UNITED STATES DISTRICT COURT

DISTRICT OF MASSACHUSETTS

}

JEROME DECKLER, Individually and On Behalf of )All Others Similarly Situated, )

Plaintiff,

vs. }

IONICS, INC ., ARTHUR L. GOLDSTEIN and )

DANIEL M. KUZMAK, )

Defendants. )

CIVIL ACTION NO. 03-CV-

10393 (WGY)

JURY TRIAL DEMANDED

AMENDED CLASS ACT ION COMPLAINT

Lead Plaintiff John L. Crowell has alleged the following based upon the investigation o f

plaintiff s counsel, which included a review of United States Securities and Exchange Commissio n

("SEC") filings by Tonics, Inc. ("Ionics" or the "Company"), as well as regulatory filings and reports ,

securities analysts' reports and advisories about the Company, press releases and other publi c

statements issued by the Company, interviews with former Ionics' employees, media reports about th e

Company, and plaintiff believes that substantial additional evidentiary support will exist for the allega-

tions set forth herein after a reasonable opportunity for discovery . In accordance with the Court's prio r

rulings, the required sources for factual allegations are identified in brackets, by code, after each clause .

Where no source is identified for a clause, the next citation to a source applies to that clause as well

to all prior clauses after the previous citation) . Appendix A to this Complaint provides th e

definition for each code .

NATURE OF THE ACTION

This is a federal class action on behalf of purchasers of the common stock of Ionic s

between October 25, 2001 and March 14, 2003, inclusive (the "Class Period"), seeking to pursu e

remedies under the Securities Exchange Act of 1934 (the "Exchange Act" )

JURISDICTION AND VENUE

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

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

Securities and Exchange Commission ("SEC") [17 C.F.R. § 240 .1Ob-5] . <LP>

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

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

4 . Venue is proper in this District pursuant to Section 27 of the Exchange Act and 2 8

U.S.C. § 1391(b) <LP>, as many of the acts and practices complained of herein occurred in

substantial part in this District . <IB>

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

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

interstate telephone communications and the facilities of the national securities markets . <PF, IBS

PARTIES

6 . By Order of this Court dated June 9, 2003, John L. Crowell (the "Lead Plaintiff} was

appointed lead plaintiff in this action. <LP> Lead Plaintiff purchased Ionics common stock during the

2

Class Period <PK> at artificially inflated prices and has been damaged thereby. <TC,IB> Lead

Plaintiffs certification has been previously filed in this litigation and is hereby incorporated by reference .

<LP>

7 . Defendant Ionics is a Massachusetts corporation with its principal place of busines s

located at 65 Grove Street, Watertown, Massachusetts 02472 . The Company develops and

manufactures systems and provides related services for water treatment . The Company also produces

desalination, water and wastewater treatment systems and instruments . <PF>

8 . (a) Defendant Arthur L . Goldstein ("Goldstein") was, at all relevant times, Ionics '

Chairman and Chief Executive Officer . <PF>

(b) Defendant Daniel M . Kuzmak ("Kuzmak") was, at all relevant times, Tonics' Chie f

Financial Officer ("CFO") and Vice President . <PF>

(c) Defendants Goldstein and Kuzmak are collectively referred to herein as the

"Individual Defendants ."

3

PLAINTIFF'S CLASS ACTION ALLEGATIONS

9. Plaintiff brings this action as a class action pursuant to Federal Rule of Civil Procedur e

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

common stock of Ionics between October 25, 2001 and March 14, 2003, inclusive (the "Clas s

Period") and who were damaged thereby. Excluded from the Class are defendants, the officers an d

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

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

ling interest . <LP>

10. The members of the Class are so numerous <PI> that joinder of all members is imprac-

ticable. <LP> Throughout the Class Period, Ionics common shares were actively traded on th e

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

ascertained through appropriate discovery, plaintiff believes that there are hundreds or thousands o f

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

from records maintained by Ionics or its transfer agent and may be notified of the pendency of thi s

action by mail, using the form of notice similar to that customarily used in securities class actions . <IB>

11 . Plaintiffs claims are typical of the claims of the members of the Class as all members o f

the Class are similarly affected by defendants' wrongful conduct in violation of federal law that is

complained of herein. <LP, PK as to Lead Plaintiff, IB as to Clas s

12 . Plaintiff will fairly and adequately protect the interests of the members of the Class an d

has retained counsel competent and experienced in class and securities litigation . <LP>

4

13, Common questions of law and fact exist as to all members of the Class <LP> an d

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

questions of law and fact common to the Class are :

(a) whether the federal securities laws were violated by defendants' acts as allege d

here in ;

(b) whether statements made by defendants to the investing public during the Clas s

Period misrepresented material facts about the business, operations and management of Ionics ; and

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

measure of damages .<LP>

14. 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 . <LP, IB> Furthermore,

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

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

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

SUBSTANTIVE ALLEGATION S

The Company And Its Operations

15 . Ionics develops and manufactures systems and provides related services for wate r

treatment . The Company also constructs and operates desalination, water purification and wastewate r

treatment systems and facilities . The vast majority of the Company's revenues are derived from long-

term sales and construction-type contracts . <PF> These transactions are highly complex and require a

5

highly effective system of internal controls and procedures, among other things, in order to properly

recognize contract revenues and costs in the Company's financial statements . <IB>

16 . According to Ionics' 2001 Form 14-K, the Company manages its operations throug h

four business group segments : the equipment business group ("EBG"), ultrapure water group ("UWG"),

consumer water group ("CWG"), and instrument business group ("IBG") . Within these busines s

segments, Ionics has identified certain core product and market sectors, including among others, wate r

desalination/purification equipment and facilities serving general industries and municipalities an d

ultrapure water processing systems servicing primarily, the microelectronics and power industries ,

among others. <1OK2001>

17 . In 2001, EWG and UWG accounted for approximately 67% of the Company's total

revenues . By the beginning of the Class period, these two segments had grown to approximately 80 %

of the Company's revenues due to the sale of the Company's Aqua Cool Pure Bottled Water

operations in the United States, United Kingdom and France ("Aqua Cool"), which took place i n

December 2001 . c l OK2001 >

18 . Following the disposition of Aqua Cool, Ionics retained certain Aqua Cool operations

in the Middle East and Carribean . The Aqua Cool assets sold accounted for over 16% of th e

Company's 2001 revenues, comprising the major portion of Ionics' consumer segment revenues and

assets both in the United States and abroad . <10K2001> At all relevant times, therefore, th e

defendants were highly motivated to make it appear that EWG and UWG segments were operating

profitably. <IB>

6

19 . Increasingly, over the past several years, the Company has implemented a build ow n

and operate ("build-own-operate") strategy whereby the Company, constructs, owns, operates and

maintains water desalination and purification facilities, among others activities . During the Class Period,

the Company maintained or initiated investments in, at least, seven foreign "affiliated" companies unde r

the Company's build-own-operate strategy, including Grupo Empresarial de Mejoramiento Ambiental ,

S. de R.L. de C .V. - Mexico (the "EDF project") and Desalination Company of Trinidad and Tobago ,

Ltd. ("Desalcott" or the "Trinidad project"), among others . The Company has a minority interest (50%

or less) in each of these seven foreign affiliates and therefore does not include affiliate financial

statements in the Company's consolidated financial statements . <10K2001 >

20. The Company conducts a significant amount of its EBG business through sales o f

equipment and construction services to its affiliated companies outside of the United States . In 2001 ,

over $21 million of the Company's revenues were derived from sales to affiliated companies . In 2002 ,

affiliate sales declined to $12 million .' < i OK2002> Defendants attributed the decline, primarily, to th e

completion of the Desalcott construction project in Trinidad. Purportedly, where the Company has a

20% to 50% ownership interest in an affiliate, equity basis accounting is utilized and certain profi t

eliminations (or deferrals) are made on the Company's sales to these affiliates . <1OK2001 >

Ionics Reported Artificially Inflated FinancialResults By Failing To Record Losses on Long-Term

1 Prior to 2002, defendants reported "Revenue - unaffiliated customers" for each of its business

segments in a footnote disclosure to its consolidated financial statements in its SEC filings . In 2001 defendants

reported that "unaffiliated" revenues were $466 million . However, with the filing of the Company's 2002 Form

10-K, defendants restated their prior years disclosures . The originally reported 2001 "unaffiliated" revenues of$466 million was restated by $21 million to $445 million, reflecting Ionics actual level of unaffiliated revenues .

