . For the three monthperiod ended November 30, 2003, we sold approximately 33,000 new subscriptions toour Red Hat Linux AS, ES and WS platforms compared to 12,000 subscriptions to RedHat Enterprise Linux 2 .1 in the same period in fiscal 2003 .

164. With respect to renewals of subscriptions, Defendants stated :

Unlike most proprietary software companies, we sell our enterprise software to ourcustomers in the form of a renewable annual subscription . Our customers pay us an

annual subscription fee for as long as they need to maintain a certified version of our

software. Under our standard subscription agreements, prices to customers for the first

annual renewal term are generally at the same price per installed system as during theinitial one-year term, and for any subsequent renewal terms are based on current list

prices. For our large enterprise customers, renewal rates often also reflect discounts fo r

52

increased subscription volume. Our subscription business model provides increasedvisibility into the sources of our enterprise subscription revenues as we generallyrecognize revenues from the sale of subscriptions ratably over the period of thesubscription .

H. Reasons for Falsity: 3004

165 . Defendants' statements detailed above in ¶1153-158 and 160-164 were materially

false and misleading, because, as revealed in Red Hat 's Form 10-K/A filed with the SEC o n

August 4, 2004 :

a) Total revenues for third fiscal quarter 2004 were actually $32,883,000,not the

$33,088,000 reported ;

b) Enterprise technologies subscription revenues were actu al ly $17,210,000, not the

$17,779,000 reported ;

166. The statements described above in ¶¶153-164 are also materially false an d

misleading for the reasons stated in ¶126 .

167. Defendant Thompson's forecasts for 4Q04 detailed in ¶159 above were materially

false and misleading, because, as revealed in Red Hat's Form 10-K/A filed with the SEC o n

August 4, 2004, the net income for fourth fiscal quarter 2004 was actually $4,786,000 .

I. Defendants Issue False 4004 and Fiscal Year 2004 Results

168. On March 23, 2004, the Company reported financial results for the fourth quarter

and fiscal year ended February 29, 2004, stating :

Revenue for the fourth quarter of fiscal 2004 was $37 .0 million, a sequential increase of

11 % compared to $33 . 1 million in the third quarter of fiscal 2004, and a year-over-year

increase of 43%.

For the fourth quarter of fiscal 2004, the company reported net income of $5 .0 million, or

$0.03 per share . This compares to a net income of $4.1 million, or $0.02 per share, in theprior quarter, and break-even results in the same quarter a year ago .

The company generated $32.2 million, or $0.17 per share, in positive cash flow from

operations during the fourth quarter , and a total of $61 million , or $0.33 per share, i n

53

positive cash flow from operations for the fiscal year ended February 29, 2004 . Thecompany ended the year with a cash balance of $941 million, an increase of $649 millionas compared to the balance at the end of the prior fiscal year .

In the fourth quarter of fiscal 2004, the company increased its deferred revenue balanceto $70.8 million, a sequential increase of $28 .6 million , or 68%, as compared to the thirdquarter of fiscal 2004.

169. Highlights for the fourth quarter and year end were summarized as :

• Fourth quarter sales of subscriptions for Red Hat Enterprise Linux technologiesincreased by 87,000 new subscriptions, comprised of 61,000 subscriptions soldinto the enterprise IT market and 26,000 subscriptions sold into the HPC andhosting markets .

• Renewal rates for sales of Red Hat Enterprise Linux remained strong atapproximately 90% .

• Gross margins increased to record levels, with blended gross margins at 76% andgross margins of Enterprise subscription technologies at 91%.

• Operating profit, before stock-based compensation, increased to $4 .6 million, or12% of total revenue.

170. Again commenting on the Company' s results, Defendant Thompson stated, "For

Red Hat, fiscal 2004 was a year marked by great execution, as we delivered strong growth in

revenues, cash flows, and profitability. The growth rates in the adoption of Red Hat Enterpris e

Linux has exceeded our expectations to date and we are positive on the outlook for fiscal 2005 . "

171 . A conference call with analysts also was held on March 23, 2004, in which

Defendants Szulik and Thompson participated and during which both Defendants Szulik an d

Thompson repeated the FY04 and 4Q04 results . Defendant Thompson added :

Third, growth rate in enterprise technology subscription revenues increasedsignificantly into Q4. This growth is being driven by the leverage created from

cumulative to (INAUDIBLE) subscriptions of Red Hat Enterp rise Linux of

206,000 subscriptions . at February 29, 2004 . Enterprise subscription revenues

increased sequentially by $6.2 million or 35% as compared to Q3 . This compares

to a sequential quarterly growth rate of 19% in Q3 .

54

Q4 showed very strong growth in our enterprise technology subscription revenues whichincreased by $6 .2 million, or 35% as compared to Q3, and increased by $13 .2 million, or122% as compared to the same prior year quarter . The significant increase in enterprise

technologies subscription revenue is being driven by the recognition of revenues from the

sales of subscriptions to Red Hat Enterprise Linux in prior quarters and fromsubscriptions sold in the current quarter . In Q4 we experienced more ratable sales ofsubscriptions to Red Hat Enterprise Linux across the three months of the quarter than wehad in the past which contributed to our Q4 subscriptions revenue growth . We continueto forecast, however, that our subscription sales volume will be rated more heavily in thelast 30 days of each quarter .

172. Defendant Thompson predicted the following financial performance for th e

Company in 1 Q05 :

Total revenues in the range of 42 .5 to $43 .5 million, which represent a sequentialgrowth rate of 15% to 17 .5% over Q4. Enterprise technology subscriptionrevenues will be in the range of 30 .4 to $30.8 million, an increase of 26% to 28%,as compared to Q4. This increase is primarily being driven by the increase incumulative deployed subscriptions from Red Hat Enterprise Linux as a result ofthe 87,000 subscription that we sold in the fourth quarter .

173. The next day, March 24, 2004, Red Hat shares traded as high as $22 .11 on a

trading volume of 42.33 million shares, before closing at $20 .01 per share .

174. On May 14, 2004, the Company filed its Form 10-K for the period ending

February 29, 2004 incorporating the results announced on March 23, 2004 . The Form 10-K was

signed by Defendants Thompson and Szulik and contained the same certifications of Defendant s

Szulik and Thompson in the 3Q03 Form 10-Q. See ¶1119-120 above) .

175. In the Revenue Recognition Section of the Form 10-K, Defendants repeated tha t

the Company recognized revenue ratably over the period of the subscription, explaining:

Revenue Recognitio n

We recognize revenue in accordance with Statement of Position No . 97-2,

"Software Revenue Recognition" ("SOP 97-2"), as amended by SOP 98-4 andSOP 98-9, Emerging Issues Task Force No . 00-21 ("EITF 00-21') and Staff

Accounting Bulletin No . 104 ("SAB 104") depending upon the nature of the

arrangement. Revenue recognition in accordance with these pronouncements canbe complex due to the nature and variability of our sales transactions.

55

Subscription Revenue

Subscription revenue is comprised of enterprise and embedded revenues .

Enterprise subscription revenue is comprised primarily of revenue from sales ofRed Hat Enterprise Linux software solutions, however we also generate enterprisesubscription revenue from sales of Red Hat Linux, software development tools,technical support and maintenance fees .

During fiscal 2003, we released the first versions of our Red Hat Enterprise Linuxofferings, Red Hat Enterprise Linux AS, ES and WS . These technologies are soldunder a subscription agreement with specified renewal rates. Our Red HatEnterprise Linux ("RHEL") products have one and three year base subscriptionperiods . The base subscription entitles the end user to the technology itself andpost customer support services (' PCS") consisting of; security errata, updates tothe technology, upgrades to new versions of RHEL on a when and if availablebasis during the term of the subscription, and various levels of Red Hat support.We recognize the revenue from the sale of our Red Hat Enterprise Linux offeringsratably over the period of the subscription . We do not sell the RHEL technologyor the components of the PCS that are included in the subscription on a standalone basis.

We sell Red Hat Enterprise Linux through four channels : distribution, direct sales,original equipment manufacturers ("OEMs") and the web . In the majority of ourtransactions, subscriptions to Red Hat Enterprise Linux are sold on a stand-alonebasis. Our standard subscription term is one year . The revenue associated with thesale of subscription to Red Hat Enterprise Linux is recognized ratably over theperiod of the end users subscription .

Our subscription agreements with our large enterprise customers sometimes

include multiple subscription and/or service elements . These arrangements

typically include a subscription to Red Hat Enterprise Linux, Red Hat Network,

training services and/or professional consulting. For these contracts, we separatethe various elements and recognize revenue attributable to each element in themanner that best matches the delivery of value to our customer . Red Hat

Enterprise Linux and Red Hat Network subscription revenues are recognized

ratably over the subscription term, training services revenue is recognized whenstudents attend class, and professional services revenue is recognized on a timeand materials basis as the services are delivered . When possible, we allocaterevenue to each component of the contract based on vendor specific objective

evidence ("VSOE") of its fair value. VSOE for our Red Hat Enterprise Linux

subscription agreements is created by the fact that we regularly sell RHELsubscriptions on a stand alone basis with renewal rates for year two equal to theamount paid in year one or there is a stated renewal rate in the contract . In

contracts where VSOE exists for training or consulting services, such VSOE is

demonstrated by either; the ability to purchase additional training or consulting

services at specified rates and on a stand alone basis upon expiration of th e

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original term of the multiple element arrangement or regularly selling the trainingor consulting services on a stand alone basis at substantially the same rates asthose charged in the multiple element arrangement . In certain multiple elementarrangements where VSOE cannot be established, the entire value of the contractis recognized ratably over the term of the agreement. Our training and consultingservices are not essential to the functionality of Red Hat Enterprise Linux . Themajority of our customers purchase subscriptions to Red Hat Enterprise Linuxwithout purchasing any training or consulting services.

In addition, our enterprise subscription revenue is partially derived from sales ofour Red Hat Network service offerings . Red Hat Network is an Internet-based set

of services to assure the security, availability and reliability of all of our Red Hatsoftware solutions . Red Hat Network is sold in the form of an annual subscriptionand revenues related to these are recognized ratably over the term of thesubscription.

Embedded subscription revenue consists of revenue for technical support and

maintenance serv ices provided pursuant to software compiling, debugging andoptimization agreements . Revenue is deferred and recognized ratably over the

term of the agreement, which is typically 12 months .

176. The 4Q04 and FY04 reported results as follows :

4Q04 Fiscal Year 2004

Total Revenue $36,965,000 $126,084,000

Gross Profit $27,941,000 $91,215,000

Total operating expense $25,407,000 $88,003,000

Income (loss) from operations $2,534,000 $3,212,000

Net Income (loss) $4,997,000 $13,998,000

177. Fueled by the positive earnings releases of December 18, 2003 and March 23 ,

2004, which was reiterated in the Company's Form 10-K filed on May 14, 2004, Red Hat stoc k

experienced a tremendous surge in value, reaching its Class Period high of $28 .84 per share on

June 1, 2004.

57

178 . In addition, contained in the Form 10-K was a Report of Independent Auditors

by PWC dated May 6, 2004. PWC's report assured investors that the Company conformed

with GAAP , and repeated the language in their previous year's report. See ¶138 above) .

J . Reasons for Falsity: 40 and FY 2004

179. Defendants' statements regarding fourth fiscal quarter 2004 results , detailed

above in ¶¶168-171 and 174-176, were materially false and misleading , because, as revealed in

Red Hat's Form 10-K/A filed with the SEC on August 4, 2004 :

a) Total revenues for fourth fiscal quarter 2004 were actually $36,771,000, not the

$36,965,000 reported ;

b) Gross profit for the fourth fiscal quarter 2004 was actually $27,854,000, not the

$27,941,000 reported ;

c) Income from operations for the fourth fiscal quarter 2004 was actually

$2,323,000, not the $2,534,000 reported ; and

d) Net income for the fourth fiscal quarter of 2004 was actually $4,786,000, not th e

$4,997,000 repo rted.

180. Defendants ' statements regarding fiscal year 2004 results, detailed above in

¶¶168-171 and 174-176 , were materially false and misleading, because, as revealed in Red Hat' s

Form 10-K/A filed with the SEC on August 4, 2004:

a) Total revenues for fiscal year 2004 were actually $124,737,000, not the

$126,084,000 reported;

b) Gross profit for fiscal year 2004 was actually $90,801,000, not the $91,215,000

reported ;

c) Income from operations for fiscal year 2004 was actually $2,946,000, not the

$3,212,000 reported; and

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d) Net income for fiscal year 2004 was actually $13,732,000 mil lion, not the

$13,998,000 reported .

181 . The statements described above in ¶¶168-171 and 174-176, including PWC' s

Report of Independent Accountants, are materially false and misleading for the reasons stated i n

¶126 .

182. Defendant Thompson' s forecasts for 1 Q05 detailed in ¶172 above were materiall y

false and misleading, because, as revealed in Red Hat's Form 10-Q filed belatedly with the SEC

on July 19, 2004, total revenues were $41,764,000, not in the range of $42 .5 to 43 .5 million

forecasted, and enterprise technology subscription revenues were $29,968,000, not in the range

of $30.4 to 30.8 million forecasted.

K. Red Hat's June 17, 2004 False Statements

(1) False statements regarding revenue recognition

183 . On June 17, 2004 , Red Hat announced its first qua rter results for the fiscal quarter

ended May 31, 2004, revealing that its revenues of $41 .6 million fell short of the Company' s

guidance of$42.5-43. 5 million and consensus expectations of $43 million . In an analyst

conference call, Red Hat again issued false statements regarding Red Hat's revenue recognitio n

policy, with Red Hat's CFO responding to analysts as follows :

KEVIN THOMPSON, EXEC VP, CFO, RED HAT, INC. :

Enterprise subscription revenues increased by $5 .9 million, or 25%, to $29 .9

million in the first quarter of fiscal 2005 . In Q1, enterprise subscription revenueswere slightly lower than we anticipated, as the largest percentage of thesubscriptions sold by our direct sales team in North America and EMEA weresold in the last few weeks of the last month of our fiscal quarter . Which reducedthe amount of revenues that we recognized from these subscriptions in Q1 . This

follows the fourth quarter in which our bookings were very ratable across the

quarter .

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** *

KATHY EBGERT : You're welcome . Second, revenue was lighter th an guidanceat 41 .6 million and I think you said that was because the quarter was very back-end weighted . Is it that some of these 75 ,000 units or some of the 98 ,000 unitsweren't -- the revenue wasn't actually booked at all in this quarter?

KEVIN THOMPSON: Yeah, when you look at the way, uh -- the way our -- ourbookings go out across the quarter we really had two issues . One we had arelatively soft March coming out of a very strong February and then had a goodApril and then a very, very simple May but with a lot of those volumes comingvery late in the quarter, so it was very small amount of revenue taken on very --on a lot of those transactions. So that revenue obviously will -- you know, just amatter of timing so it finds its way into Q2 . I think the other areas is our retailrevenues were a little bit soft in the quarter, not a very big number . Uh, and wesaw our embedded revenues come down just a little bit as we really shifted ourfocus as I indicated we signed an agreement with a very large telecommunicationsequipment manufacturer and we're starting to see Red Hat Enterprise Linux notonly through our relations Wind River but also directly begin to be compelling,uh, to these organizations . So we're seeing a shift in the business in that area .

** *

BRENT TRILL, ANALYST, PRUDENTIAL : Thank you. Kevin, your commentsabout Q1 being more back-end loaded , is it fair to say that some of those dealsactually closed early in Q2, they were just a matter of timing on some of the

contracts, can you just give us a sense of -- it was only a $900 ,000 miss, but whatwas -

KEVIN THOMPSON: Yeah, I think when you look at the -- when you look at the

quarter, Brent, and you look at the way we recognize revenue, you know, if youslip, you know, three or four million dollars of bookings out of March into Aprilthen you've lost a full month of potentially revenue on -- on those transactions .

So, you know, what we saw was that we had a very strong quarter, we had --actually had the best quarter that we've ever had from Enterprise Linux's

perspective obviously which translates into the best quarter we've had in terms ofsimilar value on a booking side of the business, just most of that business on thedirect side, and in Europe and in North America in particular, uh, came very, very

late in the quarter. And, you know, I can't necessarily tell you all the -- all thetrends that created that but we had a -- you know, a number of transactions thatwere -- we knew they were going to close and they did close they just took longer

to close than we thought. And longer to close than what -- than historically, you

know, in terms of timing it took to bring them in, but we had a pipeline we hadgoing into the quarter we're pretty confident about the volumes we're going to get

to. I think we got way to the high side of the volumes we expected for this quarter

and so we had a very strong bookings quarter it just came in a little late .

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184. On June 17, 2004, Bloomberg News reporter Dina Bass interviewed Defendant

Szulik regarding the timing of the announcement of the resignation of Defendant Thompson .

The interview was broadcast on Bloomberg . During the interview, Defendant Szulik falsel y

claimed that the company recognizes revenue from the time it is earned, and not back to th e

beginning of the month:

BASS: Now, the market after hours reacted rather negatively to your sales report,why do you think people were as concerned about the sales shortfall, as they wereand do you think they have a right to be that concerned ?

SZULIK: No and certainly, they have a right , as you know, to do anything theywant but from our perspective it was a very s trong quarter and as you look atwhere some of the shortfall came through it really happened in three areas andtwo of those areas, which are non-strategic to the company, the decline in retailbox sales, the embedded business and the latter part was end of - some end ofquarter bookings that came in with our subscription form of revenue recognitionhad an incremental impact on the total top line number.

BASS: And how did that work? Was that a - you were explaining on theconference call because the contracts were signed a little bit later in the quarter,how did that work?