Defendants have never commented on the reasons for the restatement .

7

Contracts in the Period They Were Incurred

21 . On November 5, 2002, Ionics stunned the market by issuing a press releas e

announcing that it was restating its financial results for the first and second quarters of fiscal 2002 . The

net effect of the restatement reduced the Company's previously reported net earnings by approximatel y

$1 .3 million, or over 31%, for the six months ended June 30, 2002 . The Company attributed the

restatement to "intercompany transactions between the Company and its French subsidiary

that were erroneously recorded at the subsidiary level." {Emphasis added .] <PR 1 1 15/2002>

22. In truth, however, the "intercompany transactions" were, in fact, certain unrecorde d

"project cost overruns," among other tings <1OK2002> which the Company had incurred on the ED F

project in Mexico prior to and during the first and second quarters of 2002, but failed to report in it s

consolidated operating results . <W4, W5>

23 . Specifically, at least $600,000 of the Company's restated costs and expenses related

to costs overruns incurred in connection with Ionics' EDF project in Mexico . <W4> Plaintiffs '

interviews with former employees of Ionics France revealed that when the Company was closing it s

books for the first quarter of 2002, during April 2002, a dispute arose between Ionics' corporat e

controller, Anthony DiPaola, and certain officers of Ionics France over the recording of EDF cost

overruns, which defendants directed Ionics France to record . The Ionics France officers notifie d

defendants that the disputed costs would not be reflected on the French subsidiary's books because th e

costs related to losses arising from the Company's business segments in the United States and Mexico .

<W4, W5> The former employee of Ionics France stated in this regard as follows :

8

In April 2002, management in Watertown, Massachusetts asked [the Ionics

France controller] if France was still losing money and he said it was . At the

same time, "suddenly they lost a fortune in the states on the corporate books,so they thought the best way Ito handle this] was to charge more to France . "

"When something was good it went on the corporate books . When it was not - it went

on the local [French] books ." [Emphasis added .] <W4>

24. According to this former employee, defendant Goldstein, among others, directed

Ionics' French subsidiary to record these losses . The witness stated in pertinent part as follows :

[ . . .]Art Goldstein, the CEO, ordered it. Ed Cichon, the vicepresident and headof the business equipment group, Anthony DiPaala, the controller, gave himthe instructions to falsify the books and then signed off on them when [the

French controller] would not .

Ionics "lost money everywhere. The company put the losses of the corporation on

France just to hide the truth . [ . . .] "

For example, the Trinidad project, called EDS, had lost $2 million in U.S.

dollars. Ionics told [the Ionics France controller] : "It is not your project but

you have to support this in your books. " [Emphasis added .] <W4>

25 . In addition, another former employee of Ionics France confirmed similar informatio n

related to the unrecorded cost overruns, stating :

"[The vice president of Ionics Europe] was fired because he refused to [record]

transactions between the U .S . and France . It was many, many [ . . .] transactions they

were looking for . There had been a lot of losses in the United States. They were

looking at several transactions. [The vice president of Ionics Europe] was not ready to

accept this [ . . .] . "

Because [the vice president of Ionics Europe] refused to sign off on these illegaltransactions he was fired in April 2002 . "[The vice president of Ionics Europe] [has]

been killed by some managers in Ionics," he said . "Everything was decided by you

know who, [CEO Goldstein] and Ed Cichon .

"They charged France with the wrong charges ." <W5>

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26 . Furthermore, the former employee stated that defendants motive for shifting costs t o

France, at this particular time, related to a "tax strategy" that would reduce the Company's tax liabilitie s

arising from a $19 million gain related to the December 2001 sales of Ionics' Aqua Cool operations i n

France . <W4> Another former employee also stated that during the second quarter of 2002 ,

defendants attempted to falsify tax documents prepared in connection with the sale stating in pertinent

part as follows :

[The vice president of Ionics Europe] said Ionics sold Aqua Cool water in France for

five or six years . "We did a lot of profit . But they [defendants] declared a long-termprofit [in the second quarter of 2002] when it should have been a short-term profit after

three years. [The vice president of Ionics Europe] refused to sign it . "

"They were charging France and Europe with [ . . .]losses in the States ." [The vice

president of Ionics Europe] [estimated the losses] added up to $5 million to $6 million

U.S. dollars, which was probably from losses in projects the company had in Trinidad

and Kuwait . "We are all upset . We invested ourselves for many years and months .

Now we have nothing because the management was wrong ." [Emphasis added .]

<W5>

27. Based on the foregoing, defendants knew, as early as April 2002, that Ionics Franc e

did not record the costs and expenses associated with the EDF project cost overruns, among others ,

which defendants had ordered the French subsidiary's controller to record during the first and secon d

quarter of 2002 . <W4, W5>

28. Ionics has now restated its financial statements for the first and second quarter of 2002 ,

thereby admitting that those financial statements were materially false and misleading when issued .

<PR11151Q2, IB .>

Ionics Improperly Accounted For Long-TermContract Revenues Thereby MateriallyOverstating Its Financial Results

10

29, In addition to the foregoing accounting improprieties, during the Class Period, Ionic s

overstated its revenues and profits by millions of dollars by improperly accounting for costs and

expenses associated with the Company's long-term equipment and construction contracts . <W 1, W2 ,

W3, W4>

30. In this regard, Ionics shifted "cost overruns" on certain long-term equipment sale s

contracts and construction projects from unprofitable project(s), where they were actually incurred, t o

other unrelated projects that could absorb the costs and mask the losses . This enabled defendants t o

continue to accrue contract revenues under the percentage of completion accounting method using cos t

estimates, which had been falsified to exclude the cost overruns . <W1>

31 . Purportedly, the Company recognizes revenues on its equipment sales contracts usin g

periodic estimates of the ratio of costs incurred to date and the total estimated costs to complete th e

contract (the "percentage of completion accounting method") . (See ~¶ 8 0-95 )

32. Interviews with numerous former employees of Ionics confirm that defendants routinel y

approved the falsification of cost estimates on equipment manufacturing and construction contracts .

For example, contract cost estimates were falsified at the Company's Bridgeville, Pennsylvani a

manufacturing facility in order to allow Ionics to continue to accrue sales revenues and profits on certain

commercial and U. S . Navy nuclear programs that, in fact, were unprofitable . As confirmed by a

former employee at the Company's Pittsburgh, Pennsylvania office (divisional headquarters for th e

Bridgeville plant), during January 2001, the Company's executive officers, including defendant Kuzma k

and Ted Papastavros ("Papastavros"), Ionic's treasurer and executive vice president, directed an d

1 1

approved the falsification of the percentage of completion estimates on several manufacturing project s

in order to "spread millions of dollars" of purported sales revenues over several years making it appea r

that each of the projects were profitable during 2001 . <W1 >

33 . Specifically, the former employee stated that in January 2001 he attended a meeting ,

also attended by defendant Kuzmak, Papastavros and the president of the Pittsburgh division R .

Gounder ("Gounder"), to discuss "some accounting principles" related to losses on equipment contract s

for the manufacture of parts for commercial and U .S . Navy nuclear programs at the Pittsburgh

division's Bridgeville plant . According to the former employee the following events transpired at the

meeting :

"We were showing a loss on a contract, and most don't show losses . They [Kuzmak

and Papastavros] wanted to know why we were losing money on [ . . .] one project .

Go-under told them that the numbers were being changed to cover the losses andmake all the projects look like they were earning money . Gounder admitted that

he [improperly] spread millions of dollars in profit over four years . At the meeting

Kuzmak stated, `I want to go on the record stating it's not proper accounting -

but it's nice to make money. "' [Emphasis added .] <W 1>

34. In addition, plaintiff's interviews with former employees of the Company's Europea n

operations confirmed that similar practices occurred with Ionics' recognition of revenues through it s

foreign affiliate in Trinidad, Desalcott . The former employee stated that defendants recognize d

revenues prematurely, in order to "compensate" the Company for losses it was incurring during th e

construction phase of the project :

In 2000 Ionics entered into a business agreement with Desalcott for a huge watertreatment project in Trinidad. Ionics was only supposed to give technologicalassistance on the project, which was supposed to be built by [Hafeez Karamath

Engineering Services Ltd . ("HKESL")] . But Ionics had to hire contractors and actually

12

built the plant because [HKESL] could not do the construction . "The partner was

deficient, it didn't have any equipment . "

As a result, Ionics funded the $20 million cost to build the plant . [ . . .] the total cost of

the Trinidad project was $300 million. About $120 million of this was the water

treatment cost, which was Ionics only part of the contract .

In the third quarter of 2001, Steve Vitcauscas, the vice president of finance,[stated] that Ionics recorded revenue to compensate far this loss. According to

accounting rules, Ionics was only supposed to record future revenue on cubic meters of

water that had been sold . The plant was not yet completed, but Ionics recorded all

the revenue in advance anyway. "Ionics recorded all this revenue to compensate for

the loss," [ . . .] "Ionics was only supposed to do the technology, but they had to hire

contractors . Vitcauscas [stated], "It was a big problem because the partner had no

money." [Emphasis added .] <W4>

35 . Furthermore, Ionics lacked the internal controls necessary to properly utilize percentag e

of completion accounting. Indeed, according to two former divisional controllers employed by th e

Company from November 1990 to March 2003, Ionics had no dedicated internal audit function .

Instead "desk audits" were purportedly performed by the divisional controllers to review cost estimate s

and other information developed by operations personnel . The "desk audit" results were then sent to

the corporate office . The Company's independent auditor Price WaterhouseCoopers relied on thes e

reports and incorporated them into its periodic examinations . As a result, a former divisional controlle r

stated that the Company was not properly recognizing revenue based on the percentage of completio n

method because operational personnel, whose performance rating was based on the unit's financia l

results, were preparing the forecasts and estimates underlying the Company's revenue accruals . <W4,

W> For example :

(a) A forrzier controller in Ionics' Asian division, employed by the Company from

February 2001 to March 2003, stated that, at other Companies he had worked for, the estimates used

13

to recognize revenue under the percentage of completion method were "scrubbed down" or closel y

examined each quarter . By contrast at Ionics the numbers are "driven by estimates from operation s

people" and that subsequent examinations of the estimates are not performed . In most cases, the

former controller believed that the divisional controllers were not "examining the numbers a t

all, except for the numbers on a big project like Kuwait." [Emphasis added .] <W3> ; and

(b) In addition, prior to the Class Period, a former controller of the Company' s

Pittsburgh Division, stated that he knew the Company overstated equipment contract revenues b y

$2.2 million in 1999 . When the former controller alerted Bob Halliday, Ionics' vice president of

finance, and Anthony Di Paola, Ionics' corporate controller, to the misstatement, they

examined the transactions but never corrected the overstatement. The former manager stated,

"They passed on it, if you will. " [Emphasis added.] <W2>

Ionics Materially Misstated the 200 1Operating Results of Its Bottled Water Operations

36. On December 3, 2001, defendants announced that Ionics entered into an agreement t o

sell its Aqua Cool Pure Bottled Water ("Aqua Cool") business to Perrier-Vittel, S .A., a subsidiary of

Nestle, S .A. (collectively "Nestle"). Ionics agreed to sell Aqua Cool operations in the United States ,

United Kingdom and France for a reported $220 million, subject to certain price adjustments APR

12/3/01> .

37. Following the Aqua Cool sale announcement, the price of Ionics common stoc k

appreciated over 12%, closing at $30 .99 on December 7, 2001 after several days of heavy trading .

<YHO, PIS

14

38 . Unknown to investors, however, Ionics engaged in a scheme to artificially inflate Aqu a

Cool's product sales and customer base in the period immediately preceding the Nestle acquisition i n

order to facilitate the sale and to meet or exceed certain financial performance criteria set out in th e

sales agreement with Nestle .

39. As reported by former Ionics employees, defendants inflated Aqua Cool's revenues by

ordering its sales force to deliver hundreds of thousands of unordered and unwanted bottled wate r

products to Aqua Cool's retail customers . <W6, W7> For example :

(a) A former customer service representative in Baltimore, MD, employed by th e

Company from April 1999 to December 2001, stated that word came from corporate headquarters i n

Watertown to all employees that they were to deliver extra bottles of water to all Aqua Cool

customers . "All customers were to get an extra bottle, regardless of whether they wanted the m

or not. They told all the delivery drivers to just go ahead and drop water . It was shady ." Customers

were charged the customary $5 to $7.50 per 5 -gallon bottle, even though they never ordere d

the water. Aqua Cool dumped "well over 10,000 bottles of water on customers in the D C

area alone. " The former customer service representative believed this was a company-wide

operation . <W6>

(b) A former operations manager in Boston, MA, employed by the Company from Jul y

2001 to February 2002, stated that immediately before Aqua Cool was sold to Perrier in Decembe r

2001, Ionics "kind of fudged the books by increasing the amount of the customer base . "

Ionics ordered each driver to deliver an extra bottle of water to customers who had not bee n

on th e books recently and bill them for it. These customers were those who got infrequent

15

deliveries, such as once a month or every other month. The vice president who was the head of Aqu a

Cool in the U.S . sent an e-mail directive to the heads of each of the 13 offices across the U.S. "My

manager got it and forwarded it to me ." The former operations manager received the directive via a n

e-mail from a regional executive in the Maryland office. These extra deliveries were called "white-ticke t

deliveries." Normally the deliveries were invoiced on blue tickets . "We paid the drivers an incentive o f

about $1 dollar per ticket to get this done ." If customers complained we said 'it's free .' If they didn't

we charged them for it . We were averaging about 400-to-500 [extra] bottles a day ." The operation

was underway for about six weeks, and customers paid from $7 to $9 dollars for each extra five-gallo n

bottle if they did not complain .

Ionics' delivered the extra bottles to increase the amount of its customer base at the time it

was sold to [Nestle] at the end of December 2001 . The former operations manager said he heard

that Perrier placed $10 million in escrow for Ionics as part of the deal, and the amount Ionics received

depended on its customer numbers . The former operations manager said he complained about thi s

practice in an e-mail to the vice president of Aqua Cool in corporate headquarters . The vice president

did not respond, but the former operations manager was told by [immediate superiors] "to never

contact the vice president again." [Emphasis added .] <W7>

40. The aforementioned improper sales activities artificially inflated Aqua Cool's reporte d

sales revenues of $76 .2 million for 2001 by millions of dollars and materially overstated the number o f

"active" customers for the Aqua Cool operations sold to Nestle . <W6, W7> In December 2001 ,

defendants reported a $112 million gain from the Aqua Cool sale to Nestle, less certain reserves fo r

possible price adjustments as per the sales agreement with Nestle . <10K2001> In the fourth quarter of

16

2002, defendants announced a settlement of the price adjustments with Nestles . The settlement

reduced the Aqua Cool sales price to $207 million, or $13 million less than the initially reported sale s

price of $220 million . <1OK2002>

41 . Though defendants have never admitted their participation in the scheme to overstat e

Aqua Cool's revenues and customer base in the months immediately preceding the sale, it is apparen t

that a major portion of the $13 million price reduction was the direct result of defendants '

overstatement of Aqua Cools's revenues and customer base through Tonics' improper sales practices ,

including the delivery of unordered and unwanted bottled water products to its retail customers a s

detailed herein . <IB>

Ionics Failed To Disclose Material DeficienciesIn The Company's System of Internal Control s

42 . Throughout the Class Period defendants represented that the Company's publicl y

stated "critical accounting policies" were being administered through a functioning system of interna l

controls . The Company's Annual Reports filed with the SEC during the Class Period stated i n

pertinent part as follows :

The Company closely monitors compliance and consistency of application of its criticalaccounting policies related to contract accounting. In addition, reviews of the status of

contracts are performed through periodic contract status and performance reviews. In

all cases, changes to total estimated costs and anticipated losses, if any, are recognizedin the period in which determined . <10K2401 >