SZULIK: You know it's interesting, we don't recognize revenue the way atraditional software company does . It's recognized as 100 percent of the revenueswhen the product is sold, so technically, we have 20 days per month to recognizethat revenue, so if a, you know, a product or business is sold, on the 28th or the29`h of the month, we only have one or two days of which to recognize therevenue for that sale, so in this current quarter - I'm sorry, the Q1 quarter that wejust completed, there were one or two contracts that came in that had an impactthat only gave us two or three days of revenue recognition but the good news ofthat of course, is that that sale will show up in deferred revenue, which is - whichgrew 21 percent quarter-over-quarter, so it catches up to us in the second quarter .

(2) Defendant Szulik lies about the restatement and the SEC

185. In the June 17, 2004, Bloomberg News referred to above, Defendant Szulik al so

materially misled investors by stating that a restatement and/or SEC investigation was "not

happening":

BASS : OK. Now, you reported your earnings for last quarter in a rather unusualfashion this week. After Monday's announcement that Kevin Thompson would be

61

stepping down, your shares declined and then you put out part of the numbers onTuesday, why do it that way? Why not put out everything on Tuesday,particularly, since based on the information that you gave on Tuesday, you leftout sales that you could've extrapolated the sales number out from what youreleased?

SZULIK: Well, you know, this is - I'm glad that you raised that point becausethe company has prided itself on transparency, not only in the software code butas part of our overall corporate governance and responsibility and when Kevinmade the decision to leave Red Hat ; he wanted to leave on a good quarter . Thatinformation, we felt, became material to investors and we communicated it,promptly, to the investment community. What we learned and why wecommunicated the pre-announcement of the economics because I guess it's ararity these days that CFO has the option of leaving on his terms when things aregoing well and what we learned from many analysts, is that they expectednegative news, L e. a financial restatement or an SEC investigation because it'squite uncommon that a CFO would leave when things are going well and so, wewanted to reassure investors that that was not hanaenine and more importantlythat the health of the business is strong and we think Kevin has done a fantasticjob and we wish him all the best and support, in the future .

L. Reasons for Falsity of the June 17, 2004 Statements

186. The statements described above in ¶1183-185 are materially false and misleading

for the reasons stated in 1 126 above .

187. Defendant Szulilc 's statements in the June 17, 2004 Bloomberg News interview,

were materially false and misleading because :

a) Red Hat had been prematurely recognizing revenue from subscriptions for th e

previous five years;

b) PWC had already notified Defendants that the Company had to change its revenue

recognition methods from a monthly to a daily basis ;

c) As a result of the change in revenue recognition method, the Company would in

fact have to restate its financials ;

d) Red Hat had already received an inquiry from the SEC regarding its Annual

Report on Form 10-K; and

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e) Defendant Szulik was fully aware of all of the facts listed above, and knew that a

restatement would soon be forthcoming .

IX. DEFENDANT'S ONUSSIONS AND FAILURE TO REVEAL THE TRUT H

188. In addition to the false and misleading statements described in detail throughou t

this Complaint, Defendants also failed to disclose the truth regarding Red Hat's financial

condition . Specifically, and in addition to the other omissions described in this Complaint,

Defendants failed to tell the public that: a) it was recognizing revenue before it was earned as

described throughout this Complaint ; and b) that recognizing revenue ratably over the period of

the subscription actually meant that Red Hat was recognizing revenue before the term of the

subscription began, and therefore Red Hat's reported financial results were materially false and

misleading .

X. DEFENDANTS' FALSE FINANCIAL REPORTING

A. Defendants Violated GAAP

189. At all relevant times during the Class Period, Red Hat represented that thei r

financial statements when issued were prepared in conformity with Generally Accepted

Accounting Principles ("GAAP"), which are recognized by the accounting profession and the

SEC as the uniform rules , conventions and procedures necessary to define accepted accounting

practice at a particular time . However, in order to artificially inflate the price of Red Hat's stock,

Defendants prematurely recognized revenue in violation of GAAP and SEC reporting

requirements to falsely inflate Red Hat's revenues, earnings and earnings per share during the

Class Period .

190. Red Hat's materially false and misleading financial statements resulted from a

series of deliberate senior management decisions designed to conceal the truth regarding Red

Hat's actual operating results . PWC, the long time auditors of Red Hat, knew or should hav e

63

known of the accounting manipulations . As a result of the egregious nature of the accounting

fraud, PWC withdrew its audit opinions for the 2002, 2003, and 2004 audits when it issued a new

audit report in the restatement for those years .

191 . The magnitude of the amounts by which Red Hat's financial statements wer e

materially misstated is not yet fully known. The Company's amended Form 10-K for the fiscal

year ending February 29, 2004 includes details of the restatement for the fiscal quarters of 2003

and 2004 and the annual adjustments for fiscal years 2004, 2003 and 2002 . However, according

to the Company's July 13, 2004 press release and Form 8-K, the method of recognizing revenue

from subscriptions, which the restatement is meant to correct, had been consistently applied for

the previous five years . This would include the fiscal years 2001 and 2000, in addition to the

fiscal years 2002, 2003 and 2004 . Moreover, the restated 10-K shows that the Company made

adjustments to the accumulated deficit account, which indicates that Red Hat made adjustments

to prior period income. The Company has not revealed, and Plaintiffs have no way of knowing,

what impact the restatement had on results for fiscal years 2001 and 2000, going all the way back

to the Company's IPO in August 1999 .

192. As set forth in Statement of Financial Accounting Concepts ("SFAC") No . 1,

Objectives of Financial Reporting by Business Enterprises, 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 .

193. The SEC requires that public companies file quarterly and annual financial

statements that are prepared in conformity with GAAP . SEC Rule 4-01(a) of Regulation S-X

states that "[f]inancial statements filed with the Commission which are not prepared i n

64

accordance with generally accepted accounting principles will be presumed to be misleading or

inaccurate ." 17 C.F.R. § 210.4-01(a)(1) .

194. Management is responsible for preparing fin ancial statements that conform with

GAAP. The AICPA Professional Standards provide :

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, record, process,summarize, and report transactions (as well as events and conditions) consistentwith management'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 animplicit and integral part of management's responsibility.

AU § 110.02 (1998) .

195. Generally GAAP provides that revenue should not be recognized until it i s

realized or realizable and earned . FASB Statement of Financial Accounting Concepts No . 5,

Recognition and Measurement in Financial Statements of Business Enterprises (December 1984)

("SFAC No.5"), ¶83-84; Accounting Research Bulletin No . 43, Restatement and Revision of

Accounting Research Bulletins (June 1953) Chapter 1A ¶1 ; Accounting Principles Board

Opinion No. 10 Omnibus Opinion, (December 1966), ¶12 .

196. SFAC No. 5, paragraph 83(b) states that "[a]n entity's revenue-earning activities

involve delivering or producing goods, rendering services, or other activities that constitute its

ongoing major or central operations , and revenues are considered to have been earned when the

entity has substantially accomplished what it must do to be entitled to the benefits represented by

the revenues ."

197. SFAC No. 5, Paragraph 84(a) continues "[t]he two conditions (being realized or

realizable and being earned) are usually met by the time product or merch andise is delivered or

serv ices are rendered to customers , and revenues from manufacturing and selling activities and

65

gains and losses from sales of other assets are commonly recognized at time of sale (usuall y

meaning delivery) ."

198 . SFAC No. 5, Paragraph 84(d) continues "[ i]f services are rendered or rights to use

assets extend continuously over time (for example, interest or rent), reliable measures based on

contractual prices established in advance are commonly available, and revenues may b e

recognized as earned as time passes . "

199 . AICPA Statements of Position 97-2 ("SOP 97-2"), Software Revenue

Recognition , is the GAAP th at governs when revenue should be recognized, and at what

amounts, for licensing, selling, leasing, or otherwise marketing computer software . SOP 97-2

supersedes SOP 91-1 and became effective for transactions entered into in fiscal years beginnin g

after December 15, 1997. SOP 97-2 provides :

If the arrangement does not require significant production, modification, orcustomization of software, revenue should be recognized when all of thefollowing criteria are met .

Persuasive evidence of an arrangement exists .• Delivery has occurred .• The vendor's fee is fixed or determinable .• Collectibility is probable.

200. SOP 97-2 further provides, where software arrangements provide multipl e

elements , for example, software products, upgrades/enhancements, PCS, or services, the fee

should be allocated to the various elements based on vendor-specific objective evidence for fair

value . SOP 97-2, Pars 9 and 10 . However :

.12 If sufficient vendor-specific objective evidence does not exist for theallocation of revenue to the various elements of the arrangement, all revenue fromthe arrangement should be deferred until the earlier of the point at which (a) suchsufficient vendor-specific objective evidence does exist or (b) all elements of the

arrangement have been delivered. The following exceptions to this guidance are

provided . . .

66

If the arrangement is in substance a subscription the entire fee should berecognized ratably (see paragraphs .48 and .49) . . .

.31 Customer Cancellation Privileges. Fees from licenses cancelable bycustomers are neither fixed nor determinable until the cancellation privilegeslapse. Fees from licenses with cancellation privileges expiring ratably over thelicense period are considered to become determinable ratably over the licenseperiod as the cancellation privileges lapse .

.48 As part of a multiple-element arrangement with a user, a vendor may agree todeliver software products currently and to deliver unspecified additional softwareproducts in the future . . .

49 The software elements of the kinds of arrangements discussed in paragraph .48should be accounted for as subscriptions. No allocations of revenue should bemade among any of the software products, and all software-product revenue fromthe arrangement should be recognized ratably over the term of the arrangementbeginning with delivery of the first product .

201 . SEC Staff Accounting Bulletin No. 101-Revenue Recognition in Fin ancial

Statements ("SAB 101"), as amended by SAB 104 on December 17, 2003, states that :

The [SEC] staff believes that revenue generally is realized or realizable andearned when all of the following criteria are met :

• Persuasive evidence of an arrangement exists ,• Delivery has occurred or services have been rendered ,• The seller's price to the buyer is fixed or determinable, and• Collectibility is reasonably assured .

202. SAB 101 provides further guidance on appropriate revenue recognition practices :

4. Fixed Or Determinable Sales Price

A company's contracts may include customer cancellation or termination clauses .

Cancellation or termination provisions may be indicative of a demonstrationperiod or an otherwise incomplete transaction . Examples of transactions that

financial management and auditors should be aware of and where such provisionsmay exist include "side" agreements and significant transactions with unusual

terms and conditions. These contractual provisions raise questions as to whether

the sales price is fixed or determinable . The sales price in arrangements that are

cancelable by the customer are neither fixed nor determinable until th e

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cancellation privileges lapse . 6 If the cancellation privileges expire ratably over astated contractual term , the sales p rice is considered to become determinableratably over the stated term . 7

203. SEC Staff Accounting Bulletin Topic 13, Revenue Recognition, states that

"revenue should not be recognized until it is realized or realizable and earned ." Specifically,

Topic 13(A)(3)(d) states :

d. License fee revenue

Facts: Assume that intellectual property is physically delivered and payment isreceived on December 20, upon the registrant's consummation of an agreementgranting its customer a license to use the intellectual property for a termbeginning on the following January 1 .

Question : Should the license fee be recognized in the period ending December31 ?

Interpretive Response : No. In licensing and similar arrangements (e .g., licenses of

motion pictures, software, technology, and other intangibles), the staff believesthat delivery does not occur for revenue recognition purposes until the licenseterm begins . Accordingly, if a licensed product or technology is physicallydelivered to the customer, but the license term has not yet begun, revenue should

not be recognized prior to inception of the license term . Upon inception of thelicense teen, revenue should be recognized in a manner consistent with the natureof the transaction and the earnings process .

[emphasis added ]

204. Asset forth in Red Hat's February 29, 2004 Form 10-K, Red Hat's policy o n

recognition of revenue is stated as follows :

Revenue Recognition : The Company recognizes revenue in accordance wi thStatement of Position No. 97-2, "Software Revenue Recognition" ("SOP 97-2"),as amended by SOP 98-4 and SOP 98-9, and Staff Accounting Bulletin No . 101("SAB 101 ") . Revenue recognition in accordance with these pronouncements c anbe complex due to the nature and variability of sales transactions . The Companyestablishes persuasive evidence of an arrangement for each type of revenue basedon either a signed contract with the end customer , a click-through contract on the

6 SAB 101 cites SOP 97-2, ¶31 .

SAB 101 cites SOP 97-2, ¶31 .

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Company's website, whereby the customer agrees to the Company's standardsubscription terms, distribution contracts with OEM's and resellers, or, in the caseof individual training seats, through receipt of payment which indicatesacceptance of the Company's training agreement terms .

205 . Red Hat recorded revenue from subscriptions on a monthly basis, rather than on a

daily basis. The Company used a method that resulted in revenue recognition as if the

subscription commenced on the first day of the month in which the subscription was sold . For

example, the Company would have recognized one-twelfth of the revenue of a twelve-month

subscription in the calendar month during which the subscription commenced, and the remaining

subscription revenue over the next eleven calendar months .

206. During the Class Period, Defendants knowingly and intentionally booked an d

reported material amounts of revenue , in violation of GAAP, including SOP 97-2 . Defendants

did so by deliberately, or at least severely recklessly, employing an accounting manipulation in

which they prematurely recognized revenue from subscription agreements on a month ly basis,

rather than a daily basis , which resulted in revenue recognition as if the subscription commenced

on the first day of the month in which the subscription was sold . Defendants knew or should

have known that revenue was improperly recognized as evidenced by the plethora of meetings at

which the Company' s financial condition were discussed .

207. The press releases, conference calls wi th analysts and filings wi th the SEC

detai ling "record" financial results detailed above in Section VIII were materially false and

misleading because Red Hat's financial results during the Class Period were artificially inflated

due to Defendants ' improper revenue recognition practices .

208 . Defendants were required to cause the Company to disclose, in its periodic filings

with the SEC, financial statements , and news releases the existence of the material facts

described herein and to appropriately recognize and report income in conformity with GAAP .

69

Defendants failed to cause the Company to make such disclosures and to account for and to

report income in conformity with GAAP .

209. Due to the non-disclosures and non-GAAP accounting, the above particularized

documents which Defendants caused the Company to disseminate to the investing public during

the Class Period were materially false and misleading .

210. Defendants knew and ignored, or were reckless in not knowing, the facts which

indicated that the above particularized press releases, public statements, and filings with the SEC

which were disseminated to the investing public during the Class Period, were materially false

and misleading for the reasons set forth above.

B. Red Hat's Financial Restatement

211 . The fact that Red Hat restated is an admission that (1) the publicly-issued

financial statements for each of the restated periods were not prepared in conformity with

GAAP; (2) that they materially misrepresented Red Hat's and the Company' s financial

condition and results of operations ; and (3) that the financial statements reported during the Class

Period were incorrect based on information available to Defendants at the time the results

were originally reported

212. Under GAAP, a restatement of previously issued financial statements is the most

serious step, reserved only for circumstances where no lesser remedy is available . As recently

noted by the SEC, "GAAP only allows a restatement of prior financial statements based upon

information `that existed at the time the financial statements were prepared,"' and "restatements

should not be used to make any adjustments to take into account subsequent information that did

not and could not have existed at the time the original financial statements were prepared ."

213. Accounting Principles Board ("APB") Opinion No . 20, Accounting Changes,

provides that restatements are only permitted, and are required, to correct material accountin g

70

errors or irregularities that existed at the time the financial statements were prepared. APB 20

has defined the kind of "errors" that may be corrected through a restatement: "Errors in financial

statements result from mathematical mistakes , mistakes in the application of accounting

principles, or oversight or misuse of facts that existed at the time that the financial statements

were prepared." See APB 20 ¶'j7-13 .

214. By restating its own financial statements , Red Hat admitted that each document

publishing the original financial statements contained an untrue statement of material fact . The

Company's restatement is an admission that each of the annual and quarterly reports on Form

10-K and Form 10-Q for the fiscal years 2002, 2003 and 2004, as well as the first fiscal quarter

2005 ended May 31, 2004, that were filed with the SEC contained untrue statements of material

fact. Similarly, by restating, the Company also conceded that each of the press release s

disseminated to the investing public and other statements referred to in Section VIII above,

contained untrue statements of material fact .

215 . Indeed, Red Hat's massive restatement was not due to a simple mathematical

error, honest misapplication of a standard or oversight . Instead, the restatement was due to

intentional misuse of the facts known at the time the financial statements were prepared and

issued to the investing public .

216. The SEC has recently reiterated its position that, in its investigations of restated

financial statements, it often finds that the persons responsible for the improper accounting acted

with scienter :

[T]he Commission often seeks to enter into evidence restated financial statement,

and the documentation behind those restatements, in its securities fraudenforcement actions in order, inter alia, to prove the falsity and materiality of theoriginal financial statements [and] to demonstrate that persons responsible for theoriginal misstatements acted with scienter . . .

71

In re Sunbeam Sec. Litig., No. 98-8258-Civ .- Middlebrooks (S .D. Fla. filed Jan 31, 2002) (SEC

Amicus Curiae Brief Regarding Defendants' Motion In Limine to Exclude Evidence of the

restatement and Restatement Report) .

217. The restatements at issue in this case contain several indicators of scienter :

(a) The type of restatement (misuse of the facts) - The restatement at issue was dueto blatant misuse of the facts . As alleged below, in many instances, Red Hateither knew what the correct accounting treatment was, and ignored it, orrecklessly turned a blind eye to the information they had .

(b) The size of the restatement -Red Hat's net income originally reported for thethird quarter 2003 (November 30, 2002) in the amount of $214,000 was restatedto a loss of $789,000, change of over 468% .