43 . In truth and in fact, however, at all relevant times the Company's system of interna l

controls was materially deficient . Indeed, on March 31, 2003, defendants admitted that in connectio n

with the audit of its 2002 financial statements the Company was advised by its independent auditor "tha t

1 7

certain of its internal controls had deficiencies and material weaknesses ." The Company's 2002 Form

10-K stated in relevant part as follows :

In connection with the audit of its financial statements for 2002, the Company wasadvised by its independent auditor that certain of its internal controls had deficiencies

and material control weaknesses. Consequently, and with the goal of further improvingthe quality and timeliness of the information available to management, the Company iscontinuing to implement measures designed to address those deficiencies andweaknesses as follows :

o valuate and strengthen its financial and accounting staff and theirknowledge and understanding of key policies under U .S. generallyaccepted accounting principles and of their responsibilities ;

o to improve monitoring controls to assure the prevention or detection ofmaterial accounting errors on a timely basis ;

o to reduce the time necessary to collect and report financial andoperating data by improving the timing and accuracy of forecasting andemphasizing more frequent reviews of the Company's balance sheetsand reconciliation of intercompany balances ;

o to continue to update its accounting policies and procedures .<l OK2042>

44. In addition to the internal control deficiencies cited by the Company's auditors ,

defendants revealed in the Form 10-K that they had been attempting to correct known weaknesses

throughout 2002 . The 2002 Form 10-K stated:

Prior to the evaluation of the Company's disclosure controls and procedures made inconnection with the filing of its Quarterly Report on Form 10-Q for the periods endedSeptember 30, 2002, the Company made changes in its internal controls and tookother actions designed to enhance the Company's internal controls, which consisted ofthe following :

o the hiring of new personnel including, two new segment controllers inApril and July of 2002, three new divisional controllers in May an dSeptember of 2002, a corporate director of accounting in July 2002 ,

1 $

and a new consolidation accountant in September 2002, to enhance the

quality of its accounting capabilities ;

o the replacement of the senior operating executive at the Company'sFrench subsidiary and the reassignment of much of the operationalresponsibility or that subsidiary to the Company's Italian subsidiary;

o the implementation of a new financial consolidation software package(which became operational in September 2002) ;

o the implementation of a centralized bid and proposal review and

approval process at the beginning of 2002 ;

o the expansion of the internal audit function through the use of outside

resources beginning in March 2002 ;

o the formalization of certain accounting and information technologypolicies and procedures at various times throughout the year ;

o the hiring of a Director of Project Management in October 2002 tooversee prof ect-related procedures and to train proj ect managers atlocations to enable them to better comply with Company goals, policie s

and procedures ; and

o the institution of procedures requiring written quarterly certifications andrepresentations from the head of each business group and the localcontroller of each business location .

Since that evaluation in November 2002, the Company has made additional changes inits internal controls and taken other actions designed to enhance the Company's internal

controls, which consisted of the following :

o the formation of a disclosure committee to oversee the effectiveness ofthe Company's disclosure controls and procedures ;

o in furtherance of the centralized bid and proposal review and approvalprocess, the establishment of formal, systematic procedures forreviewing all major commercial projects being undertaken by theCompany, including monthly participation by senior management ;

19

o the finalization of a project database to facilitate the tracking andanalysis of project performance throughout the Company in December

2002;

a the hiring of a senior financial manager into a newly created position as

European Controller in December 2002, who is responsible forproviding financial oversight and control for the Equipment BusinessGroup's European operations ; and

o the conduct of a conference, and other educational activities, for theCompany's segment and divisional controllers and corporate accountingstaff, which included programs regarding, among other topics,inter-company transactions, key policies under U .S. generally accepted

accounting principles (e .g., SAB 101, SOP 81-1), the Sarbanes-Oxley

Act of 2002, internal controls, U .S . regulation of international

transactions, and key responsibilities of the local controllers .

<1OK2002>

Materially False and Misleading StatementsIssued During the Class Period

45 . The Class Period starts on October 25, 2001 . On that date, Ionics issued a press

release announcing its financial results for the third quarter and nine months ended September 30, 2001 .

For the third quarter, the Company reported revenues of $118.3 million compared to $124 .9 million in

the third quarter of 2000, with net income of $4 .2 million and earnings per share of $0 .24 compared to

$2 .9 million and $0 .18, respectively. For the nine-month period, revenues were $354 .9 million

compared to $330 .5 million in the first nine months of 2000, with net income of $11 .4 million and

earnings per share of $0 .66 compared to $10 .7 million and $0 .65, respectively. Defendant Goldstein

commented on the results :

"While our earnings per share in the third quarter were up 33% compared to one yearearlier, these results nonetheless reflect the impact of a significant decline in sales ofultrapure water equipment for the semiconductor industry . While the level of activequotations and bids outstanding has remained high in other areas of our business suc h

20

as water desalination and water reuse, short-term projections for capital equipmentspending have been rendered somewhat uncertain as a result of business conditions and

the recent tragic events in this country. On the other hand, our water supply and servicebusinesses have continued to remain stable and predictable and provided a substantial

portion of the profits generated by the Company in the third quarter." <pR10I25101 >

46. On November 13, 2x01, Ionics filed its quarterly report on Form 10-Q for the third

quarter and nine months ended September 30, 2001 . The Form 10-Q, signed by defendant s

Goldstein and Kuzmak, incorporated the Company's previously issued financial results and included th e

following representations related to the third quarter financial results of Tonics' CWG segment includin g

the Company's Aqua Cool bottled water operations :

The revenues of CWG increased $6 .1 million, or 21 .4%, in the third quarter of 2001compared to the third quarter of 2000 . Similarly, CWG revenues increased $12 .3

million, or 15 .1%, in the nine-month period of 2001 compared to the nine-month

period of 2000 . These increases were due to continued growth in both the bottledwater business, primarily in the United Kingdom, and home water businesses .

<1OQ9/30101 >

47. On December 3, 2001, Ionics issued a press release announcing that it had entered int o

an agreement to sell its Aqua Cool bottled water business to Nestle . Ionics agreed to sell Aqua Cool

operations in the United States, United Kingdom and France for a reported $220 million, defendan t

Goldstein commented on the sale, in relevant part, as follows :

Ionics is selling its Aqua Cool Pure Bottled Water business, which is currentlygenerating revenues of over $70 million per year, primarily to enable greatercorporate focus on its activities in water desalination, water reuse, surface waterpurification, ultrapure water and water quality instrumentation . These growingbusinesses, in which Ionics is a world leader, are based on Ionics' core technologies inmembrane-based water treatment and are expected to require substantial resources

and capital commitments in the future . The sale to the Perrier Group will enable us todirect resources to the growing worldwide "build, own and operate" ["BOO"] marketfor water and wastewater systems, to decrease corporate debt and to pursue newopportunities for growth within the areas of our core competence . We are very

21

pleased and confident that the Aqua Cool customer base in 33 locations in the UnitedStates, the United Kingdom and France will continue to be well-served by

Perrier-Vittel. We believe this transaction will be in the best interests of the Company

and its shareholders. [Emphasis added.] <PR12/3/01 >

48 . Following defendants' announcement of the Aqua Cool sale, shares of Ionics commo n

stock appreciated over 12%, closing at $30.99 on December 7, 2001 after several days of heavy

trading. <YHO, PD

49. On January 15, 2002, the Company filed with the SEC on Form 8-K the "Maste r

Agreement" entered into with Nestle concerning the Aqua Cool sale . The agreement disclosed that th e

sales price of the Aqua Cool operations was subject to adjustment based upon, among other things, th e

number of active customer accounts at the date of transfer . The agreement states in pertinent part a s

follows :

Active Customer Counts . (a) Not later than 180 days after the Closing Date, BuyerRepresentative shall review the Equipment Customers of the Business as of the ClosingDate to determine which such Equipment Customers qualify as Active Customers,including which Incremental Customers are eligible to be included as Active Customersin the European Customer Count . For avoidance of doubt, Persons who do not

become Equipment Customers of the Business until after the Closing Date shall notqualify as Active Customers or be included in the Customer Counts .