(c) The duration over which the improper accounting was perpetrated - Therevenue recognition method corrected by the restatement had been utilized forfive years.

(d) The time period restated - As more fully detailed herein, Red Hat restated overthree years of financial statements to correct fraudulent accounting for fiscal years2002, 2003 and 2004, as well as first fiscal quarter 2005, and the restatement andchange in revenue recognition method impacted the previous two fiscal years,2001 and 2000.

(e) The types of accounting manipulations employed - As detailed herein theimproper accounting corrected by this restatement did not occur as a result ofgood faith differences in accounting judgments, or interpretations of complicatedor vague accounting rules . The accounting rules and precepts violated by Red Hatwere long established, basic accounting standards and concepts, such as the mostbasic rule of recording revenue in the period it was actually incurred .

218. The improper accounting was not a result of inexperienced accounting manager s

who did not understand accounting rules, nor can it be blamed solely on poor accounting

controls. To the contrary, Red Hat's financial officers knew what they were doing . They were

experienced CPA's and seasoned financial professionals with significant accounting, auditing

and SEC reporting experience . For example, Defendant Thompson worked at Arthur Anderson

and PWC prior to his tenure at Red Hat . Defendant Thompson, as a result of his "Big Six"

72

accounting and auditing background, was well versed in evaluating, establishing, and auditin g

accounting policies, practices and internal accounting controls .

219. Tellingly, Defendants in this case did not themselves discover their "error" and

report it while re-reviewing earlier facts and rush to come forward . Instead, they were caught b y

their new outside auditor partner at PWC, and forced to restate. (See ¶¶88 -90 and 101 above) .

C. Defendants ' Additional GAAP Violations

220. In addition to the GAAP and SEC violations desc ribed above, the Company also

violated several additional fundamental GAAP principles :

The principle that interim financial reporting should be based upon th e

same accounting principles and practices used to prepare annual financial statements wa s

violated (APB No . 28, ¶10);

ii. The principle that financial reporting should provide information that i s

useful to present and potential investors and creditors and other users in making rationa l

investment , credit and similar decisions was violated (FASB CON No. 1, ¶34) ;

iii . The principle that financial reporting should provide information about the

economic resources of an enterprise, the claims to those resources, and effects of transactions,

events and circumstances that change resources and claims to those resources was violate d

(FASB CON No . 1, ¶40) ;

iv. The principle that financial reporting should provide information abou t

how management of an enterprise has discharged its stewardship responsibility to owners

(stockholders) for the use of enterprise resources entrusted to it was violated . To the extent that

management offers securities of the enterprise to the public, it voluntarily accepts wider

responsibilities for accountability to prospective investors and to the public in general (FASB

CON No. 1, 150) ;

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v. The principle that financial reporting should provide information about an

enterprise 's financial performance during a pe riod was violated . Investors and creditors often

use information about the past to help in assessing the prospects of an enterprise . Thus , although

investment and credit decisions reflect investors ' expectations about future enterp rise

performance, those expectations are commonly based at least partly on evaluations of past

enterp rise performance (FASB CON No. 1, ¶42) ;

vi. The principle that financial reporting should be reliable in that it

represents what it purports to represent was violated . That information should be reliable as wel l

as relevant is a notion that is central to accounting (FASB CON No . 2, ¶158-59) ;

vii . The principle of completeness , which means that no information is

omitted that may be necessary to ensure that the Financial Statements validly represent

underlying events and conditions , was violated (FASB CON No . 2, ¶79) ; and

viii . The principle that conservatism be used as a prudent reaction t o

uncertainty in order to ensure that uncertainties and risks inherent in business situations ar e

adequately considered was violated. The best way to avoid injury to investors is to try to ensure

that what is reported represents what it purports to represent (FASB CON No . 2, ¶¶95, 97) .

221 . Further, the undisclosed adverse information concealed by Defendants during th e

Class Period is the type of information that, because of SEC regulations, regulations of the

national stock exchanges and customary business practice, is expected by investors and securities

analysts to be disclosed and is known by corporate officials and their legal and financial advisors

to be the type of information that is expected to be and must be disclosed.

M. PWC'S AUDITING VIOLATIONS

222. The auditing standard of care is established by principles and standards

recognized and accepted by the accounting profession . As certified public accounts and auditors ,

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PWC and Barber are charged with knowledge of, and must comply with, these principles and

standards known as Generally Accepted Auditing St andards ("GAAS") and GAAP. PWC and

Barber are also charged with knowledge of, and must comply with all applicable law, including ,

but not limited to, SEC rules and regulations .

223 . As one of the largest audit firms in the world, PWC was well aware of the

strategies, methods and procedures required by GAAS to conduct a p roper audit. Also, PWC

and Barber knew of the audit risks inherent at Red Hat and the industry in which Red Hat

operated because of the comp rehensive services it provided to Red Hat, over the years and its

experience in the computer software/technology indust ry.

224. GAAS are promulgated by the American Institute of Certified Public Accountants

("AICPA") and embody ten standards, which concern an auditor's professional qualities and the

judgment to be exercised in the performance of the auditor' s examination and report . The GAAS

standards include General Standards, Field Work Standards, and Reporting Standards as follows :

• General Standards

• Training and Proficiency - requiring adequate training andproficiency as an auditor .

• Independence - requiring independence in mental attitude byauditor .

• Due Care - requiring due professional care to be exercised inplanning and performing the audit and in preparing the auditreport .

• Fieldwork Standards

• Planning and Supervising - requiring audit work to be properlyplanned and any assistants to be supervised .

• Internal Control - requiring sufficient understanding of the auditedentity's internal control in order to plan the audit and determine

tests to be performed.

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• Evidential Matter - requiring sufficient competent evidence to beobtained by auditor through inspection, observation, inquiry andconfirmation to afford a reasonable basis for audit opinion .

• Reporting Standards

• GAAP - requiring auditors ' report to state whe ther financialstatements are presented in accordance with generally acceptedaccounting principles .

• Consistency - requiring auditor to identify deviations fromaccounting principles applied in previously audited period .

• Disclosure - requiring informative disclosures in audited financialstatements to be reasonably adequate .

• Reporting Obligation - requiring an expression of the auditor'sopinion of financial statements , or an assertion that an opinioncannot be expressed and the reason.

225. These ten auditing standards provide the professional framework for the

Statement on Auditing Standards (SAS), promulgated by the Auditing Standards Board (ASB) o f

the AICPA . Auditors are required by the SEC, and under the AICPA Code of Professional

Conduct, to comply with these standards .

226. GAAP are promulgated by the Financial Accounting Standards Board and

embody the conventions , rules and procedures necessary to define accepted accounting practices

at a particular time . Additional GAAP based standards and p rinciples governing accountancy

include : Financial Accounting St andards ("FAS"); FAS Interpretations ; and Accounting

P rinciples Board ("APB") Opinions . PWC and Barber are required to know and apply GAAP to

meet their professional obligations to Red Hat .

227 . Financial audits , such as those PWC and Barber were retained to conduct for Re d

Hat, require the verification of information contained in Red Hat's financial statements throug h

the examination of underlying accounting records and o ther audit evidence. PWC and Barber, as

auditors , were required to follow GAAS to determine whe ther Red Hat's financial statements

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fairly presented Red Hat 's financial position and results of operation , including a determination

of whether the financial statements are presented in accordance with GAAP.

228. PWC and Barber were required to audit Red Hat 's financial statements in

accordance with GAAS, and report the audit results to Red Hat , the board of directors , the audi t

committee and the members of the investing public, including Plaintiffs and the other member s

of the Class .

229. On May 29, 2003, Red Hat filed its 2003 annual report on Form 10-K for the

fiscal year ended February 28, 2003 ("the 2003 Form 10-K") . The 2003 Form 10-K included

PWC's unqualified audit report dated March 25, 2003, which falsely represented that PWC had

conducted its audit for Red Hat 's year end 2003 financial statements in accordance with GAAS,

and that Red Hat's financial statements conformed with GAAP :

In our opinion, the accompanying consolidated balance sheets and therelated consolidated statements of operations, of stockholders' equity, andof cash flows present fairly, in all material respects, the financial position of

Red Hat, Inc . and its subsidiaries at February 28, 2003 and 2002, and the

results of their operations and their cash flows for each of the three years in

the period ended February 28, 2003 in conformity with accountingprinciples generally accepted in the United States of America . These

financial statements are the responsibility of the Company's management ;

our responsibility is to express an opinion on these financial statementsbased on our audits . We conducted our audits of these statements inaccordance with auditing standards generally accepted in the United States

of America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free of

material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements,

assessing the accounting principles used and significant estimates made bymanagement, and evaluating the overall financial statement presentation .

We believe that our audits provide a reasonable basis for our opinion .

230. PWC and Barber issued unqua lified audit opinions on Red Hat's fin ancial

statements for fiscal year end financial statements for fiscal years 2000, 2001, 2002, 2003 and

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2004, which falsely represented that PWC had conducted its audits in accord ance with GAAS,

and that Red Hat's fin ancial statements conformed with GAAP.

231 . Contrary to the statements in its audit report, PWC and Barber did not perform its

fiscal years 2000 through 2004 audits in accordance with GAAS, and the financial statements

were not in conformity with GAAP.

232. PWC and Barber possessed knowledge or were severely reckless in not

possessing knowledge of that Red Hat was prematurely recognizing revenue and that this was

not in compliance with GAAP. PWC and Barber failed to design audit procedures to test

revenue, net income and EPS more extensively than originally planned, or heighten its scrutiny

in its audit to obtain greater assurances that Red Hat's revenue net income and EPS were

accurately stated . These actions greatly enhanced and facilitated Red Hat ' s fraudulent and

unlawful scheme to overstate revenue, net income and EPS as alleged herein .

233 . With knowledge of Red Hat 's true financial condition, or in reckless disregard

thereof, PWC certified the materially false and misleading financial statements of Red Hat and

provided unqualified Independent Auditors' Reports, which were included in the companies' SEC

filings and publicly disseminated statements. Without these materially false and misleading

unqualified audit opinions and reports, the fraud alleged above could not have been perpetrated .

234. The pervasiveness of the fraud involving Red Hat's premature recognition o f

revenue (more than five years) ; the requirement that PWC and Barber independently review and

test the Company's revenue ; and the rarity of such a vast restatement and corresponding

withdrawal of PWC's audit opinions all provide evidence that PWC and Barber knew and/or

severely recklessly disregarded that its Class Period statements and omissions were materially

false and misleading .

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235. PWC and Barber knew or recklessly disregarded that Red Hat 's financial

statements were materially false and misleading during the Class Period because Red Ha t

prematurely recognized revenue from subscriptions on a monthly basis, in violation of GAAP

and SEC rules .

236. PWC and Barber's intentional or severely reckless failure to comply with GAAS

and PWC and Barber' s performance on the Red Hat audits rose to the level of severe

recklessness and/or knowing fraud .

A. PWC and Barber 's Violations of GAAS

237. PWC and Barber represented in unqualified audit opinions in connection wi th the

filing of Red Hat's Forms 10 -K that the audits were performed in a manner consistent wi th

GAAS. Such representations were materially false, misleading and wi thout reasonable basis.

PWC and Barber 's breach of GAAS is evidenced, in part, by its wi thdrawal of its unqualified

audit opinions for the 2002, 2003 and 2004 fiscal year audits . 8

0 AU Section 561, "Subsequent Discovery of Facts Existing at the Date of the Auditor'sReport" sets forth the implications of PWC's withdrawal of its unqualified audit opinion :

.05 When the subsequently discovered information is found both to be reliableand to have existed at the date of the auditor's report, the auditor should takeaction in accordance with the procedures set out in subsequent paragraphs if thenature and effect of the matter are such that (a) his report would have beenaffected if the information had been known to him at the date of his report andhad not been reflected in the financial statements and (b) he believes there arepersons currently relying or likely to rely on the financial statements who wouldattach importance to the information. With respect to (b), consideration should begiven, among other things, to the time elapsed since the financial statements wereissued .

.06 When the auditor has concluded, after considering (a) and (b) in that action

should be taken to prevent future reliance on his report, he should advise his clientto make appropriate disclosure of the newly discovered facts and their impact onthe financial statements to persons who are known to be currently relying or whoare likely to rely on the financial statements and the related auditor's report . When

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238. PWC and Barber knew or were severely reckless in not knowing that fraudulent

activities by Red Hat resulted in the Company's financial statements contravening provisions of

GAAP. This is evidenced by : (1) the close relationship between PWC and Red Hat ; (2) Red

Hat's statement in the July 13, 2004 press release that Red Hat's financial information for fiscal

years 2002, 2003 and 2004, and the first fiscal quarter of 2005 would be restated ; and (3) PWC's

withdrawal of its unqualified audit opinions for the 2002, 2003 and 2004 fiscal year audits of

Red Hat .

the client undertakes to make appropriate disclosure, the method used and thedisclosure made will depend on the circumstances .

a. If the effect on the financial statements or auditor's report of the subsequentlydiscovered information can promptly be determined, disclosure should consist ofissuing, as soon as practicable, revised financial statements and auditor's report .The reasons for the revision usually should be described in a note to the financialstatements and referred to in the auditor's report . Generally, only the mostrecently issued audited financial statements would need to be revised, eventhough the revision resulted from events that had occurred in prior years .

b. When issuance of financial statements accompanied by the auditor's report for asubsequent period is imminent, so that disclosure is not delayed, appropriatedisclosure of the revision can be made in such statements instead of reissuing theearlier statements pursuant to subparagraph (a) .

c . When the effect on the financial statements of the subsequently discoveredinformation cannot be determined without a prolonged investigation, the issuanceof revised financial statements and auditor's report would necessarily be delayed .In this circumstance, when it appears that the information will require a revisionof the statements, appropriate disclosure would consist of notification by theclient to persons who are known to be relying or who are likely to rely on thefinancial statements and the related report that they should not be relied upon, andthat revised financial statements and auditor's report will be issued uponcompletion of an investigation . If applicable, the client should be advised todiscuss with the Securities and Exchange Commission, stock exchanges, andappropriate regulatory agencies the disclosure to be made or other measures to betaken in the circumstances .

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239. PWC and Barber also breached 7 of the 10 required GAAS standards, to-wit: (a)

1 st General Standard - by failing to maintain their independence ; (b) 3`h General Standard - by

failing to exercise due professional care in the planning and perform ance of Red Hat audit and in

the preparation of PWC' s audit reports ; (c) is` Standard of Fieldwork - by negligently planning

and supervising Red Hat audits; (d) 3`l Standard of Fieldwork - by failing to obtain through

inspection, observation , inquiries and confirmations competent evidential matter to afford a

reasonable basis for audit opinions on the financial statements; (e) 1st Standard of Reporting - by

reporting that Red Hat's financial statements were presented in accordance with GAAP; (f) 3'd

Standard of Reporting - by failing to determine whether informative disclosures in fin ancial

statements were reasonably adequate ; and (g) 4th Standard of Reporting - by issuing unqualified

audit reports on materially misstated financial statements .

240. Additionally, AU 316 paragraph 23 states that Sec tion 319 entitled

"Consideration of Internal Control in a Financial Statement Audit," requires the auditor to

obtain a sufficient understanding of the entity's internal control over financial reporting to pla n

the audit . It also notes that such knowledge should be used to identify types of potential

misstatements, consider factors that affect the risk of material misstatement and design

substantive tests . The understanding will affect the auditor's consideration of the significance of

fraud risk factors . In addition, when considering the significance of fraud risk factors, the

auditor may wish to assess whether there are specific controls that mitigate the risk or whether

specific control deficiencies may exacerbate the risk .

241 . Under AU 316 paragraph 27, judgments about the risk of material misstatement

due to fraud may affect the audit in the following ways :

• Professional skepticism . Due professional care requires the auditor toexercise professional skepticism - that is, an attitude that includes a

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questioning mind and critical assessment of audit evidence . Someexamples demonstrating the application of professional skepticism inresponse to the auditor's assessment of the risk of material misstatementdue to fraud include (a) increased sensitivity in the selection of thenature and extent of documentation to be examined in support ofmaterial transactions ; and (b) increased recognition of the need tocorroborate management explanations or representations concerningmaterial matters - such as further analytical procedures, examination ofdocumentation or discussion with others within or outside the entity .

• Accounting principles and policies . The auditor may decide to considerfurther management's selection and application of significant accounting

policies, particularly those related to revenue recognition, assetvaluation, or capitalizing versus expensing . In this respect, the auditormay have a greater concern about whether the accounting principlesselected and policies adopted are being applied in an inappropriatemanner to create a material misstatement of the financial statements .

242. Some examples of responses to the auditor' s assessment of the risk of material

misstatements arising from fraudulent financial reporting are set forth in AU 316: paragraph 17:

(a) Risk factors relating to management's characteristics and influence overthe control environment. Examples include -

• A motivation for management to engage in fraudulent financialreporting. Specific indicators might include -

-- A significant portion of management's compensationrepresented by bonuses, stock options or other incentives, thevalue of which is contingent upon the entity achieving undulyaggressive targets for operating results, financial position, orcash flow.

-- An excessive interest by management in maintaining orincreasing the entity's stock price or earnings trend through theuse of unusually aggressive accounting practices .

-- A practice by management of committing to analysts,creditors, and other third parties to achieve what appear to beunduly aggressive or clearly unrealistic forecasts .

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• A failure by management to display and communicate an appropriateattitude regarding internal control and the financial reportingprocess. Specific indicators might include -

* *

-- Domination of management by a single person or small groupwithout compensating controls such as effective oversight by theboard of directors or audit committee .