(b) Within 180 days after the Closing Date, Buyer Representative shall deliver to Seller

a certificate showing the number of Active Customers in the European Business and theU.S . Business (respectively, the "European Customer Count" and the "U.S. CustomerCount," and collectively, the "Customer Counts"), together with copies of appropriate

supporting documentation . Seller shall have 90 days to review the CustomerCounts and supporting documentation and give Buyer Representative a

written notice which shall either: (I) state that Seller accepts the Customer

Counts as submitted; or (ii) describes in reasonable detail, including the names

of customers and the reason for any proposed adjustment, each proposed

adjustment that Seller proposes be made to the Customer Counts. If Buyer

Representative has not received a written notice from Seller within the 90-day review

period, Seller, the U .K. Subsidiary and the French Holding Company shall conclusively

22

be deemed to have accepted the Customer Counts as submitted by Buyer

Representative . If Seller does give timely notice of dispute that includes a proposedadjustment to which Buyer Representative objects, Buyer Representative and Sellershall negotiate in good faith to resolve the dispute . If they have not resolved the dispute

within 30 days following Buyer Representative's receipt of Seller's notice, the dispute

shall be resolved by an international accounting firm in the same manner

provided for in Section 2.06(c)(iii) in the case of disputed adjustments in

connection with the Preliminary Closing Net Asset Statement.

"Active Customer" means :

(a) an Equipment Customer of the Business that, both (i) receives a delivery ofwater (unless such Equipment Customer uses a Bottleless Cooler, in whichcase the delivery requirement shall not apply) or beverage service suppliesduring the last full 60-day invoice-cycle period ending prior to the ClosingDate, and (ii) makes a payment on account of an equipment lease or rental or

delivery of water or beverage service supplies within 90 days . from thebeginning of such 60-day invoice-cycle period; or

(b) if an Equipment Customer's Start Date is within the 90 days prior to the

Closing Date, an Equipment Customer that both (i) receives a delivery of water

(unless such Equipment Customer uses a Bottleless Cooler, in which case the

delivery requirement shall not apply) or beverage service supplies within 60

days from such Equipment Customer's Start Date, and (ii) makes a payment on

account of an invoice relating to such Equipment Customer's equipment lease

or rental or delivery of water or beverage service supplies within 90 drays from

the date of such invoice; provided, however, that an Equipment Customer that leasesor rents, or is provided, more than one bottled water cooler, Bottleless Cooler,

refrigerator, microwave or coffee brewer which are covered by a single invoice and

that satisfies the applicable water delivery and payment requirements set forth in clause(a) or (b) of the definition of "Active Customer" with respect to at least one piece ofequipment so leased, rented or provided shall be counted as a separate "ActiveCustomer" for all pieces of equipment covered by such invoice; and provided further,

however, that an Equipment Customer of the French Business that (1) leases or rents,or is provided, a bottled water cooler, Bottleless Cooler, refrigerator, microwave orcoffee brewer on an annual basis, (2) shall have paid in advance for such annual periodthe amounts due with respect to such lease, rental or provision and (3) shall havereceived and acknowledged a delivery of water in accordance with the applicabl ewater delivery requirements set forth in subclause (i) of either clause (a) or (b) of the

23

definition of "Active Customer" shall be deemed to be an "Active Customer ." In

addition, on a case-by-case basis, Seller may request that Buyer Representativeconsider, and Buyer Representative shall consider in good faith, including as an "Activ e

Customer" any Equipment Customer who has satisfied the applicable water deliveryrequirements set forth in subclause (i) of either clause (a) or (b) of the definition of"Active Customer" but whose payment shall have been received after expiration of theapplicable period specified in subclause (ii) of either clause (a) or (b) of the definition of"Active Customer" (but not later than 180 days after the Closing Date) solely as a resultof interruptions, delays or disruptions in postal delivery service in the market in whichsuch Equipment Customer is located or from which such Equipment Customer's bills

are sent; and any such Equipment Customer who Buyer Representative and Seller

agree shall be an "Active Customer" shall be deemed to be an "Active Customer "

notwithstanding anything to the contrary in this definition of "Active Customer ."

[Emphasis added.] <8K1115101 >

50. On March 7, 2002, the Company issued a press release announcing its financial result s

for the fourth quarter and fiscal year ended December 31, 2001 . The Company reported revenues for

the fourth quarter were $111 .8 million compared to revenues of $144 .1 million for the fourth quarter o f

2000. Net income for the quarter was $33 .3 million, or $1 .90 per share, compared to a net loss o f

$12 .6 million, or $0.77 per share, for the fourth quarter of 2000 . The press release stated in pertinent

part as follows :

Revenues for the year were $466 .7 million [including Aqua Cool revenues of

approximately $76 .2 million] compared to revenues of $474 .6 million in 2000. Net

income for the year was $44 .7 million, or $2.59 per share, compared to a net loss of

$1 .9 million, or $0.12 per share, in 2000 .

Net income for the fourth quarter includes a one-time, non-operating gain of

$3.57per share on the sale of the Company's Aqua Cool Pure Bottled Water

business to Nestle S.A., as well as one-time and unusual costs which reduced

operating income by $1 .68 per share . The one-time and unusual costs include charges

in the fourth quarter associated with the planned divestiture of the Company's majority

interest in its Malaysian affiliate as well as asset and goodwill impairment charges ;

losses in the Consumer Water Group which occurred primarily in conjunctio n

with the Aqua Cool business being readied for sale ; cost increases on the civil

construction portion of two contracts ; and increased bad debt write-offs and othe r

24

charges. Results for the fourth quarter and the year also were affected by a substantial

increase in the effective tax rate . [Emphasis added . ]

Defendant Goldstein, commenting on the Company's financial results, stated in pertinent part, a s

follows:

Looking forward to 2002, we are pleased that despite continuing weakness inmicroelectronics, corporate bookings were at a near record level in the fourth quarterand that backlog reached $258 .9 million, an increase of $38 .9 million during the

quarter." He further noted that Ionics' portion of a facility to be built in Kuwait inconjunction with the award of a large water reuse concession contract was not yetincluded in bookings or the year-end backlog. <PR3/7/02>

51 . On March 29, 2002, the Company filed its Annual Report on Form 10-K for the fiscal

year ended December 31, 2001, which confirmed the Company's previously announced financia l

results and was signed by defendants Goldstein and Kuzmak . The Form 10-K included the following

representations related to the disposition of Ionics' Aqua Cool operations in the United States, Unite d

Kingdom and France :

On December 31, 2001, the Company completed the sale of its Aqua Coot Pure

Bottled Water operations in the United States, the United Kingdom andFrance to affiliates of Perrier-Mittel, S .A., a subsidiary of Nestle, S.A. for

approximately $220 million, of which $10 million is being held in escrowpursuant to the terms of the divestiture agreement . The amount of the purchaseprice is subject to final adjustment based on the number of customers andworking capital levels as defined in the divestiture agreement . The Companyanticipates that the final determination of such purchase price adjustments will becompleted in the third quarter of 2002 . Including reserves established for any purchase

price adjustments, the Company recorded apre-tai gain on the sale amounting to$102.8 million. The Aqua Cool Pure Bottled Water business had sales of $ 76.2

million in 2001, $67.2 million in 2000 and $60 .1 million in 1999, losses before taxes

and interest of $0 .6 million in 2001 and $0.9 million in 2000, and income before taxes

and interest of $6 .9 million in 1999. The consolidated financial statements andaccompanying notes reflect the operating results of the Aqua Cool Pure Bottled Waterbusiness as a continuing operation in the Consumer Water Group segment . [Emphasis

added.] <1OK2001>

25

52. The statements referenced above in ¶~ 45-47 and 50-51 were each materially false an d

misleading when made because they failed to disclose and misrepresented the following adverse facts ,

among others :

(a) that the Company's reported Aqua Cool sales revenues of $ 76 .2 million during

2001 <l OK2001 > were materially overstated by tens of millions of dollars as a result of defendants '

improper sales practices, including sales generated by the delivery and subsequent billing of unordere d

bottled water products to Aqua Cool's retail customers ; <W6, W7, IB>

(b) that the Company's revenues accrued under the "percentage of completio n

accounting method," among others, were materially overstated as a result of defendants falsification o f

contract cost estimates, which included the `intercompany transfer' of certain project cost overrun s

related to the EDF project, among others ;WW1, W2, W3, W4, W5, IB >

(c) as a result of the foregoing, the Company's reported financial results were materiall y

overstated ;

(d) as detailed herein in ¶¶ 67-104, that the Company's financial statements were no t

prepared in accordance with Generally Accepted Accounting Principles ("GAAP") and were therefor e

materially false and misleading ; and

(e) that the Company's system of internal controls was materially deficient resulting i n

the defendants inability to ascertain the true operating results and financial condition of the Company .