-- Inadequate monitoring of significant controls .

-- Management failing to correct known reportable conditions on atimely basis .

243. AU 316, paragraph 30 provides :

• Revenue recognition . If there is a risk of material misstatement due tofraud that may involve or result in improper revenue recognition, it maybe appropriate to confirm with customers certain relevant contract termsand the absence of side agreements - inasmuch as the appropriateaccounting is often influenced by such terms or agreements . For'example, acceptance criteria, delivery and payment terms and theabsence of future or continuing vendor obligations, the right to return theproduct, guaranteed resale amounts, and cancellation or refundprovisions often are relevant in such circumstances .

244. SAS No. 61 (AU Sec . 380), Communication with Audit Committees, states that

"the auditor should determine that the audit committee is informed about the process used by

management in formulating particularly sensitive accounting estimates and about the basis for

the auditor's conclusions regarding the reasonableness of those estimates ." Additionally, SAS

No. 61 "requires auditors of Securities and Exchange Commission (SEC) clients to discuss with

audit committees the auditor's judgments about the quality, and not just the acceptability, of the

company's accounting principles and underlying estimates in its financial statements ."

245. APB 20 provides that, where a company misjudges an estimate for accounting

purposes, the misjudgment should be corrected prospectively through a charge to revenues .

Conversely, a restatement is required where the company committed an "error ." An "error" in

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financial statements results from "mathematical mistakes, mistakes in the application of

accounting principles , or oversight or misuse of facts that existed at the time the fin ancial

statements were prepared ." FAS 16 calls such restatements "rare in modern financial

accounting. "

246. PWC and Barber violated GAAS and the standards set forth in SAS No. 1 and

SAS No . 53 by, inter alia, failing to adequately plan their audit and properly supervise the work

of assistants and to establish and carry out procedures reasonably designed to search for and

detect the existence of errors and irregularities that would have a material effect upon the

financial statements.

247. PWC and Barber violated GAAS Standard of Field Work No . 2, which requires

the auditor to make a proper study of existing internal controls , including accounting, fin ancial

and managerial controls, to determine whether reliance thereon was justified , and, if such

contro ls are not reliable , to expand the nature and scope of the auditing procedures to be applied .

The standard provides that a sufficient understanding of an entity's internal control structure be

obtained to adequately pl an the audit and to determine the nature , timing and extent of tests to be

performed . AU § 150 .02. In all audits, the auditor should perform procedures to obtain a

sufficient understanding of three elements of an entity's internal control structure: the control

environment ; the accounting system; and control procedures. AU § 319 .02 .

248. As a result of its failure to accurately repo rt on Red Hat's fiscal 2000 throug h

2004 and first fiscal quarter 2005 financial statements, PWC and Barber utterly failed in their

role as an auditor as defined by the SEC . SEC Accounting Series Release No . 296,

Relationships Between Registrants and Independent Accountants, Securities Act Release No .

6341, Exchange Act Release No . 18044, states in part :

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Moreover, the capital formation process depends in large part on the confidenceof investors in financial reporting. An investor's willingness to commit hiscapital to an impersonal market is dependent on the availability of accurate,material and timely information regarding the corporations in which he hasinvested or proposes to invest . The quality of information disseminated in thesecurities markets and the continuing conviction of individual investors that such

information is reliable are thus key to the formation and effective allocation ofcapital. Accordingly, the audit function must be meaningfully performed and theaccountants' independence not compromised . The auditor must be free to decidequestions against his client's interests if his independent professional judgmentcompels that result .

249. PWC 's and Barber 's opinions , which represented that Red Hat's fiscal years 2000

through 2004 fi nancial statements were presented in conformity with GAAP, were materiall y

false and misleading because PWC and Barber knew or were severely reckless in not knowing

that Red Hat 's financial statements violated the principles of fair reporting and GAAP .

250. PWC and Barber knew or severely recklessly disregarded facts indicating that

they should have: (a) disclaimed or issued adverse opinions on Red Hat fiscal 2000 through 2004

fiscal year end financial statements ; or (b) withdrawn, corrected or modified its opinions for

fiscal years 2000 through 2004 to recognize Red Hat improper accounting and financial

reporting as described above.

B. PWC Violated Section 1OA(b)(1) of the Exchange Ac t

251. During the time of the conduct described above, Section IOA(b)(1) of th e

Exchange Act provided in relevant part :

If, in the course of conducting an audit . . ., the independent public accountantdetects or otherwise becomes aware of information indicating that an illegal act(whether or not perceived to have a material effect on the financial statements ofthe issuer) has or may have occurred, the accountant shall, in accordance withgenerally accepted accounting standards . . . determine whether it is likely that anillegal act has occurred ; and if so, determine and consider the possible effect ofthe illegal act on the financial statements of the issuer . . . and as soon aspracticable, inform the appropriate level of the management of the issuer andassure that the audit committee of the issuer, or the board of directors . . . in theabsence of such a committee, is adequately informed with respect to illegal actsthat have been detected or have otherwise come to the attention of such

85

accountant in the course of the audit, unless the illegal act is clearlyinconsequential .

252. PWC knew or was severely reckless in not knowing that Red Hat improperly

recognized revenue, as described in ¶1189-210 above .

C. PWC Violated Its Own Accounting Guidelines

253. In addition to violating the formal rules regulating accounting, PWC's

participation in the revenue recognition scheme violates its own internal procedures . In Section

2.17 of PWC's Software Revenue Recognition -- User-Friendly Guide, it clearly states that "in

no circumstances should revenue be recognized prior to the commencement to the initial license

period." Moreover, the guide states that this is consistent with SAB 101, as well as TPA 5100.70

(which is the AICPA's Technical Practice Aids section entitled "Effect of Commencement of an

Initial License Term and Software Revenue Recognition") .

D. PWC and Barber Eneaged in Improper Professional Conduct Within theMeanine of Commission Rule of Prac tice 102(e)

254. An auditor is required to exercise professional skepticism when performing audit

procedures and gathering and analyzing audit evidence . AICPA Codification of Statements on

Auditing Standards ("AU") Section 230.07 .

255 . Based on the foregoing, in connection with its audit of Red Hat's year end

financial statements, PWC and Barber failed to maintain the attitude of professional skepticism

required by GAAS concerning Red Hat's accounting for revenue. PWC and Barber did not

follow up on the materiality of the non-GAAP revenue recognition method of accounting that

PWC and Barber were aware that Red Hat used . Furthermo re, PWC and Barber accepted

uncorroborated representations of Red Hat's management in lieu of performing additional audit

procedures, in contravention of AU Section 33 .

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256. For example, in the Management Representation Letters, management represente d

that GAAP had been applied in the preparation of the financial statements for each year end fo r

the fiscal years 2000 through 2004 . However, as described above, this representation wa s

contradicted by other audit evidence PWC and Barber obtained .9 PWC and Barber failed to

maintain their professional skepticism .

257. In addition, in conducting an audit, an auditor must obtain sufficient competen t

evidential matter through inspection, observation, inquiries, and confirmations to afford a

reasonable basis for an opinion regarding the financial statements under audit. AU Sections

150.02 & 326 .01 .

258. Based on the foregoing, in connection with Red Hat's fiscal year end 2000

through 2004 financial statements , PWC and Barber failed to obtain sufficient competent

evidence (including sufficient management representations) in support of Red Hat's accounting

for revenue recognition for its licensing of software .

259. Auditors must also exercise due professional care in performing the audit an d

preparing the audit report . AU Sections 150.02 and 230 .01 .

260. In connection with the audit of Red Hat's 2000 through 2004 fiscal year en d

financial statements , PWC and Barber failed to exercise due p rofessional care by failing to plan

and perform audit procedures necessary to afford a reasonable basis for PWC's audit opinions .

As described above, PWC and Barber were well aware of Red Hat's Non-GAAP method of

revenue recognition reported in Red Hat 's financial statements .

9 "[R]epresentations from management are part of the evidential matter the independent auditorobtains, but they are not a substitute for the application of those auditing procedures necessary toafford a reasonable basis for an opinion regarding the financial statements under audit ." AU

Section 333 .02 .

87

261 . Despite PWC's and Barber's awareness of the non-GAAP revenue recognition and

other information that could materially impact the financial statements, PWC and Barber failed

to perform sufficient audit procedures to assess properly whether Red Hat's accounting fo r

revenue recognition was in conformi ty with GAAP. As a result , Red Hat improperly recognized

non-GAAP revenue and, as described above, misused it to materially inflate earn ings for the

fiscal years 2000 through 2004, as well as first fiscal quarter 2005.

262. In conducting an audit , an auditor is required to state in the auditor's repo rt

whether, in the auditor's opinion, the financial statements are presented in all material respects in

conformity with GAAP . AU Sections 410 and 411 . An auditor may express that the financial

statements are presented in conformity with GAAP only when the auditor has formed such an

opinion on the basis of an audit performed in accord ance with GAAS. AU Section 508 .07 .

263 . Based on the foregoing , in connection with the audit of Red Hat 's fiscal year ends

2000 through 2004 financial statements, PWC and Barber failed to render an accurate audit

report when they stated that Red Hat' s financial statements had been prepared in conformity with

GAAP and the audit had been performed in accordance with GAAS . In fact, the financial

statements were not in conformity with GAAP, and the audit was not performed in accordance

with GAAS .

264. The failures of Barber, a PWC engagement partner and managing partner of

PWC's Raleigh, North Carolina office, to comply with GAAS in the conduct of the audit bind

and are imputed to PWC .

E. PWC's Lack of Independenc e

265. Section 13(a) of the Exchange Act requires that financial statements filed with the

Commission be certified by "independent accountants ." Rule 13a-1 specifically requires issuers

to file annual reports containing financial statements certified by independent public accountants .

88

Regulation S-X under the Exchange Act sets forth, among other things, the requirements

applicable to audited financial statements included in periodic reports filed by an issuer pursuant

to Section 13 of the Exchange Act . Rule 2-02(b)(1) of Regulation S-X requires an auditor's

report to state, "whether the audit was made in accordance with generally accepted auditing

standards [GAAS] ." Consistent with the Commission's rules and pronouncements, GAAS

requires auditors to maintain strict independence from their audit clients . Statement on Auditing

Standards ("SAS") No .1 explains the independence requirement as follows :

It is of utmost importance to the profession that the general public maintainconfidence in the independence of independent auditors . Public confidence wouldbe impaired by evidence that independence was actually lacking, and it also mightbe impaired by the existence of circumstances which reasonable people mightbelieve likely to influence independence. To be independent, the auditor must beintellectually honest; to be recognized as independent, he must be free from anyobligation to or interest in the client, its management or its owners . . . .Independent auditors should not only be independent in fact ; they should avoidsituations that may lead outsiders to doubt their independence .

266. Rule 2-01(b)(1) of Regulation S-X, in effect during the relevant period, states tha t

"[t]he Commission will not recognize any certified pub lic accountant or public accountant who is

not in fact independent ." To determine whether auditors are independent for purposes of GAAS,

the Commission looks to the AICPA rules, among other things . SAS No . 1 provides that the

independence ru les of the AICPA Code of Professional Conduct "[h]ave the force of professional

law for the independent auditor. "

267. Annual and quarterly reports fi led by issuers under Section 13(a) of the Exchange

Act, and Rules 13a-1 and 13a-13 thereunder, must accurately reflect the financial condition and

operating results of the issuer. Rule 12b-20 further requires the inclusion of any additional

material information that is necessary to make required statements, in light of the circumstances

under which they were made, not misleading . Section 13(b)(2)(A) of the Exchange Act requires

issuers to "make and keep books, records, and accounts, which, in reasonable detail, accuratel y

89

and fairly reflect the transactions and dispositions of the assets of the issuer ." Section 13 (b)(2)(B)

of the Exchange Act requires issuers to devise and maintain a system of internal accounting

controls sufficient to provide reasonable assurances that transactions are recorded as necessary to

permit the preparation of fin ancial statements in conformity with GAAP and to maintain the

accountability of assets .

268. In each of the instances described above , PWC and Barber lacked the requisite

independence with respect to Red Hat . This conduct constituted improper professional conduct

within the meaning of Rule 102(e)(1)(iv)(A) . PWC and Barber failed to comply with Rule 2-

02(b)(1) of Regulation S-X by issuing audit reports stating that the audits were done in

accordance with GAAS, when, in fact, PWC and Barber lacked the requisite independence when

the audits were performed .

XII. DEFENDANTS REAPED ENORMOUS FINANCIAL BENEFITS THROUGHTHEIR FRAUDULENT SCHEME

A. Defendants Acted With Scienter

269. In addition to the other reasons alleged in this Complaint, Defendants acted with

scienter (with knowledge and/or intent) in that Defendants knew that the public documents and

statements issues or disseminated in the name of the Company were mate rially false and

misleading; knew that such statements or documents would be issued or disseminated to the

investing public ; and knowingly and substantially participated or acquiesced in the issuance or

dissemination of such statements or documents as primary violations of the federal securities

laws. As set forth elsewhere herein in detail , Defendants , by virtue of their receipt of

information reflecting the true facts regarding Red Hat , their contro l over, and/or receipt and/or

modification of Red Hat 's allegedly materially misleading misstatements and/or their

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associations with the Company which made them privy to confidential proprietary information

concerning Red Hat, participated in the fraudulent scheme alleged herein .

270. Defendants knew and/or recklessly disregarded the falsity and misleading nature

of the information which they caused to be disseminated to the investing public . The ongoing

fraudulent scheme described in this complaint could not have been perpetrated over a substantial

period of time, as has occurred, without the knowledge and complicity of the personnel at the

highest level of the Company, including the Individual Defendants and Red Hat's auditor PWC .

271 . Defendants had the motive and opportunity to perpetrate the fraudulent scheme

and course of business described herein for the following reasons :

a) The scheme allowed the Individual Defendants to collectively reap approximately

$94,055,651 through the sale of almost 6 million shares of Red Hat common stock at artificially

inflated prices ;

b) The scheme enabled Red Hat to raise $600 million dollars through the sale of low

interest convertible debentures ;

c) The scheme permitted Red Hat to acquire storage infrastructure software

company Sistina Software, Inc . for $31 million, using its artificially inflated stock price as

currency;

d) The accounting machinations in which Defendants engaged (i.e., improper

recognition of revenue from subscription contracts, which was the Company's primary revenue

source, to boost revenue in the reporting periods in which the contracts were entered) constitutes

a practice that could only have been deliberately instituted with knowledge or reckless disregard

that revenues, net income, and operating profits would be artificially inflated by reporting tha t

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more revenue had been earned in the quarter in which the subscription contract was entered than

actually was the case; and

e) The Individual Defendants were the most senior officers of Red Hat, issued

statements and press releases on behalf of Red Hat and had the opportunity to commit the fraud

alleged in this Complaint .

B. Defendants' Insider Selling Was Unusual In Timing And Amoun t

272 . In addition to the indicators of scienter discussed above, and throughout this

complaint, the scienter of the Red Hat Defendants is further evidenced by the massive amount of

insider trading during the Class Period, which is both particularly unusual, and highly suspicious,

in timing and amount . A chart depicting Defendants' pre-Class Period and Class Period sales is

attached hereto as Exhibit A.

273 . Defendant Szulik engaged in both pre-Class Period and Class Period transactions ,

but his sales during the Class Period are staggering in comparison . Szulik's pre-Class Period

transactions, from January 1, 2000 to December 16, 2002, amounted to 213,826 shares being

sold for proceeds of $5,048,883, consisting of 2 .76% of his total holdings . This amount is but a

fraction of Szulik's Class Period transactions : 2,899,800 shares sold for proceeds of $43,597,194

between the period of December 17, 2002 and July 12, 2004, consisting of 30 .32% of his total

holdings. This equates to over ten times the number of shares sold prior to the Class Period.

Even more suspicious is the fact that most of Szulik's class -period transactions took place in

February of 2004 - just one month before the Fiscal Year 2005 was to begin, which was the

time period the new auditor would be reviewing .

274. As a result of the upcoming PWC auditor rotation, Szulik began to unload his

shares of Red Hat onto the unsuspecting investing public . During the month of February alone,

Szulik unloaded over 1 .2 million shares of Red Hat stock, reaping proceeds of approximatel y

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$22 million. Moreover, Szulik's trading in the month of February, 2004 comprises more than

halfof Szulik's $44 million Class Period sales, with sales on almost every day of the month

amounting to proceeds of $22,110,094 .

275. The same general pattern of February sales can be demonstrated for Defendant s

Thompson, Cormier and Webbink . Defendant Thompson, who joined the company in

September 2000, did not make an y trades before the Class Period. However, during the Class

Period, he sold 135,000 shares for proceeds of $2,910,450 .10 These sales represent 23.35% of

his total holdings, and take place between January of 2004 and April of 2004, thus immediately

proceeding the dreaded mandatory auditor rotation .

276. Cormier, who joined Red Hat one month prior to the beginning of the Class

Period, also sold shares during the Class Period, just months before the PWC auditor rotation

was scheduled to take place, selling 80,000 shares for proceeds of $1,771,720 . Cormier sold

21 .75% of holdings during the Class Period.

277. Webbink engaged in very few pre-Class Period transactions, only selling 908

shares for proceeds of $4,222, representing a mere 1 .95% ofhis holdings . These trades pale in

comparison to Webbink's Class Period transactions , when he sold 215,706 shares for proceeds of

$3,701,360. These sales amount to 76.00% of his holdings. In particular, Webbink sold most of

his shares between January 9, 2004 and May 24, 2004, selling 129 ,706 shares of Red Hat stock

for proceeds of approximately $3.1 million.