<W2,W3, 10K2002> .

53 . On May 6, 2002, Ionics issued a press release announcing its financial results for th e

first quarter of 2002, the three month period ending March 31, 2002 . For the quarter, defendant s

26

reported revenues of $80.3 million, as compared with revenues of $ 1 23 million in the same quarter o f

the prior year. Net income for the quarter was $1 .9 million, as compared with net income of $3 million

in the same quarter of the prior year . Earnings per share were $0 .11 per share, as compared wit h

earnings per share of $0 .18 in the same quarter of the prior year . Defendant Goldstein, commenting o n

the Company's performance, stated, in pertinent part, as follows :

[Results for the quarter reflected continuing costs associated with the Company'sMalaysian business, the planned divestiture of which is now expected to be concludedduring the second quarter, as well as certain continuing restructuring costs associated

with the sale of the bottled water business . <PR5/6/2002 >

54. On May 15, 2002, Ionics filed its Form 10-Q for the first quarter of 2002, the perio d

ending March 31, 2002, with the SEC which confirmed the previously announced financial results an d

was signed by defendants Goldstein and Kuzmak . The Form 10-Q included the followin g

representations concerning the Company's reported revenues for Ionics' two largest operating

segments :

EBG [Equipment Business Group] revenues of $38 .3 million decreased by $6.7 million,

or 14.9%, compared to revenues of $45 .0 million during the first quarter of 2001 . Thisdecrease was primarily attributable to lower capital equipment revenues ,

reflecting the wind-down of the construction phase of the Trinida d

desalination project, as well as lower volume levels associated with the Zero Liquid

Discharge business .

UWG [Ultrapure Water Group] revenues of $25.0 million decreased by $15.8 million,

or 38.7%, compared to revenues of $40 .8 million in the first quarter of 2001 . Revenuelevels for UWG were affected by continued softness in the capital equipment portion ofthe microelectronics industry, both domestically and internationally . [Emphasis added . ]

In the notes to the consolidated financial statements contained in the Form 10-Q, defendant s

represented that :

27

In the opinion of the management of Ionics, Incorporated (the "Company"), alladjustments have been made that are necessary for a fair statement of the consolidatedfinancial position of the Company, the consolidated results of its operations and the

consolidated cash flows for each period presented . <l OQ3/31102>

55 . On August 1, 2002, Ionics issued a press release announcing its financial results for th e

second quarter of 2002, the period ending June 30, 2002 . For the quarter, defendants reported

revenues of $79 .3 million, as compared with revenues of $113 .7 million in the same quarter of the prio r

year. Net income for the quarter was $2 .1 million, as compared with net income of $4 .2 million in the

same quarter of the prior year. Earnings per share were $0 .12 per share, as compared with earning s

per share of $0 .24 in the same quarter of the prior year . <PR8/l/02>

56. On August 14, 2002, Ionics filed its Form 10-Q for the second quarter of 2002, the

period ending June 30, 2002, with the SEC, which confirmed the previously announced financia l

results, and was signed by defendants Goldstein and Kuzmak . The Form 10-Q included the following

representations concerning the Company's revenues for Ionics' two largest operating segments :

EBG revenues during the second quarter of 2002 of $38 .6 million decreased by $7 .5

million, or 16 .3%, compared to revenues of $46.2 million during the second quarter of2001 . For the six-month period ended June 30, 2002, EBG revenues of $76 .9 million

decreased $14 .2 million, or 15 .6% .

UWG revenues during the second quarter of 2002 of $25 .2 million decreased by $5 .6

million, or 18 .3%, compared to revenues of $30 .8 million in the second quarter of

2001 . During the six-month period ended June 30, 2002, revenues of $50.2 million

decreased $21 .4 million, or 29.9%, compared to revenues of $71 .7 million for the six

months ended June 30, 2001 . In both periods ended June 30, 2002, revenue levels

were affected by continued softness in the microelectronics industry, particularly with

respect to domestic capital equipment sales .

In the notes to the consolidated financial statements contained in the Form 10-Q, defendant s

represented that :

28

[I]n the opinion of the management of the Company, all adjustments have been madethat are necessary for a fair statement of the consolidated financial position of theCompany, the consolidated results of its operations and the consolidated cash flows for

each period presented . <10Q6/30/02>

57. The statements referenced above in 115 3 - 5 6 were each materially false and misleading

for the reasons set forth at ¶ 52 . In addition, the statements referenced in ¶¶ 53-56 were eac h

materially false and misleading because they failed to disclose and misrepresented the following advers e

facts , among others :

(a) that the Company's operating results were materially overstated as a result o f

defendants failure to reflect project cost overruns related to the EDF project, among others, in th e

Company's consolidated financial results . <W4, W5> In particular, defendants have admitted that i n

the first quarter of 2002, they overstated Ionics operating income by more than 53% . For the second

quarter of 2002, defendants have admitted that they overstated Ionics' operation income by more tha n

41% <PR11/5 12002>; and

(b) based on the foregoing, as detailed herein in ¶T 67-104, the Company's financial

statements for the first and second quarters of 2002, were not prepared in accordance with GAAP and

were therefore materially false and misleading . Indeed, Ionics has now restated those financial

statements, thereby admitting that the financial statements were materially false and misleading when

issued. Thus, it was not true that the financial statements contain "all adjustments have been made tha t

are necessary for a fair statement of the consolidated financial position of the Company ." <PR11/5102 >

58 . Then, on November 5, 2002, the Company shocked the market by announcing that i t

would be restating its financial results for the first and second quarters of 2002 `primarily as a result

29

of intercompany transactions between the Company and its French subsidiary that wer e

erroneously recorded at the subsidiary level." The restated financial results included revenues fo r

the first and second quarters of 2002 of $80 million and $79 .7 million, respectively (as compared t o

$80.3 million and $79 .3 million originally reported) ; net income for the first and second quarters o f

2002 of $1 .5 million and $1 .2 million, respectively (as compared to $1 .9 million and $2 .1 million

originally reported) ; and earnings per share for the first and second quarters of 2002 of $0 .08 and

$0.07, respectively (as compared to $0 .11 and $0 .12 originally reported) . The Company als o

reported its financial results for the third quarter of 2002, including a large loss associated with it s

operations in France . As a result of these losses, the Company announced that it had decided to

"downsize, discontinue and consolidate various operations of its French subsidiary ." Defendant

Goldstein, commenting on the Company's performance and the need to restate its prior financial results ,

stated, in pertinent part, as follows :

[W]hile Ionics' management was disappointed by the need to adjust Q1 and Q2 2002results primarily due to the issues relating to its French subsidiary, and the need to takeunexpected downsizing and cost reduction actions at that subsidiary, management wasencouraged by the record backlog which was achieved during an uncertain and difficult

economic period worldwide . <pR11/5/02 >

59 . Immediately following the issuance of Ionics' third quarter earnings, defendants held a

conference call with analysts to review the Company's results . The conference call was attended by

defendants Goldstein and Kuzmak as well as Ted Papastavros . A transcript of the conference call ,

published by the Fair Disclosure Wire, stated, in relevant part, as follows :

[GOLDSTEIN] : First of all, let me say that our earnings for this quarter were a

disappointment. They were 11 cents a share, profit, compared to a Street estimateroughly of 18 cents a share, and that was before (ph) reflecting about nine cents a share

30

in the quarter, and about 15 cents a share on a year to date basis . As we will describe,we pushed some of this back to Q1 and Q2, for a total impact on a year to date basisof 15 cents per share relative to issues at our French subsidiary.