10 Lead Plaintiff has reason to believe that Thompson sold an additional 190,000 shares duringthe class period, which would bring his total to 325,000 shares sold for proceeds of $4,375,000 .However, as Lead Plaintiff could not verify these trades with an SEC Form 4, they were notincluded. These unverified trades indicate that Thompson sold 42 .31 % of his Red Hat stockduring the class period .

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278 . A similarly large pattern of class-period transactions can be demonstrated with

Defendant Buckley' s transactions . Buckley 's pre -class transactions amounted to only 985,000

shares sold for proceeds of $10,111,665, with 23.70% of his holdings sold, compared t o

2,667,240 shares sold for proceeds of $42,074,927 during the Class Period - three times as many

shares sold during the Class Period ." In fact, according to the 2004 Proxy Statement filed

August 13, 2004, Buckley has sold 100% of his shares during the Class Period and holds n o

remaining stock in Red Hat .

279. Defendants Szulik, Buckley, Thompson, Webbink, and Cormier collectively sol d

close to 6 million shares of Red Hat stock during the Class Period for proceeds of approximatel y

$94,055,651 without revealing the adverse facts known to them concerning Red Hat's busines s

and prospects, as are described in this Complaint . A summary of their insider sales is illus trated

on the chart below :

Red Hat, INC. SUMMARY OF PRE-CLASS PERIOD SALES vs. CLASS PERIODINSIDER SALES

Insider Shares SoldPre-Class

Period

ProceedsDuring Pre -Class Period

Shares SoldDurine Class

Period

ProceedsDuring Class

Period

Matthew Szulik 213,826 $5,048,883 2,899,800 $43,597,194

Timothy Buckley 985,000 $10,111,665 2,667,240 $42,074,927

Kevin Thompson 0 $0 135,000 $2,910,450

Mark Webbink 908 $4,222 215,706 $3,701,360

Paul Cormier 0 $0 80,000 $1,771,720

11 Lead Plaintiff has reason to believe that Buckley sold an additional 317,800 shares during theclass period , which would bring his total to 325 ,000 shares sold for proceeds of $4,375,000 .

However, as Lead Plaintiff could not verify these trades with an SEC Form 4, they were not

included.

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280. Even within Red Hat, high-level employees were shocked and dismayed at the

astonishing level and timing of insider trading, as well as the timing of the sales in relation to the

news of the restatement . For example, the Former Red Hat Independent Contractor Principal

Consultant/Program Manager said that that even before the public announcements regarding the

impending earnings restatements, it was "not a secret" within Red Hat that the Company's senior

executives, including Szulik, Buckley, and General Counsel Webbink, sold "many millions" of

dollars of their personal holdings in Red Hat . He said that these significant stock sales did not

"sit right" with him or with his Red Hat colleagues .

281 . Other employees recognized the unabashed dumping of the Individual Defendant s

personal holdings as well . The Former Director of Professional Services said that when the

Company had an audit partner rotation in 2004, it was highly likely that the "fun and games"

were going to stop, and, in the witness' view, Thompson saw the writing on the wall, and

decided that it was "time to bail ." In addition, the Former Regional Account Manager

remembered that senior management's attempts to cut their respective financial losses in light of

the announcement that was coming often served as fodder for discussion amongst the Red Hat

staff. Finally, the Former Inside Account Executive summed it up by saying that Szulik was

there to "rape that Company and then he'll bail out" and the shareholders would be left holding

the bag.

282. Particularly twisted was the fact that while these insiders reaped millions i n

profits, emails encouraging the staff not to sell their Red Hat stock were regularly disseminated

by Red Hat's senior management . The Former Regional Account Manager said that these email

communications consistently asserted that Red Hat staff would be unwise to sell their stock in

the Company, as the stock's valuation was expected to continually increase. The emails insisted

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that Red Hat's stock was on target to "be at $80 someday ." The witness recalled that he and his

colleagues wondered aloud as to why it was that members of Red Hat's senior management were

actively selling such large percentages of their holdings in the Company if the stock was on

target to hit $80 per share.

283 . This highly suspicious and outrageous selling of Red Hat stock by high-level Re d

Hat insiders who knew what effect the auditor rotation could have on the company is even

further evidence that each of the Individual Defendants was aware that the Company's revenue

recognition scheme could be exposed, setting off a chain of events which could devastate the

value of their holdings by tens of millions of dollars.

C . The Defendants ' Compensation . Bonuses, and Other Incentives were HighlyDependent on Meeting Red Hat 's Aggressive Financial Obiectives andEstimates

284. According to Red Hat's 2001, 2002, and 2003 Proxy Statements, "[a]n

executive's total compensation package includes a cash salary and bonus determined by the

compensation committee, long-term incentive compensation in the form of stock options and

various benefits ." As highlighted in the Company's 2004 Proxy Statement, bonus "[p]ayouts are

based on a combination of Company performance, including revenue and earnings targets, and

the achievement of individual goals and objectives ." This bonus policy provided Defendants

with a great incentive to meet their numbers . For instance, during fiscal year 2004, according to

the 2004 Proxy Statement, "the Company performance was below internal target levels, and

therefore executives were eligible to receive below target bonuses under the VC Plan . During

fiscal 2003, the Company did not meet internal minimum performance levels and therefore

executives were not eligible for bonus payments under the VC Plan ."

285 . Moreover, as evidenced below, a large part of Defendants' compensation was in

the form of underlying stock options, and thus was directly tied to the performance of Red Ha t

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stock. This gave Defendants a great incentive to meet analysts' estimates and keep revenues

high at any cost .

(1) Defendant Szulik

286. Defendant Szulik's compensation, according to Red Hat's 2001,2002,2003 an d

2004 Proxy Statements, was "based upon the Company's overall performance , the perform ance

of his management team , the compensation paid by competing companies and the Company's

prospects , among other objectives and subjective factors, including the achievement of

perform ance targets in accordance with the Company's executive compensation policies ."

According to the Company's 2001 Proxy Statement, during fiscal year 2001 , Defendant Szulik's

salary was $233,771, with a $152 ,312 bonus and 1,000 ,000 underlying securi ties options.

During fiscal year 2002, according to the Company's 2004 Proxy Statement , Defendant Szulik's

salary was $350,000, with a $72,500 bonus and 2,000,000 underlying securities options. In

addition, according to the 2004 Proxy Statement, Defend ant Szulik 's salary in fiscal year 2003

was $350,000 with 1,000,000 underlying securities options, and in fiscal year 2004 was

$350,000, with a $174,675 bonus and 1,000,000 underlying securities options.

287. Defendant Szulik is also a party to an incentive stock option agreement and a non-

qualified stock option agreement, providing for the lapsing in full of Red Hat's repurchase right

as to any unvested option shares upon Defendant Szulik's termination of employment . In fiscal

year 2002, according to the Company's 2002 Proxy Statement, Defendant Szulik received

$3,860,000 in restricted stock awards, which were the result of 1,000,000 shares purchasable for

$.50 per share. According to the Company's 2003 Proxy Statement, "[flair market value on the

date of the grant was $4.36 per share. As of 2/28/03, fair market value was $5 .89 per share and

the aggregate value is $5,390,000 . 125,000 shares vest each quarter over a period of thre e

years."

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288. In addition to participation in the normal executive compensation "VC Plan",

Defendant Szulik was eligible to earn up to $100,000 upon the achievement of certain strategic

objectives . Defendant Szulik in fact satisfied these objectives and earned the additional

$100,000 for fiscal year 2004 .

289. According to the Company's 2003 Proxy Statement, Red Hat entered into a n

Employment Agreement with Defendant Szulik effective July 24, 2002 . Defendant Szulik's

"arrangement includes an annual salary of $350,000, subject to increase, annual incentive cash

bonus equal to the greater of $200,000 or fifty percent of his salary as well as annual stock

option awards of at least 500,000 shares which shall vest in equal amounts on a quarterly basis

over a four year period following the date of grant ." In addition, during fiscal year 2004,

Defendant Szulik was granted 500,000 stock options at an exercise price of $6 .80 as an incentive

to encourage Defendant Szulik to continue his service as CEO. The compensation committee

also determined that an additional stock option grant to purchase 500,000 shares at an exercise

price of $ .50 would be "a suitable means of providing additional incentive" to Defendant Szulik .

(2) Defendant Thompson

290. According to the Company's 2001 Proxy Statement, during fiscal year 2001 ,

Defendant Thompson's salary was $93,625, with a $49,063 bonus and 350,000 securities

underlying options. During fiscal year 2002, according to the Company's 2002 Proxy Statement,

Defendant Thompson's salary was $250,000 with a $55,567 bonus and 500,000 underlying

securities options . In addition, according to the Company's 2004 Proxy Statement, Defendant

Thompson's salary in fiscal year 2003 was $250,000 with 100,000 underlying securities options,

and in fiscal year 2004 was $250,000, with a $59,172 bonus and 100,000 underlying securities

options.

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291 . During fiscal year ending February 28, 2001, according to Red Hat's 2001 Proxy

Statement, Defendant Thompson received a $200,000 relocation advance, which was non-

interest bearing and forgiven ratably over four years, provided Defendant Thompson remained

with Red Hat. Of this advance, according to the Company's yearly Proxy Statements, $29,167

was forgiven during fiscal year 2001, $50,000 during fiscal year 2002, $50,000 during fiscal year

2003, and $50,000 during fiscal year 2004 . As of February 29, 2004, Defendant Thompson

owed Red Hat $20,833 of this relocation expense .

(3) Defendant Buckley

292. According to the Company's 2001 Proxy Statement, during fiscal year 2001,

Defendant Buckley's salary was $188,333, with a $226,875 bonus and an additional 200,000

underlying securities options . During fiscal year 2002, according to the Company's 2002 Proxy

Statement, Defendant Buckley's salary was $250,000, with a $30,000 bonus. In addition,

according to the Company's 2004 Proxy Statement, Defendant Buckley's salary in fiscal year

2003 was $250,000 and in fiscal year 2004 was $188,500, with a $71,006 bonus . Defendant

Buckley, like Defendant Szulik, was a party to an incentive stock option agreement and a non-

qualified stock option agreement, which provided for the lapsing in full of Red Hat's repurchase

right as to any unvested option shares upon the termination of his employment .

(4) Defendant Webbink

293 . According to the Company's 2001 Proxy Statement, during fiscal year 2001 ,

Defendant Webbink's salary was $110,518, with a $35,938 bonus and 100,000 underlying

securities options. During fiscal year 2002, according to the Company's 2002 Proxy Statement,

Defendant Webbink's salary was $185,000, with a $25,875 bonus and 225,000 underlying

securities options. In addition, according to the Company's 2004 Proxy Statement, Defendant

Webbink's salary in fiscal year 2003 was $185,000, with 50,000 underlying securities options ,

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and in fiscal year 2004 was $185 ,000, with a $ 33,582 bonus and 50,000 underlying securitie s

options .

(5) Defendant Cormier

294. During fiscal year 2002, according to the Company's 2002 Proxy Statement ,

Defendant Conmier's salary was $225,112, with a $10,000 bonus and 425,000 underlying

securities options . According to the Company's 2004 Proxy Statement, Defendant Cormier's

salary in fiscal year 2003 was $275,000, with 100,000 underlying securities options, and in fiscal

year 2004 was $275,000, with a $56,172 bonus and 100,000 underlying securities options .

D. Defendants Were Motivated To Inflate Red Hat Stock In Order To CompleteStockBased Acquisitions During The Class Period

295. Defendants were further motivated to conceal the adverse facts detailed herein i n

order to acquire other companies using Red Hat's artificially inflated shares. On December 18,

2003, Red Hat announced that it had entered into an Agreement and Plan of Merger on

December 17, 2003, under which a wholly-owned subsidiary of Red Hat would merge with and

into Sistina Software, Inc. ("Sistina"), with Sistina as the surviving entity . Under the agreement,

Red Hat acquired all outstanding common stock of Sistina in exchange for the issuance of

1,979,874 shares of Red Hat stock and the assumption of all outstanding Sistina stock options

valued, in aggregate, at $30 .7 million. The transaction closed on December 23, 2003 .

296. Although the Sistina acquisition was the only acquisition completed during th e

Class Period, Defendants acquired several other companies before and after the Class Period . In

a December 18, 2003 conference call with analysts, Defendant Thompson shared Defendants'

intent to pursue other acquisition opportunities . In addition, the proceeds from a private

placement during the Class Period were also intended for acquisitions, as explained in a January

6, 2004 press release.

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E. Defendants Propped Up the Company 's Stock Price In Order to Complete aSale of $600 Million in Convertible Senior Debentures

297 . Defendants also concealed the adverse facts detailed herein in order to complete a

private placement of $600 million of Convertible Senior Debentures bearing an interest rate of

0.50% per annum, payable each January 15 and July 15, beginning on July 15, 2004. Defendants

announced the private placement of $400 million in convertible senior debentures in a press

release dated January 5, 2004. When the private offering commenced on January 12, 2004, it

had increased to $600 million . According to the Company's January 6, 2004 press release, Red

Hat "expect[ed] to use the net proceeds for general corporate purposes, including possible

acquisitions of complementary businesses and technologies and the expansion of its international

operations." On May 11, 2004, the Company filed an initial Registration Statement allowing the

purchasers of the $600 Convertible Senior Debentures to, from time to time, resell their

debentures and the shares of common stock issuable upon conversion of the debentures . That

Registration Statement ultimately became effective August 18, 2004 . Had the truth been known

about the Company's revenue recognition policy, the private debt placement would not have

been possible at such favorable terms .

F. Defendant 's Had Access to an Enormous Amount of Detailed FinancialInformation at Their Fingertips

298. A wide array of detailed accounting and financial information was constantly

available to the Individual Defendants. With the availability and use of these systems, reports,

and meetings each of the Individual Defendants were privy to current, updated, and detailed

accounting and financial information at all times .

(1) Red Hat utilized accounting software

299. According to the Former Senior Staff Accountant, aDM "dashboard" system (a

tool whereby managers learn of key performance information, which is updated continuousl y

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with streaming/real-time data, in order to monitor and manage the key risk indicators and key

performance indicators that characterize critical aspects of business performance) was used to

obtain current real-time accounting information regarding the Company's financial standing . In

addition, the witness said Red Hat's financial information was also maintained within an Oracle

Ili CRMProject Accounting package, which Defendant Thompson used to get information on

the company's financial condition at any time .

(2) Regular internal reports were given directly to management

300. The Individual Defendants also periodically and regularly received and reviewe d

detailed financial reports which were generated internally at Red Hat . As the Former Director of

Professional Services explained, all of the information regarding Red Hat's financial standing

and accounting records was available and broken down within Red Hat Director of Operations

Mandeep Chaddha's Core Office Reports . Therefore, he confirmed that Red Hat management

always had information regarding the Company's financial standing and accounting records at its

disposal. The witness also said he knew that Red Hat's internal revenue reports were in fact

updated on at least a monthly basis, possibly a weekly basis .

(3) The Finance Department held regular meetings

301 . On top of all this information, Red Hat's finance department periodically hel d

accounting meetings . The Former Senior Staff Accountant personally attended regular

accounting meetings that were held by Senior Finance Manager Bart Kalsu, Senior Vice

President of Revenue Accounts William Tendel, and, at times, Defendant Thompson . He stated

that these accounting meetings were held monthly, or sometimes every other month .

G. The Individual Defendants Controlled All Aspects of Red Hat

302. Moreover, according to the Former Managing Consultant/Director of Professional

Services, Defendants Szulik and Thompson controlled "every single aspect" of Red Hat' s

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business, in that they "made all the decisions ." According to this former employee, almost no

decision "about anything" could be made at Red Hat without Defendants Szulik and/or

Thompson's personal approval, and that "everything flowed up" with little or no delegation of

authority. Moreover, if any Red Hat employee questioned anything that Defendants Szulik or

Thompson did, "that person disappeared, fast ." The Former Director of Business Intelligence

corroborated this, saying Defendant Szulik knew "everything about everything" that had to do

with Red Hat and its operations, and that he was involved with "every little thing at Red Hat ."

(1) Defendant Szulik

303 . According to the Former Director of Business Intelligence, Defendant Szulik wa s

very involved in all aspects of Red Hat's adoption and implementation of the subscription model

and the processes associated with Red Hat's subscription renewals . In fact, according to this

former employee, Defendant Szulik regularly met with "anybody and everybody" and was

constantly involved in debate regarding Red Hat's renewal rates. Defendant Szulik also

reportedly held regular `reverse sessions" to address and explore any and all issues associated

with the subscription renewal rates . According to the former Director of Business Intelligence,

Defendant Szulik's knowledge regarding Red Hat's vulnerability in terms of renewal rates, as

well as his involvement in the day-to-day operations at Red Hat "is a given ."

(2) Defendant Thompson

304. The Former Field Services Representative confirmed that Defendant Thompso n

had direct knowledge of the Company's subscription renewal forecasts . According to the

Former Regional Account Manager, Red Hat sales personnel forecasted how many accounts

were likely to renew for a given period . This information was put into Excel spreadsheets, after

which the sales managers rolled up the subscription contract renewal forecasts and rolled the

reports up to Defendant Thompson directly. In addition, according to the Former Director o f

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Professional Services, Defendant Thompson knew that Red Hat had an established history of

manipulating its revenues in order to achieve its quarterly revenue goals, and that the problem in

fact spanned beyond the Company's policy of recognizing 1/12 of its contractu al revenue on the

last day of a given month end .