. . .the issues in France that we're talking about were discovered less than two

weeks ago, as we were in the process of closing our third quarter. In the past fewdays, last week, really, we took action to downsize the French operation . We also tookaction, as you've seen in the release today, to restate earnings by approximately one

cent for Q1, and about 3 .5 cents for Q2, and that's on a normalized tax basis . Dan will

be talking a little more about that later .

We believe the issue we uncovered in France was an anomaly as far as operations atIonics are concerned . What we discovered ourselves and what we communicatedto our outside auditors -- they didn 't discover this, we did -- were two improper,inaccurate recordings ofwhat essentially was a s ingle inter-company

[transaction] which was don e by the Controller at our French subs idiary. In

looking at the problems in France, the second issue we addressed was certainoverstaffing in France relative to current and expected future revenues .

I should point out that to a significant degree, th eproblem we had in France before

we recognized the inter-company transactions issue masked the operating

problem that we had there and pushed the resolution of staffing and overhead

reduction issuesfrom the end of Q3 --from the end ofQ2, when we should

have discovered it, to the end of Q3. In conjunction with our actions in informing our

auditors of the improper recording of the inter-company transactions I just mentioned,

which were caused by the failure of our subsidiary Control ler to fol low corporate

instructions, and his incorrect recording of inter-company transactions, we took the

fol lowing immediate actions in France . We fired the French Controller. We took action

to e l iminate 25 to 30 positions, which will take p lace, some immediate ly, and some over

the next two months, as well as portions of the facil ities they occupy .

Incidentally, these charges will result in a charge to earnings of somewhere between five

and six cents per share, total, in between either Q4 of this year, probably somewhat

more of it in Q4, and some in Q 1 of next year . We also took actions to redistribute

certain of the business activities we have in France to our other business groups . We

assigned our instrument activities there to our instrument business group, and our

ultra-pure water activities there to our ultra-pure water group, all this with the idea of

downsizing in France .

31

60. Defendants were also questioned concerning the adequacy of the Company's internal

controls :

[ANALYST] : [ . . .] it does feel like there have been a number of surprise issues from thevarious overseas operations, and I'm sure you'll tell me that I'm being unfair, but it doesfeel that not only us as shareholders/analysts get blindsided, but you as well by some ofthese things, whether it's Kuwait -- but whether it's Malaysia, or some of the otherissues in recent quarters, you know, Trinidad not going to plan . I guess my very large

picture question is, how well, now that you have -- you know, you've established some

new reporting systems, you've established a stronger financial team. You know, how

good of a handle do you really feel that you have on your entire operations, globally, at

this point? And obviously, the reason for the question is, you know, how much at risk

are we from these sorts of things of various types happening again?

ART GOLDSTEIN : Well, first of all, [ . . .] it's a good question, and let me say that wetake that question extremely seriously. One of the reasons we beefed up our internalaudit team, our controller team -- we hired a new manager of corporate accounting .We hired new controllers in our equipment business group and our ultra-pure watergroup was because Ionics, even though it's a relatively small company, is dealing withsome very interesting, challenging and wonderful opportunities in our business wherewe've been the pioneer. And, unfortunately, what comes with that is a fair amount ofcomplexity and we've been working very hard to get that complexity under control . [ . . . ]

It was our own fastidiousness with respect to dealing with this problem that reallyresulted in this report. In a way, it's a confirmation of the fact that the new glasses wepurchased to see things better, to see things more clearly, are actually working . And sowhile I can't tell you that there will never be another problem--and I don't think anyCEO in any company could say that--I feel pretty good about the systems we've put inplace, I feel pretty good about the new software package and consolidation packagewe've put in place, which worked for the first time this quarter, and I think--I'll knockwood as I say this, Debra (ph)--I think we're OK going forward . I don't expect to seethis kind of problem again. OFD11/5102 >

61 . Following this announcement, shares of Ionics fell $5 .01 per share, or more than 20% ,

to close at $19 .46 per share, on volume of more than 1 .7 million shares traded, or almost thirty times

the average daily volume . <YHO, P1>

The Truth Begins To Emerge

32

62. The Class Period ends on March 14, 2003, when the Company issued a press release

announcing its financial results for the fourth quarter and twelve-months ended December 31, 2002 .

The Company reported a loss of $0.1 lper share for the fourth quarter, excluding final price-adjustmen t

gains on the Aqua Cool sale of $0.21 per share . The Company's operating loss for the fourth quarter

reflected an increase of $2 .4 million, or $0 .06 per share, in Ionics' reserve for doubtful accounts an d

"higher than normal legal and accounting" costs of $0 .04 per share . Defendant Goldstein commented

on the Company's results :

[ . . .]the challenges confronted by the Company in the fourth quarter and throughout theyear resulted in earnings which were well below expectations . The challenges included :a lack of recovery in capital spending which particularly impacted water equipmentsales to industrial customers; a continuing decline in the microelectronics industry withonly the Asian market showing modest activity ; and the continuation of the Company'semphasis on the "build-own-operate" (BOO) model, which in many cases has the effectof removing capital equipment sales from the current period and spreading revenuesfrom the supply of water and related margin over future years . In addition, 2002revenues and earnings were reduced as a result of the sale of the Aqua Cool bottledwater business to Nestle at the end of 2001 and by higher than normal legal andaccounting expenses . <PR3/14/03 >

63 . Following this announcement the price of Ionics common stock fell approximately 5 %

to close at $16 .70 on March 14, 2003, in heavy trading of 1 .2 million shares . <YHO, PIS

Post-Class Period Disclosure s

64 . On March 31, 2003, the Company filed its annual report on Form 10-K for the fisca l

year ended December 31, 2002 . The Form 10-K revealed that, in connection with the audit of it s

2002 financial statements, the Company was advised by its independent auditor "that certain of its

internal controls had deficienc ies and material weaknesses." The Form 10-K stated in relevan t

part as follows :

33

In connection with the audit of its financial statements for 2002, the Company was

advised by its independent auditor that certain of its internal controls had deficienciesand material control weaknesses . Consequently, and with the goal of further improvingthe quality and timeliness of the information available to management, the Company iscontinuing to implement measures designed to address those deficiencies andweaknesses as follows :

o to evaluate and strengthen its financial and accounting staff

and their knowledge and understanding of key policies under

U.S. generally accepted accounting principles and of their

responsibilities;

o to improve monitoring controls to assure the prevention or detection ofmaterial accounting errors on a timely basis ;

o to reduce the time necessary to collect and report financial andoperating data by improving the timing and accuracy of forecasting andemphasizing more frequent reviews of the Company's balance sheetsand reconciliation of intercompany balances ;

o to continue to update its accounting policies and procedures .<10K2002 >

65 . The Form 10-K also disclosed for the first time the nature of the transactions that

caused the Company to restate its financial results for the first and second quarters of fiscal 2002. Prior

to this disclosure, defendants had merely described the transactions as "intercompany transactions tha t

were erroneously recorded at the [French] subsidiary level ." Defendants now revealed that th e

transactions related to "project cost overruns ." The Form 10-K stated in relevant part as follows :

The Company's conso lidated financial statements for the three months ended March31, 2002 and June 30, 2002 and the six months ended June 30, 2002 were restatedprimarily as a result of intercompany transactions including transactions between theCompany and its French subsidiary that were erroneously recorded at the subsidiarylevel . The restatement resu lted primarily from the French subsidiary's failure to properlyrecord intercompany adjustments necessary to correct errors on its books, whichbecame apparent to the Company's corporate management during the preparation o fthe Company's consolidated financial statements for the three- and nine-month periodsended Sep tember 30, 2002 . These adjustments primarily affected accounting

34

entries related to revenues from sales of spare parts and expenses related to

project cost overruns, sales support costs and severance costs. These

adjustments, which increased the historical pre-tax loss at the French

subsidiary in the quarters ended March 31, 2002 and June 30, 2002 and the

forecast of the French subsidiary's pre-tax lasses for the year ended December

31, 2002, resulted in the Company's determination that it was more likely than not thatthe Company would not fully realize future tax benefits associated with the Frenchsubsidiary's net operating losses. Accordingly, the Company's income tax expense andits effective annual tax rate for the three months ended June 30, 2002 were increased .[Emphasis added .] <i0K2002>

66. Regarding the Aqua Cool sale, the Form 10-K disclosed that the final purchase pric e

adjustment settled between the Company and Nestle reduced the selling price of the Aqua Coo l

operations by approximately $13 million from the initially reported sales price of $220 million .