(3) Defendant Webbink

305. As Red Hat's General Counsel , Defendant Webbink had signi ficant control and

input into Red Hat's operations. As the Former Director of Professional Services confirmed,

Defendant Webbink was generally involved in "everything" in association with Red Hat's

operations . The Former Business Development Manager said that for "some time," Defendant

Webbink was required to sign off on all customer contracts . He stated that Defendant Webbink's

signature was definitely required in "all legal matters" and that there was no doubt that

Defendant Webbink was regularly "involved" in Red Hat's operations from a legal standpoint .

The Former Director of Professional Services also confirmed that for "quite some time,"

Defendant Webbink signed off on "all customer contracts, big and small ." He stated that

Defendant Webbink's office was "right next to Thompson's" and that the two had a "visual" of

each other throughout the day. He also stated that there was no question that Webbink was a

regularly interacting "peer" to Szulik and Thompson at Red Hat, and that there was no doubt that

Defendant Webbink was Red Hat's "final counsel for the Corporation . "

(4) Defendant Buckley

306. As Red Hat's Senior Vice President and Chief Operating Officer, Defendant

Buckley had significant control and input into Red Hat's operations .

(5) Defendant Cormier

307. As Red Hat's Red Hat's Executive Vice President of Engineering, Defendant

Cormier. The Former Business Development Manager said Cormier's role was to "ge t

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involved" whenever there were problems/issues that arose with large customer accounts . The

Technical Account Manager clarified this further, stating that Defendant Cormier was "not just a

crisis manager," and was involved in Red Hat's customer management outside of just "dealing

with problems."

H. Defendant PWC Had Siviificant Financial Incentives to Appease Red Hat

308. As reported on Red Hat's Proxy statements, Defendant PWC has been

handsomely compensated throughout their engagement with Red Hat . For instance, Defendant

PWC was paid $1,068,554 and $846,651 in fiscal years ending February 28, 2001, and February

28, 2002, respectively.

309. During the Class Period, according to Red Hat's Proxy Statement filed June 12 ,

2003, Defendant PWC was paid $413,435 in fees for the fiscal year ending February 28, 2003,

and $681,070 in fees for fiscal year ending February 29, 2004. These fees are quite large,

especially considering the fact that PWC's office in Raleigh is very small .

XIII. CLASS ACTION ALLEGATION S

310. Plaintiffbrings this action as a federal class action pursuant to Federal Rules o f

Civil Procedure 23(a) and (b)(3) on behalf of a class (the "Class"), consisting of all those who

purchased the securities of Red Hat between December 17, 2002 and July 12, 2004 inclusive,

(the "Class Period") and who were damaged thereby. Excluded from the Class are Defendants,

the officers and directors of the Company, 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 .

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

impracticable . Throughout the Class Period, Red Hat securities were actively traded on the

NASDAQ National Market. While the exact number of Class members is unknown to Plaintiff

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at this time and can only be ascertained through approp riate discovery, Plaintiff believes tha t

there are hundreds or thousands of members in the proposed Class .

312 . Plaintiff's claims are typical of the claims of the members of the Class, because

plaintiff and all of the Class members sustained damages arising out of Defendants' wrongful

conduct complained of herein .

313. Plaintiff will fairly and adequately protect the interests of the Class members an d

has retained counsel who is experienced and competent in class actions and securities litigation .

314. A class action is superior to all other available methods for the fair and efficien t

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

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

and burden of individual litigation make it impossible for the members of the Class t o

individually redress the wrongs done to them . There will be no difficulty in the management of

this action as a class action.

315 . Questions of law and fact common to the members of the Class predominate ove r

any questions that may affect only individual members, in that Defendants have acted o n

grounds generally applicable to the entire Class . Among the questions of law and fact common

to the Class are :

a) Whether the federal securities laws were violated by Defendants' acts as alleged

herein ;

b) Whether the Company's publicly disseminated press releases and statement s

during the Class Period omitted and/or misrepresented material facts ;

c) Whether Defendants breached any duty to convey material facts or to correc t

material facts previously disseminated ;

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d) Whether the Defendants acted willfully, with knowledge or recklessly, in omitting

and/or misrepresenting material facts ; and

e) Whether the members of the Class have sustained damages and, if so, what is th e

appropriate measure of damages .

XIV. APPLICABILITY OF PRESUMPTION OF RELIANCE : FRAUD ON THEMARKET DOCTRINE

316. Plaintiffs will rely, in part, upon the presumption of reliance established by th e

fraud-on-the-market doctrine in that, among other things :

a) Defendants made public misrepresentations or failed to disclose facts during th e

Class Period;

b) The omissions and misrepresentations were material ;

c) Red Hat securities traded in an efficient market ;

d) The misrepresentation alleged would tend to induce a reasonable investor to

misjudge the value of the Company' s securities; and

e) Plaintiff and other members of the Class purchased Red Hat securities betwee n

the time Defendants misrepresented or failed to disclose material facts and the time the true fact s

were disclosed, without knowledge of the misrepresented or omitted facts .

317. At all relevant times , the market for Red Hat securities was an efficient market for

the following reasons, among others :

a) Red Hat securities were listed and actively traded during the Class Period on th e

NASDAQ exchange, an open, highly efficient and automated market . The average daily volume

of the Red Hat common stock during the Class Period was 3,518,357 shares . The total numbe r

of shares traded during the Class Period was 1,382,714,429 shares ;

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b) As a regulated issuer, Red Hat regularly made public filings, including its Forms

10-K, Forms 10-Q and related press releases, with the SEC ;

c) Red Hat was followed by analysts from major brokerages including America's

Growth Capital ; Banc of America Securities; Cans & Company; C.E. Unterberg Towbin ; CIBC

World Markets ; Citigroup Smith Barney; Credit Suisse First Boston; Decatur Jones Equity

Partners, LLC ; Deutsche Bank Securities, Inc.; First Albany ; Goldman, Sachs & Co.; Jefferies

and Company; IMP Securities ; JP Morgan Chase ; McDonald Investments ; Midwest Research;

Pacific Crest Securities ; Prudential Financial ; Robert W. Baird & Co . ; SG Cohen & Co .

Spellman Research; SunTrust Robinson Humphrey ; Susquehanna Financial Group ; Thomas

Weisel Partners ; USB Investment Research ; Wachovia Capital Markets, LLC ; and WR

Hambrecht & Co. The reports of these analysts were redistributed to the brokerages' sales force,

their customers, and the public at large ; and

d) Red Hat regularly communicated with public investors via established market

communication mechanisms, including the Company's website, regular disseminations of press

releases on the major news wire services, and other wide-ranging public disclosures, such as

communications with the financial press and other similar reporting services .

318. As a result, the market for Red Hat securities digested current informatio n

regarding the Company from the publicly available sources described above and reflected such

information in the prices of Red Hat's securities . As would be expected where a security is

traded in an efficient market, material news concerning Red Hat's business had an immediate

effect on the market price of Red Hat's securities, as evidenced by the rapid decline in the market

price in the immediate aftermath of Red Hat's corrective disclosures as described herein . Under

these circumstances, all purchasers of Red Hat's securities during the Class Period suffere d

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similar injury due to the fact that the price of Red Hat securities was artificially inflated

throughout the Class Period. At the times they purchased or otherwise acquired Red Hat's

securities, Lead Plaintiff and other members of the Class were without knowledge of the facts

concerning the wrongful conduct alleged herein and could not reasonably have discovered those

facts. As a result, the presumption of reliance applies . Plaintiffs will also rely, in part, upon the

presumption of reliance established by a material omission .

COUNT I

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

319. Lead Plaintiffs repeat and reiteratess the allegations set forth above as though

fully set forth herein . This claim is asserted against all Defendants .

320. During the Class Period, Defendants carried out a plan, scheme and course o f

conduct which was intended to and, throughout the Class Period which did : (a) deceive the

investing public, including Lead Plaintiffs and other Class members, as alleged herein ; (b)

artificially inflate and maintain the market price of Red Hat's publicly traded securities ; and (c)

cause Lead Plaintiffs and other members of the Class to purchase Red Hat's publicly traded

securities at artificially inflated prices . In furtherance of this unlawful scheme, plan and course

of conduct, Defendants took the actions set forth herein . Defendants are sued as primary

participants in the wrongful and illegal conduct charged herein .

321 . In addition to the duty of full disclosure imposed on Defendants as a result o f

their making of affirmative statements and reports, or participation in the making of affirmative

statements and reports to the investing public , they each had a duty to promptly disseminate

truthful information that would be material to investors in compli ance wi th the integrated

disclosure provisions of the SEC as embodied in SEC Regulation S-X (17 C .F .R. § 210.01 et

109

seq.), S-K (17 C .F.R. § 229.10 et seq .) and other SEC regulations, including accurate and

truthful information with respect to Red Hat's operations, financial condition and performance so

that the market prices of the Company's publicly traded securities would be based on truthful,

complete and accurate information.

322. Defendants, individually and in concert, directly and indirectly, by the use, means

or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a

continuous course of conduct to conceal adverse material information about the business,

business practices, performance, operations and future prospects of Red Hat as specified herein .

323. 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 Red Hat's value an d

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 Red Hat 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 Red Hat's

securities during the Class Period.

324. As a result of the dissemination of the materially false and misleading informatio n

and failure to disclose material facts, as set forth above, the market price of Red Hat's securities

were artificially inflated during the Class Period . In ignorance of the fact that market prices of

Red Hat'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

110

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 Plaintiffs and the other members of the Class acquired Red Hat

securities during the Class Period at artificially high prices and were damaged thereby .

325. At the time of said misrepresentations and omissions, Lead Plaintiffs and other

members of the Class were ignorant of their falsity, and believed them to be true . Had Lead

Plaintiffs, the other members of the Class and the marketplace known of the true performance,

business practices, future prospects and intrinsic value of Red Hat stock, which were not

disclosed by Defendants, Lead Plaintiffs and other members of the Class would not have

purchased or otherwise acquired their Red Hat publicly traded securities during the Class Period,

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 .

326. By virtue of the foregoing, Defendants have each violated Section 10(b) of the

Exchange Act, and Rule 1 Ob 5 promulgated thereunder.

327. As a direct and proximate result of Defendants' wrongful conduct, Lead Plaintiffs

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.

COUNT II

VIOLATION OF SECTION 20(a) OF THE EXCHANGE ACT (AGAINST SZULIK,THOMPSON, WEBBINK . BUCKLEY AND CORMIER)

328. Lead Plaintiffs repeat and reiterate the allegations set forth above as if set forth

fully herein . This claim is asserted against the Individual Defendants .

329. Defendants Szulik, Thompson, Webbink, Buckley and Cormier each acted as a

controlling person of Red Hat within the meaning of Section 20(a) of the Exchange Act a s

111

alleged herein . By virtue of their high level positions with the Company, participation in and/or

awareness of the Company 's operations and/or intimate knowledge of the Company' s actual

performance, these Defendants had the power to influence and control and did influence an d

control, directly or indirectly, the decision making of the Company, including the content and

dissemination of the various statements which Lead Plaintiffs contend are false and misleading.

Each of these Defendants was provided with or had unlimited access to copies of the Company' s

reports, press releases, public filings and other statements alleged by Lead Plaintiffs to b e

misleading prior to and/or shortly after these statements were issued and had the ability t o

prevent the issuance of the statements or cause the statements to be corrected .

330. In addition, each of these Defendants had direct involvement in the day to da y

operations of the Company and, therefore, is presumed to have had the power to control o r

influence the particular transactions giving rise to the securities violations as alleged herein, an d

exercised the same .

331 . As set forth above, Red Hat and these Defendants each violated Section 10(b) and

Rule IOb-5 by their acts and omissions as alleged in this Complaint . By virtue of their

controlling positions, these Defendants are liable pursuant to Section 20(a) of the Exchange Act .

As a direct and proximate result of these Defendants' wrongful conduct, Lead Plaintiffs and

other members of the Class suffered damages in connection with their purchases of the

Company's securities during the Class Period.

COUNT Ill - VIOLATION OF SECTION 304 OF SARBANES-OXLEY

332. Lead Plaintiffs repeat and reiterate the allegations set forth above (other than the

paragraphs in Counts I & II) as if set forth fully herein . This claim is asserted against

Defendants Szulik and Thompson.

112

333 . As described herein, Red Hat has restated its audited financial statements for the

fiscal years ended February 28, 2002, February 28, 2003, and February 29, 2004, and its

unaudited financial statements for the fiscal quarter ended May 31, 2004 . Red Hat was required

to prepare this accounting restatement due to the material noncompliance of the issuer, as a result

of misconduct, with the financial reporting requirements under the securities laws as described

herein .

334. Pursuant to the Sarbanes-Oxley Act of 2002, Pub . L. No. 107-204, Title III ,

§ 304, 116 Stat . 778, codified at 15 U.S.C. § 7243, Red Hat's CEO (Defendant Szulik) and CFO

(Defendant Thompson) are required to reimburse Red Hat for -- (1) any bonus or other incentive-

based or equity-based compensation received by Defendant Szulik or Defendant Thompson from

Red Hat during the 12-month period following the first public issuance or filing with th e

Commission (whichever first occurs) of the financial document embodying such financial

reporting requirement ; and (2) any profits realized from the sale of Red Hat securities during that

12-month period.

XV. REQUEST FOR RELIEF

WHEREFORE, Lead Plaintiffs requests a judgment, as follows :

a) Determining that this action is a proper class action, and certifying proposed class

representatives under Rule 23 of the Federal Rules of Civil Procedure ;

b) Awarding compensatory damages in favor of Lead Plaintiffs 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 ;

c) Pursuant to Section 304 of the Sarbanes-Oxley Act of 2002, 15 U .S.C. §7243,

require Red Hat's CEO (Defendant Szulik) and CFO (Defendant Thompson) to reimburse Red

Hat for (1) any bonus or other incentive-based or equity-based compensation received b y

113

Defendant Szulik or Defendant Thompson from Red Hat during the 12-month period followin g

the first public issuance or filing with the Commission (whichever first occurs) of the financia l

document embodying such financial reporting requirement ; and (2) any profits realized from the

sale of Red Hat securities during that 12-month period .

d) Awarding Lead Plaintiffs and the Class their reasonable costs and expense s

incurred in this action, including counsel fees and expert fees ;

e) Such other and further relief as the Court may deem just and proper .

XVI. JZJRY TRIAL DEMANDED

Lead Plaintiffs hereby demand a trial by jury .

114

Dated: May 5, 2005 Respectfully submitted,

THE TEN & WEBB LAW FIRM

By.

ED

Rufus EdmistenNorth Carolina Bar No . 1289William Woodward WebbNorth Carolina Bar No . 4624133 Fayetteville Street Mall, Suite 300P.O. Box 1509Raleigh, North Carolina 27602Tel : (919) 831-8700Fax : (919) 831-8749

Local Counsel for Lead Plaintiff The UnionGroup

MILBERG WEISS BERSHAD &SCHULMAN LLPMaya SaxenaFla. Bar No. 0095494msaxena@milbergweiss.comChristopher S. JonesFla. Bar No. 0306230cjones@milbergweiss .comKristi Stahnke McGregorFla. Bar No . 0732931kmcgregor@milbergweiss .comS . Melisa TwomeyFla. Bar No . 0872571mtwomey@milbergweiss .com5200 Town Center CircleTower One, Suite 600Boca Raton, FL 33486Tel: (561) 361-5000Fax : (561) 367-8400

Lead Counsel for Lead Plaintiff The Union

Group

115

CERTIFICATE OF SERVICE

I HEREBY CERTIFY a copy of the foregoing CONSOLIDATED AMENDEDCLASS ACTION COMPLAINT was e-mailed to the following counsel on May 5, 2005 :

Jeffrey B. RudmanE-mail : jeffrey .rudman@wilmerhale .comWilliam H. PaineE-mail : william .paine@wilmerhale .comWILMER CUTLER PICKERING HALE ANDDORR LLP60 State StreetBoston , MA 02109

Robert J . KopeckyE-mail : rkopecky@kirkland.comStacey G. PagonisE-mail : spagonis@kirkland.comKIRKLAND & ELLIS LLP200 East Randolf DriveChicago, IL 6060 1

Counsel for Defendant PricewaterhouseCoopersCounsel for Defendants Red Hat, Inc ., MatthewJ. Szulik and Kevin B. Thompson, Timothy JBuckley, Paul J. Cormier andMark H. Webbink

and served by U .S . Mail, postage prepaid, on May 6, 2005 to the following counsel :

Pressly M. MillenChristopher W. JonesWOMBLE CARLYLE SANDRIDGE& RICEP.O. Box 831Raleigh, NC 27602

Jeffrey B. RudmanWilliam H. PaineWILMER CUTLER PICKERING HALE ANDDORR LLP60 State StreetBoston , MA 02109

Counselfor Defendants Red Hat, Inc., MatthewJ. Szulik and Kevin B. Thompson, Timothy J.Buckley, Paul J. Cormier andMark H. Webbink

Jim W . Phillips, Jr .BROOKS , PIERCE, MCLENDON,HUMPHREY & LEONARD, LLP2000 Renaissance PlazaGreensboro , NC 27420

Robert J . KopeckyStacey G . PagonisKIRKLAND & ELLIS LLP200 East Randolf DriveChicago, IL 6060 1

Counsel for Defendant PricewaterhouseCoopers

Red Hat , Inc. Summary of Defendants ' Sales4t't

Red HatSumma of Defendants Sales 1/00 - 7/04Class Period: 1217/02 - , 7/12/04Source : Form 4's

SharesName Date Sold Price Proceeds

M. SZULIK 2/9/2000 38,826 $90.73 $3,522,6831/9/2002 100,000 $9.07 $907,000

Pre-Class Period Sales 1/17/2002 15,000 $8.25 $123,750January 2000 -12/17/02 1/22/2002 15,000 $8.75 $131,250

Sha res Proceeds 1/28/2002 15,000 $8.41 $126,150213,826 $5,048,883 2/4/2002 15,000 $8.25 $123,750

2.76% of holdings sold 2/11/2002 15,000 $7.62 $114,300

Class Period Sales 1/7/2003 250,000 $6.05 $1,512,50012/17/02 - 7/12/04 5/28/2003 5,000 $7.50 $37,500

Sha res Proceeds 5/29/2003 2,500 $7.50 $18,75 02,899 ,800 $43,597,194 6/2/2003 20,000 $7.50 $150,00030.32% of holdings sold 6/4/2003 12,500 $7.64 $95,500

6/6/2003 5,000 $8.95 $44,7506/6/2003 5,000 $9.00 $45,000

6/13/2003 10,000 $8 .22 $82,2006/17/2003 10,000 $8.05 $80,5006/18/2003 10,100 $8.56 $86,4566/24/2003 10,000 $7.50 $75,0006/25/2003 15,000 $7.80 $117,0007/1/2003 24,900 $7.64 $190,2367/2/2003 50,000 $7.69 $384,5007/2/2003 50,000 $7.68 $384,0007/2/2003 50,000 $7.66 $383,0007/2/2003 25,000 $7.68 $192,00 07/2/2003 25,000 $7.69 $192,25 07/2/2003 23,500 $7 .67 $180,24 57/2/2003 15,000 $7 .66 $114,9007/2/2003 8,000 $7.66 $61,2807/2/2003 2,100 $7.67 $16,1077/2/2003 1,400 $7.67 $10,7387/7/2003 5,000 $7.80 $39,0007/7/2003 5,000 $7.78 $38,9007/9/2003 5,000 $8.23 $41,1507/9/2003 5,000 $8.25 $41,2509/3/2003 20,000 $7.50 $150,0009/3/2003 10,000 $7.55 $75,5009/3/2003 5,500 $7.80 $42,9009/3/2003 5,000 $7.60 $38,0009/3/2003 5,000 $7.70 $38,5009/3/2003 4,400 $7.82 $34,4089/3/2003 100 $7.83 $7839/8/2003 6,100 $8.47 $51,6679/8/2003 5,000 $8.50 $42,500

Page 1 of 14

Red Hat, Inc. Summary of Defendants' Sale s

9/8/2003 5,000 $8.55 $42,7509/8/2003 3,000 $8.45 $25,3509/8/2003 600 $8.45 $5,0709/8/2003 300 $8.45 $2,5359/9/2003 10,000 $8.50 $85,000

9/10/2003 4,100 $8.10 $33,21 09/10/2003 900 $8.25 $7,4259/11/2003 2,400 $8.47 $20,3289/11/2003 1,000 $8.49 $8,4909/11/2003 500 $8.46 $4,2309/11/2003 400 $8.45 $3,3809/11/2003 400 $8.46 $3,3849/11/2003 100 $8.42 $8429/11/2003 100 $8.44 $8449/11/2003 100 $8.47 $8479/12/2003 9,000 $8.20 $73,8009/12/2003 500 $8.21 $4,1059/12/2003 400 $8.20 $3,2809/12/2003 100 $8.20 $8209/15/2003 5,000 $8.60 $43,0009/15/2003 4,800 $8.40 $40,3209/15/2003 200 $8.41 $1,6829/17/2003 8,800 $8.55 $75,2409/17/2003 5,000 $8.60 $43,0009/17/2003 1,200 $8.47 $10,1649/18/2003 2,400 $8.60 $20,6409/19/2003 5,000 $9.90 $49,5009/19/2003 5,000 $9.80 $49,0009/19/2003 5,000 $9.75 $48,75 09/19/2003 4,200 $9.62 $40,4049/19/2003 2,500 $9.63 $24,07 59/19/2003 700 $9.62 $6,7349/19/2003 100 $9.78 $9789/19/2003 100 $9.73 $9739/22/2003 5,000 $10.40 $52,0009/22/2003 3,000 $10.15 $30,4509/22/2003 2,500 $10.50 $26,2509/22/2003 2,500 $10.45 $26,1259/22/2003 2,000 $10.16 $20,3209/23/2003 2,500 $10.50 $26,25 09/23/2003 2,500 $10.60 $26,5009/25/2003 5,000 $9.66 $48,3009/25/2003 4,100 $9.89 $40,5499/25/2003 3,100 $9.88 $30,6289/25/2003 1,500 $9.86 $14,7909/25/2003 700 $9.86 $6,9029/25/2003 400 $9.87 $3,9489/25/2003 200 $9.85 $1,9709/26/2003 5,500 $9.39 $51,645 i9/26/2003 4,700 $9.75 $45,8259/26/2003 2,600 $9.45 $24,5709/26/2003 1,400 $9.40 $13,160

Page 2 of 14

Red Hat , Inc. Summary of Defendants' Sales

9/26/2003 300 $9.76 $2,9289/26/2003 200 $9.44 $1,8889/26/2003 200 $9.41 $1,8829/26/2003 100 $9.42 $9429/30/2003 5,000 $10.25 $51,2509/30/2003 4,050 $10.06 $40,7439/30/2003, 4,000 $9.87 $39,4809/30/2003 2,700 $9.67 $26,1099/30/2003 1,300 $9.63 $12,51 99/30/2003 950 $10.05 $9,5489/30/2003 800 $9.65 $7,7209/30/2003 400 $9.91 $3,9649/30/2003 400 $9.89 $3,9569/30/2003 200 $9.66 $1,9329/30/2003 100 $9.90 $9909/30/2003 100 $9.87 $98710/3/2003 3,900 $10.87 $42,39310/3/2003 1,100 $10.86 $11,94610/7/2003 5,000 $11 .05 $55,25010/7/2003 2,800 $10.96 $30,6881017/2003 1,700 $10.92 $18,56410/7/2003 200 $10.95 $2,19010/7/2003 200 $10 .94 $2,18810/7/2003 100 $10.97 $1,09710/9/2003 3,800 $11 .16 $42,40810/9/2003 1,200 $11 .15 $13,380

10/13/2003 5,000 $11 .61 $58,05010/13/2003 5,000 $12.09 $60,45010/13/2003 5,000 $12.40 $62,00010/13/2003 5,000 $12.65 $63,25010120/2003 5,000 $13.20 $66,00010/21/2003 5,000 $13.40 $67,00010/24/2003 9,700 $13.10 $127,07010/24/2003 300 $13.20 $3,96010/27/2003 3,000 $13.65 $40,95010/27/2003 2,000 $13.66 $27,32010/28/2003 5,000 $13.80 $69,000

10/29/2003 4,000 $14.00 $56,00010/29/2003 5,000 $14.30 $71,50010/29/2003 1,000 $14.01 $14,01 011/3/2003 5,000 $15.10 $75,50011/3/2003 2,500 $15.35 $38,37511/3/2003 1,100 $15.31 $16,84 1

11/3/2003 1,000 $15.35 $15,35011/3/2003 300 $15.32 $4,59611/3/2003 100 $15.30 $1,53011/6/2003 4,100 $13.63 $55,88311/6/2003 800 $13.62 $10,89611/6/2003 100 $13.65 $1,3651117/2003 5,000 $13.62 $68,100

11/10/2003 5,000 $13.50 $67,500

11/12/2003 5,000 $13.50 $67,500

Page 3 of 14

Red Hat, Inc. Summary of Defendants' Sale s

11/13/2003 4,800 $13.61 $65,32811/13/2003 100 $13.66 $1,36611/13/2003 100 $13.60 $1,36011/20/2003 5,000 $12.00 $60,00011/20/2003 5,000 , $12.25 $61,25011/20/2003 5,000 $12.50 $62,5001/12/2004 45,000 $21 .02 $945,9001/12/2004 30,000 $21 .00 $630,0001/12/2004 30,000 $21 .03 $630,9001/12/2004 12,000 $21 .01 $252,1201/13/2004 12,000 $20.90 $250,8001/16/2004 61,000 $20.51 $1,251,11 01/16/2004 50,000 $20.25 $1,012,5001/16/2004 50,000 $20.35 $1,017,5001/16/2004 50,000 $20 .46 $1,023,0001/16/2004 10,000 $20.62 $206,2001/30/2004 39,500 $19.41 $766,6951/30/2004 10,500 $19.50 $204,7502/2/2004 19,900 $18.50 $368,1502/2/2004 19,900 $18.75 $373,1252/2/2004 9,800 $18.65 $182,7702/2/2004 200 $18.66 $3,7322/2/2004 200 $18.77 $3,7542/4/2004 10,000 $17.80 $178,0002/4/2004 5,100 $17.63 $89,9132/4/2004 4,900 $17.60 $86,2402/5/2004 30,000 $17.60 $528,0002/5/2004 20,000 $17.70 $354,0002/5/2004 20,000 $17.80 $356,0002/5/2004 12,800 $17.95 $229,7602/5/2004 10,000 $17.90 $179,0002/5/2004 5,200 $17.96 $93,3922/5/2004 4,400 $17.76 $78,1442/5/2004 3,800 $17.75 $67,4502/5/2004 1,800 $17.77 $31,986215/2004 1,200 $17.97 $21,5642/5/2004 400 $17.95 $7,1802/5/2004 400 $17.96 $7,1842/6/2004 63,800 $18.05 $1,151,5902/6/2004 60,500 $18.10 $1,095,0502/6/2004 41,300 $18.20 $751,6602/6/2004 25,000 $18.00 $450,0002/6/2004 5,900 $18.17 $107,2032/6/2004 4,700 $18.08 $84,9762/6/2004 3,300 $18.11 $59,7632/6/2004 2,300 $18.19 $41,8372/6/2004 2,200 $18.30 $40,2602/6/2004 1,600 $18.26 $29,21 62/6/2004 1,400 $18.27 $25,5782/6/2004 800 $18.26 $14,6082/6/2004 700 $18.07 $12,6492/6/2004 700 $18.29 $12,80 3

Page 4 of 14

Red Hat, Inc. Summary of Defendants' Sales

2 16/2004 600 . $18 .12 $10,8722/6/2004 600 $18.29 $10,9742/6/2004 600 $18.30 $10,9802/6/2004 500 $18.25 $9,1252/6/2004 500 $18.28 $9,1402/6/2004 400 $18.51 $7,4042/6/2004 400 $18.52 $7,4082/6/2004 400 $18.11 $7,2442/6/2004 400 $18.18 $7,2722/6/2004 400 $18.30 $7,3202/6/2004 300 $18.27 $5,4812/6/2004 200 $18.15 $3,6302/6/2004 200 $18.26 $3,6522/6/2004 200 $18.28 $3,6562/6/2004 100 $18.14 $1,81 42/9/2004 37,100 $18.50 $686,3502/9/2004 400 $18 .51 $7,404

2/10/2004 32,400 $18 .00 $583,2002/10/2004 1,000 $18.03 $18,0302/10/2004 400 $18.02 $7,2082/10/2004 300 $18.01 $5,4032/10/2004 300 $18.02 $5,4062/10/2004 100 $18.00 $1,8002/10/2004 100 $18.05 $1,8052/11/2004 35,000 $18.20 $637,0002/11/2004 25,000 $18.35 $458,7502/11/2004 24,600 $18.15 $446,4902/11/2004 21,900 $18.00 $394,2002/11/2004 21,000 $18.10 $380,1002/11/2004 15,000 $18.05 $270,7502/11/2004 15,000 $18.11 $271,65 02/11/2004 13,500 $18.16 $245,16 02/11/2004 10,000 $18.06 $180,6002/11/2004 10,000 $18.08 $180,8002/11/2004 10,000 $18.12 $181,2002/11/2004 10,000 $18.13 $181,3002/11/2004 7,500 $18.01 $135,0752/11/2004 6,500 $18.25 $118,6252/12/2004 8,775 $18.77 $164,7072/12/2004 6,700 $18.89 $126,5632/12/2004 1,525 $18.80 $28,6702/12/2004 1,200 $18.86 $22,6322/12/2004 700 $18.81 $13,1672/12/2004 400 $18.87 $7,5482/12/2004 400 $18.88 $7,5522/12/2004 300 $18.84 $5,6522/13/2004 4,000 $18.62 $74,4802/13/2004 2,800 $18.65 $52,2202/13/2004 2,600 $18.54 $48,2042/13/2004 2,400 $18.45 $44,2802/13/2004 1,600 $18.63 $29,8082/13/2004 1,300 $18.60 $24,180

Page 5 of 14

Red Hat, Inc. Summary of Defendants' Sales

2/13/2004 1,200 $18.50 $22,2002/13/2004 1,100 $18.64 $20,5042/13/2004 900 $18.63 $16,7672/13/2004 500 $18.49 $9,2452/13/2004 400 $18.65 $7,4602/13/2004 400 $18.65 $7,4602/13/2004 300 $18.44 $5,5322/13/2004 200 $18.51 $3,7022/13/2004 200 $18.60 $3,7202/13/2004 100 $18.53 $1,8532/17/2004 20,000 $18.55 $371,0002/17/2004 19,000 $18.50 $351,50 02/17/2004 7,900 $18.60 $146,9402/17/2004 600 $18.51 $11,1062/17/2004 400 $18.50 $7,4002/18/2004 4,500 $18.25 $82,12 52/19/2004 7,200 $18.30 $131,7602/19/2004 3,500 $18.35 $64,22 52/19/2004 2,300 $18.41 $42,3432/19/2004 600 $18.35 $11,0102/19/2004 600 $18.38 $11,0282/19/2004 400 $18.39 $7,3562119/2004 300 $18.38 $5,5142/19/2004 300 $18.34 $5,5022/19/2004 200 $18.30 $3,6602/19/2004 200 $18.39 $3,6782/19/2004 200 $18.32 $3,6642/19/2004 200 $18.33 $3,6662/19/2004 100 $18.31 $1,8312/20/2004 36,500 $17.60 $642,4002/20/2004 31,400 $17.50 $549,5002/20/2004 8,100 $17.61 $142,64 12/20/2004 7,200 $17.51 $126,0722120/2004 3,200 $17.52 $56,0642/20/2004 2,800 $17.56 $49,1682/20/2004 2.400 $17.63 $42,31 22/20/2004 2,200 $17.53 $38,5662/20/2004 1,400 $17.55 $24,5702/20/2004 1,000 $17.63 $17,6302/20/2004 900 $17.54 $15,7862/20/2004 600 $17.65 $10,5902/20/2004 400 $17.52 $7,0082/20/2004 400 $17.61 $7,0442/20/2004 400 $17.61 $7,044

2/20/2004 300 $17.62 $5,2862/20/2004, 300 $17.64 $5,2922/20/2004 200 $17.51 $3,5022/20/2004 200 $17.51 $3,5022/20/2004 100 $17.50 $1,750

2/24/2004 25,000 $17.00 $425,0002/25/2004 25,000 $17.30 $432,500

2/25/2004 25,000 $17.35 $433,750

Page 6 of 14

Red Hat , Inc. Summary of Defendants' Sales

2/25/2004 15,000 $17.01 $255,1502/25/2004 15,000 $17.21 $258,1502/25/2004 10,000 $17.00 $170,0002/25/2004 10,000 $17.20 $172,00 02/26/2004 25,000 $17.30 $432,50 02/26/2004 25,000 $17.65 $441,2502126/2004 25,000 $17.70 $442,5002/26/2004 10,300 $17.55 $180,7652/26/2004 3,400 $17.45 $59,3302/26/2004 2,500 $17.53 $43,8252/26/2004 2,000 $17.51 $35,02 02/26/2004 1,600 $17.50 $28,0002/26/2004 1,200 $17.85 $21,4202/26/2004 1,100 $17.52 $19,2722/26/2004 1,000 $17.50 $17,5002/26/2004 700 $17.46 $12,22 22/26/2004 700 $17.56 $12,29 22/26/2004 500 $17.47 $8,7352/26/2004 400 $17.46 $6,984 -2/26/2004 400 $17.51

-$7,004

- -

2/26/2004 200 $17.47 $3,4942/26/2004 100 $17.49 $1,7492/26/2004 100 $17.60 $1,7602/27/2004 50,000 $18.00 $900,0002/27/2004 25,000 $17.80 $445,0002/27/2004 23,300 $18.12 $422,19 62/27/2004 1,700 $18.10 $30,77 03/1/2004 25,000 $18.40 $460,0003/1/2004 20,000 $18.60 $372,0003/1/2004 15,000 $18.50 $277,5003/1/2004 10,000 $18.55 $185,5003/1/2004 10,000 $18.65 $186,5003/2/2004 15,000 $18.60 $279,0003/4/2004 14,700 $19.00 $279,3003/4/2004 10,200 $18.60 $189,72 03/4/2004 10,100 $18.75 $189,37 53/4/2004 10,000 $18.85 $188,50 03/4/2004 9,900 $18.70 $185,1303/4/2004 ; 9,900 $18.95 $187,6053/4/2004 9,800 $18.50 $181,3003/4/2004 4,300 $19.0.1 $81,7433/4/2004 700 $19.02 $13,3143/4/2004 400 $19.03 $7,6123/5/2004 27,100 $19.00 $514,9003/5/2004 18,000 $19.13 $344,3403/5/2004 10,000 $19.25 $192,5003/5/2004 10,000 $19.53 $195,3003/5/2004 9,900 $19.40 $192,0603/5/2004 4,900 $19.11 $93,6393/5/2004 4,700 $19.10 $89,7703/5/2004 4,500 $19.15 $86,1753/5/2004 1,600 $19.18 $30,688

Page 7 of 14

Red Hat, Inc. Summary of Defendants' Sales

3/5/2004 1,100 $19.17 $21,0873/5/2004 900 $19.16 $17,2443/5/2004 200 $19.17 $3,8343/5/2004 100 $19.45 $1,945

M. SZULIK Pre - Class : 213,826 $5,048,883Class Period : 2,899,800 $43,597,194

K. THOMPSON

Pre-Class Period Sales 1/9/2004 30,000 $19.59 $587,700January 2000 -12117/02 1/9/2004 30,000 $19.58 $587,400Shares Proceeds 1/9/2004 10,000 $19.55 $195,500

0 $0 1/22/2004 5,000 $20.25 $101,2500.00% of holdings sold 4/7/2004 50,000 $23.98 $1,199,000

4/7/2004 10,000 $23.96 $239,600Class Period Sale s12117/02 - 7112/04 Pro - Class : 0 $0

Shares Proceeds Class Period : 135,000 $2,910,450

135,000 $2,910,45023.35% of holdings sol d

T. BUCKLEY 6/21/2000 100,000 $29.80 $2,980,0009/20/2000 20,000 $20.00 $400,000

Pre-Class Period Sales 9/22/2000 20,000 $19.07 $381,400January 2000 -12/17102 9/25/2000 40,000 $19.69 $787,600

Shares Proceeds 9/26/2000 30 ,000 $18 .75 $562,500

985,000 $10,111,665 9/27/2000 30,000 $18.76 $562,800

23.70% of holdings sold 10 /3/2000 30,000 $16.12 $483,600

7/11/2001 2,000 $3.92 $7,8407/12/2001 2,000 $3.90 $7,8007/13/2001 2,000 $3.92 $7,8407/16/2001 2,000 $3.90 $7,8007/17/2001 300 $3.70 $1,1107/18/2001 3,700 $3.75 $13,8757/19/2001 2,000 $3.63 $7,2607/20/2001 2,000 $3.38 $6,7607/23/2001 2,000 $3.55 $7,1007/24/2001 2,000 $3.69 $7,3807/25/2001 2,000 $4.09 $8,1807/26/2001 2,000 $4.00 $8,0007/27/2001 2,000 $4.02 $8,0407/30/2001 2,000 $3.98 $7,9607/31/2001 2,000 $3.94 $7,880

8/1/2001 2,000 $3.96 $7,9208/2/2001 2,000 $3.96 $7,9208/3/2001 2,000 $4.00 $8,000

Page 8 of 14

Red Hat, Inc. Summary of Defendants' Sale s

8/6/2001 2,000 $3.96 $7,9208/7/2001 2,000 $3.95 $7,9008/8/2001 2,000 $3.90 $7,8008/9/2001 2,000 $3.80 $7,600

8/10/2001 2,000 $3.80 $7,6008/13/2001 2,000 $3.71 $7,4208/14/2001 2,000 $3.72 $7,4408/15/2001 2,000 $3.71 $7,4208/16/2001 2,000 $3.79 $7,5808/17/2001 2,000 $3.86 $7,7208/20/2001 2,000 $3.85 $7,7008/21/2001 2,000 $3.86 $7,7208/22/2001 2,000 $3.75 $7,5008/23/2001 2,000 $3.69 $7,3808/24/2001 2,000 $3.65 $7,3008/27/2001 2,000 $3.66 $7,3208/28/2001 2,000 $3.52 $7,0408/29/2001 2,000 $3.40 $6,8008/30/2001 2,000 $3.45 $6,9008/31/2001 2,000 $3.41 $6,820

9/4/2001 2,000 $3.50 $7,0009/5/2001 2,000 $3.46 $6,9209/6/2001 2,000 $3.25 $6,5009f7/20011 2,000 $3.01 $6,020

9/10/2001 2,000 $3.15 $6,3009/17/2001 10,000 $2.76 $27,600

12/21/2001 100,000 $6.72 $672,00012/24/2001 3,000 $6.92 $20,76012/26/2001 3,000 $7.07 $21,21 012/27/2001 3,000 $7.00 $21,00012/28/2001 3,000 $6.74 $20,22012/31/2001 3,000 $7.00 $21,000

1/2/2002 3,000 $6.90 $20,7001/3/2002 3,000 $7.16 $21,4801/4/2002 3,000 $7.57 $22,71 01/7/2002 3,000 $8.11 $24,3301/8/2002 3,000 $8.75 $26,2501/9/2002 3,000 $8.90 $26,700

1/10/2002 3,000 $8.62 $25,8601/1 1/2002 3,000 $8.60 $25,8001/14/20021 3,000 $8.59 $25,7701/15/2002 3,000 $8.67 $26,01 01/16/2002 3,000 $8.38 $25,1401/17/2002 3,000 $8.07 $24,210 11/18/2002, 3,000 $8.90 $26,7001/22/2002 3,000 $8.86 $26,5801/23/2002 1 3,000 $7.90 $23,7001124/2002 , 3,000 $8.14 $24,4201/25/2002 3,000 $7.84 $23,5201/28/2002 3,000 $8.38 $25,1401/29/2002 3,000 $8.45 $25,3501/30/2002 3,000 $8.03 $24,090

Page 9 of 14

Red Hat, Inc. Summary of Defendants' Sales

1/31/2002 3,000 11 $8.00 $24,0002/1/2002 3,000 $8.59 $25,7702/4/2002 3,000 $8.17 $24,51 02/5/2002 3,000 $8.05 $24,1502/6/2002 3,000 $7.70 $23,1002/7/2002 3,000 $7.00 $21,0002/8/2002 3,000 $7.22 $21,660

2/11/2002 3,000 $7.50 $22,5002/12/2002 3,000 $7.33 $21,9902/13/2002 3,000 $7.43 $22,2902/14/2002 3,000 $7.28 $21,8402/15/2002 3,000 $8.38 $25,1402/19/2002 3,000 $7.10 $21,3002/20/2002 3,000 $6.71 $20,1302/21/2002 3,000 $5.95 $17,8502/22/2002 3,000 $5.94 $17,8202/25/2002 3,000 $6.10 $18,3002/26/2002 3,000 $6.15 $18,4502/27/2002 3,000 $6.30 $18,9002/28/2002 3,000 $5.83 $17,4904/1/2002 3,000 $5.60 $16,8004/2/2002 3,000 $5.50 $16,5004/3/2002 3,000 $5.11 $15,3304/4/2002 3,000 $5.01 $15,0304/5/2002 3,000 $5.03 $15,0904/8/2002 3,000 $4.73 $14,1904/9/2002 3,000 $5.21 $15,630

4/10/2002 3,000 $5.15 $15,4504/11/2002 3,000 $4.96 $14,8804/12/2002 3,000 $5.02 $15,0604/15/2002 3,000 $5.00 $15,0004/16/2002 3,000 $5.31 $15,9304/17/2002 3,000 $5.21 $15,6304/18/2002 3,000 $5.31 $15,9304/19/2002 3,000 $5.20 $15,6004/22/2002 3,000 $4.85 $14,5504/23/2002 3,000 $4.48 $13,4404/24/2002 3,000 $4.58 $13,7404/25/2002 3,000 $4.64 $13,9204/26/2002 3,000 $4.55 $13,6504/29/2002 3,000 $4.55 $13,6504/30/2002 3,000 $4.37 $13,11 0

5/1/2002 3,000 $4.35 $13,0505/2/2002 3,000 $4.65 $13,9505/3/2002 3,000 $4.85 $14,5505/6/2002 3,000 $4.86 $14,5805/7/2002 3,000 $4.45 $13,3505/8/2002 3,000 $4.62 $13,8605/9/2002 3,000 $4 .86 $14,580

5/10/2002 3,000 $4 .84 $14,5205/13/2002 3,000 $5.19 $15,5705/14/2002 3,000 $5.41 $16,230

Page 10 of 14

Red Hat, Inc. Summary of Defendants' Sales

5115/2002 3,000 $5.05 $15,1505/16/2002 3,000 $5.03 $15,0905/17/2002 3,000 $5.06 $15,1805/20/2002 3,000 $4.80 $14,4005/21/2002 3,000 $4.77 $14,31 05/22/2002 3,000 $4.86 $14,58 05/23/2002 3,000 $4.63 $13,89 05/24/2002 3,000 $4.51 $13,53 05/28/2002 3,000 $4.40 $13,2005/29/2002 3,000 $4.33 $12,9905/30/2002 3,000 $4.25 $12,7505/31/2002 3,000 $4.63 $13,8906/3/2002 3,000 $4.66 $13,9806/4/2002 3,000 $4.67 $14,01 06/5/2002 3,000 $4.95 $14,8506/6/2002 3,000 $4.75 $14,2506/7/2002 3,000 $4.59 $13,770

6/10/2002 3,000 $4.98 $14,9406/11/2002 3,000 $5.28 $15,8406/12/2002 3,000 $5.02 $15,0606/13/2002 3,000 $5.08 $15,2406/14/2002 3,000 $4.95 $14,85 06/17/2002 3,000 $5.50 $16,50 06/18/2002 3,000 $5.56 $16,6806/19/2002 3,000 $5.36 $16,08 06/20/2002 3,000 $5.35 $16,05 06/21/2002 3,000 $5.32 $15,9606/24/2002 3,000 $5.19 $15,5706/25/2002 3,000 $5.47 $16,4106/26/2002 3,000 $5.35 $16,0506/27/2002 3,000 $5.48 $16,4406/28/2002 3,000 $5.69 $17,07 07/1/2002 3,000 $5.54 $16,62 07/2/2002 3,000 $5.29 $15,87 07/3/2002 3,000 $5.14 $15,42 07/5/2002 3,000 $5.37 $16,11 07/8/2002 3,000 $5.30 $15,9007/9/2002 3,000 $5.11 $15,330

7/10/2002 3,000 $5.25 $15,7507/11/2002 3,000 $5.30 $15,9007/12/2002 3,000 $5.65 $16,9507/15/2002 3,000 $5.64 $16,92 07/16/2002 3,000 $5.57 $16,71 07/17/2002 3,000 $5.54 $16,6207/18/2002 3,000 $5.46 $16,3807/19/2002 3,000 $5.51 $16,53 07/22/2002 3,000 $5.37 $16,11 07/23/2002 3,000 $5.36 $16,08 07/24/2002 3,000 $5.34 $16,02 07/25/2002 3,000 $5.27 $15,81 07/26/2002 3,000 $4.57 $13,71 0

7/29/2002 3,000 $4.51 $13,53 0

Page 11 of 14

Red Hat, Inc. Summary of Defendants' Sale s

7/30/2002 3,000 $4.87 $14,61 07/31/2002 3,000 $4.85 $14,550

8/1/2002 3,000 $4.62 $13,8608/2/2002 3,000 $4.37 $13,11 08/5/2002 3,000 $4.29 $12,8708/6/2002 3,000 $4.34 $13,020817/2002 3,000 $4.60 $13,8008/8/2002 3,000 $4.82 $14,4608/9/2002 3,000 $4.85 $14,550

8/12/2002 3,000 $5.23 $15,6908/13/2002 3,000 $4.80 $14,4008/14/2002 3,000 $4.67 $14,0108/15/2002 3,000 $4.94 $14,8208/16/2002 3,000 $4.77 $14,3108/1912002 3,000 $5.01 $15,0308/20/2002 3,000 $5.10 $15,3008/21/2002 3,000 $5.21 $15,6308/22/2002 3,000 $5.20 $15,6008/23/2002 3,000 $5.20 $15,6008/26/2002 3,000 $5.11 $15,3308/27/2002 3,000 $5.00 $15,0008/28/2002 3,000 $4.90 $14,7008/29/2002 3,000 $4.67 $14,01 08/30/2002 3,000 $4.66 $13,9809/3/2002 3,000 $4.56 $13,680

9/12/2002 3,000 $5.08 $15,2409/13/2002 3,000 $5.20 $15,6009/16/2002 3,000 $6.04 $18,1209/17/2002 3,000 $5.76 $17,2809/18/2002 3,000 $5.17 $15,5109/19/2002 3,000 $5.05 $15,1509/20/2002 3,000 $5.12 $15,3609/23/2002 3,000 $4.81 $14,43 09/24/2002 3,000 $5.00 $15,00 09/25/2002 3,000 $4.98 $14,9409/26/2002 3,000 $4.82 $14,4609/27/2002 3,000 $4.85 $14,5509/30/2002 3,000 $4.83 $14,49010/1/2002 3,000 $4.71 $14,13010/2/2002 3,000 $4.51 $13,53010/3/2002 3,000 $4.41 $13,23010/4/2002 3,000 $4.34 $13,02010/8/2002 3,000 $3.61 $10,83010/8/2002 3,000 $3.69 $11,070

Class Period Sales 1 /7/2003 250,000 $6.05 $1,512,500

12117/02 - 7112104 9/23/2003 60,000 $10.40 $624,000

Shares P roceeds 9123/2003 30,000 $10.39 $311,700

2,667,240 $42,074,927 9/23/2003 30,000 $10.36 $310,800

100.00% of holdings sold 9/23/2003 30,000 $10.32 $309,600

9/23/2003 30,000 , $10.30 $309,0009/23/2003 30,000 $10.19 $305,700

Page 12 of 14

Red Hat , Inc. Summary of Defendants' Sale s

9/23/2003 30,000 $10.27 $308,10 09/23/2003 30,000 $10.31 $309,30 09/23/2003 30,000 $10.21 $306,3009/23/2003 20,624 $10.30 $212,42 79/23/2003 20,000 $10.30 $206,0009/23/2003 9,376 $10.30 $96,573

10/20/2003 30,000 $13.11 $393,30010/20/2003 30,000 $13.61 $408,30010/20/2003 30,000 $13.15 $394,50010/20/2003 23,500 $13.21 $310,43510120/2003 23,481 $13.06 $306,66210/2012003 21,300 $13.14 $279,88210/20/2003 19,000 $13.04 $247,76010/20/2003 8,700 $13.14 $114,31 810/20/2003 6,500 $13.06 $84,89010/2012003 6,119 $13.01 $79,60810/20/2003 1,000 $13.15 $13,15010/20/2003 400 $13.14 $5,25612/23/2003 1,416,163 $18.40 $26,057,39 912/23/2003 48,000 $18.55 $890,40012/23/2003 30,000 $18.20 $546,00012/23/2003 30,000 $18.20 $546,00012/23/2003 30,000 $18.20 $546,00012/23/2003 30,000 $18.21 $546,300 112/23/2003 30,000 $18.20 $546,00 012/23/2003 30,000 $18.21 $546,30012/23/2003 30,000 $18.20 $546,00 012/23/2003 30,000 $18.20 $546,00012/23/2003 30,000 $18.21 $546,30 012/23/2003 30,000 $18.22 $546,60012/23/2003 29,000 $18.45 $535,05 012/23/2003 29,000 $18.46 $535,34 012/23/2003 18,150 $18.58 $337,22 712/23/2003 12,237 $18.56 $227,11 912/23/2003 7,240 $18.26 $132,20212/23/2003 6,450 $18.62 $120,09912/23/2003 1,000 $18.53 $18,530

T. BUCKLEY Pro - Class : 985,000 $10,111,665Class Period : 2,667 ,240 $42,074,927

P. CORMIER 1/9/2004 20,000 $20.28 $405,6001/9/2004 20,000 $20.30 $406,000

Pre-Class Period Sales 4/712004 39,000 $24 .00 $936,000

January 2000 - 12117102 4/7/2004 1,000 $24 .12 $24,120

Shares Proceeds0 $0 Pro - Class : 0 $0

0.00% of holdings sold Class Period : 80,000 $1,771,720

Page 13 of 14

Red Hat, Inc. Summary of Defendants' Sales

Class Period Sales12/17/02 - 7112/04

Shares Proceeds80,000 $1,771,720

21 .75% of holdings sol d

M. WEBBINK 10/28/2002 908 $4.65 $4,222

Pre-Class Pe riod Sales 1/10/2003 4,000 $6.35 $25,400January 2000 -12117/02 1/13/2003 6,000 $6.41 $38,460Shares Proceeds 7/2/2003 50,000 $7.68 $384,000

908 $4,222 7/2/2003 15,000 $7.77 $116,5501 .95% of holdings sold 7/2/2003 15,000 $7.75 $116,250

1/9/2004 4,000 $20.52 $82,080Class Period Sales 1 /12/2004 4,000 $20.65 $82,60012/17/02 - 7/12/04 1/28/2004 4,000 $20.61 $82,440

Shares Proceeds 3/24/2004 4,000 $21 .84 $87,360215,706 $3,701,360 3/24/2004 4,000 $21 .88 $87,520

76.00% of holdings sold 3/29/2004 4,000 $22.48 $89,9203/29/2004 4,000 $22.47 $89,8803/29/2004 4,000 $23.50 $94,0004/5/2004 8,000 $23.72 $189,7604/5/2004 4,000 $23.73 $94,920

4/12/2004 10,500 $24.75 $259,8754/12/2004 8,000 $24.20 $193,6004/12/2004 4,000 $25.00 $100,0004/12/2004 1,591 $24.66 $39,2344/19/2004 2,490 $23.19 $57,7434/26/2004 3,125 $24.22 $75,6884/27/2004 8,000 $26.00 $208,0004/27/2004 4,000 $25.98 $103,9205/3/2004 4,000 $23.50 $94,0005/4/2004 4,000 $25.00 $100,000

5/10/2004 4,000 $24.12 $96,4805/11/2004 4,000 $25.00 $100,0005/17/2004 8,000 $25.00 $200,0005/24/2004 16,000 $25.73 $411,680

Pre - Class : 908 $4,222Class Period : 215,7061 $3,701,360

Page 14 of 14