< l OK2002> Though defendants have never admitted their participation in the scheme to overstat e

Aqua Cool's revenues and customer base in the months immediately preceding the sale, it is apparen t

that a major portion of the $13 million price reduction was the direct result of defendants '

overstatement of Aqua Cools's revenues and customer base through the delivery of unwanted bottle d

water products to its retail customers as detailed herein . <IB> The Form 10-K stated in pertinent par t

as follows :

As a result of final purchase price adjustments based on the number of customers andworking capital levels, and the resolution of certain claims made by Nestle, theCompany and Nestle reached final agreement on a purchase price of $207 .0 million inthe first quarter of 2003 . As a result of such adjustments, the Company realized anadditional pre-tax gain of $8.2 million in 2002, net of direct and incremental costs of thetransaction, including approximately $3 .4 million of non-recurring management andemployee compensation. <1QK2002>

Ionics' Financial Statements During the ClassPeriod Wer e Materially False Mis leading-

35

67 . At all relevant times during the Class Period, Ionics represented that its financial

statements were prepared in accordance with GAAP . <PF> GAAP are those principles recognized b y

the accounting profession as the conventions, rules, and procedures necessary to define accepte d

accounting practice at a particular time . As set forth in Financial Accounting Standards Boar d

("FASB") Statement of Concepts ("Concepts Statement") No. 1, one of the fundamental objectives o f

financial reporting is that it provide accurate and reliable information concerning an entity's financial

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

Financial reporting should provide information about an enterprise's financialperformance during a period . Investors and creditors often use information about thepast to help in assessing the prospects of an enterprise. Thus, although investment andcredit decisions reflect investors' and creditors' expectations about future enterpriseperformance, those expectations are commonly based at least partly on evaluations ofpast enterprise performance .

68. Regulation S-X [17 C .F.R. § 210.4-01(a)(1)] states that financial statements filed wit h

the SEC that are not prepared in conformity with GAAP are presumed to be misleading and inaccurate .

69. The representations that Ionics's financial statements were prepared in accordance wit h

GAAP were materially false and misleading because the defendants knew, or recklessly ignored that

the Company: (1) improperly inflated Aqua Cool's revenue in advance of its sale to Nestle <W6, W7>;

(2) improperly utilized the percentage-of-completion method of accounting ; and <W1, W2, W3, W4 ,

W5> (3) failed to disclose contingent liabilities and significant risks and uncertainties . <10K2002>

Each of these practices, which were sanctioned by high level management at Ionics, were, standing

alone, a material breach of GAAP . In the aggregate, they materially distorted Ionics' actual financial

performance during the Class Period, as the Company has now admitted . <pR11/5102, 1OK2002, JB>

Ionics' imprope r

36

Inflation Of Aqua-Cool Revenue

70. GAAP provides that revenue should not be recognized until it is realized or realizabl e

and earned . FASB Concepts Statement No . 5, T 83 . The conditions for revenue recognitio n

ordinarily are met when persuasive evidence of an arrangement exists, delivery has occurred or service s

have been rendered, the seller's price is fixed or determinable, collectibility of the sales price i s

reasonably assured and when the entity has substantially performed the obligations which entitle it to th e

benefits represented by the revenue . Generally, revenue should not be recognized until an exchange has

occurred and the earnings process is complete . A transfer of risk has to occur in order to effect an

"exchange" for the purposes of revenue recognition . SEC Staff Accounting Bulletin ("SAB") Na 101 ;

FASB Concept Statement Nos . 2 and 5; FASB Statement of Financial Accounting Standards

("SFAS") No . 48 ; Accounting Research Bulletin ("ARB") No . 43 ; and Accounting Principles Board

("APB") Opinion No . 10 .

71 . Ionics' December 31, 2001 financial statements disclosed that, with respect to it s

consumer water products :

[T]he Company follows the guidance provided by the Securities and ExchangeCommission's Staff Accounting Bulletin No . 101, "Revenue Recognition in FinancialStatements" (SAB 101) . The Company does not recognize revenue unless there ispersuasive evidence of an arrangement, title and risk of loss has passed to thecustomer, delivery has occurred or the services have been rendered, the sales price isfixed or determinable and collection of the related receivable is reasonably assured . Itis the Company's policy to require an arrangement with its customers, either i nthe form of a written contract or purchase order containing all of the terms

and conditions governing the arrangement, prior to the recognition of revenue .

Title and risk of loss generally passes to the customer at the time of delivery of the

product to a common carrier . At the time of the transaction, the Company assesses

whether the sale price is fixed or determinable and whether or not collection is

reasonably assured. The Company assesses whether the sale price is fixed or

determinable based upon the payment terms of the arrangement . If the sales price i s

37

not deemed to be fixed, revenue is recognized as the amounts become due from the

customer. The Company does not generally offer a right of return on its products and

the products are generally not subject to customer acceptance rights . The Company

assesses collectibility based on a number of factors, including past transaction and

collection history with a customer and the credit-worthiness of the customer . The

Company performs ongoing credit evaluations of its customers' financial condition but

generally does not require collateral from its customers . If the Company determines

that collectibility of the sales price is not reasonably assured, revenue is

deferred until such time as collection becomes reasonably assured, which isgenerally upon receipt ofpayment from the customer . The Company's productsare generally subject to warranty, and related costs are provided for in cost of saleswhen revenue is recognized. While the Company engages in extensive product qualityprograms and processes, the Company's warranty obligation is based upon historicalproduct failure rates and costs incurred in correcting a product failure . If actual productfailure rates or the costs associated with fixing failures differ from historical rates,adjustments to the warranty liability may be required in the period in which determined .[Emphasis Added] <1OK2001 >

72 . As illustrated in the chart below, prior to and during the Class Period, Ionics' rampe d

Ionics, IncorporatedAqua Cool Reven ue

200 1

March 2001 September 200 1June 2001 December 2001

3 8

up the sales of its consumer water products ahead of its sale of Aqua Cool to Nestle . <PF, PR>

22

21

20

° 19

18

17

16

73 . Unknown to investors however, the Company, in violation of GAAP and its publicl y

stated accounting policies, improperly recognized millions of dollars in revenue on "sales" to certain o f

its customers who never agreed to purchase Ionics' product . Indeed, defendants were motivated to

inflate the sales of such products as the amount the Company stood to realize on the sale of its Aqu a

Cool operations was predicated upon its financial performance and, as noted above, upon the numbe r

of its "Active Customers ." <W6, W7>

74. For example, according to a former Aqua Cool Accounts Receivable Clerk during th e

Class Period, word came from corporate headquarters in Watertown to all employees that they were

to deliver extra bottles of water to all Aqua Cool customers . The former Aqua Cool employee stated

that "All customers were to get an extra bottle, regardless of whether they wanted them or not.

They told all the delivery drivers to just go ahead and drop water . It was shady." The former

Aqua Cool employee explained that manager at the Company's DC office told her that corporat e

wanted to "rack up whatever sales they could before the sale (of Aqua Cool) . The more that

was on our books (in sales) the more money they made on the sale (to Nestle) ." The former

employee explained that customers were charged $5 to $7 . 50 per five gallon bottle, even though they

never ordered the water, and that Aqua Cool dumped "well over 10,000 bottles of water o n

customers in the DC area alone. " Meanwhile, the former employee stated that "customers called

scream ing, say ing `I don't want this. " <W6>

75 . This representation is confirmed by former employees in other parts of the U .S. For

example, a former Class Period operations manager in the Boston office of Aqua Cool stated tha t

39

shortly before Aqua Cool was sold to Nestle, Ionics "kind of fudged the books by increasing the

amount of th e customer base. " The former employee stated that Ion ics ordered each driver to

deliver an extra bottle of water and bill customers who had recently been inactive. These

were customers who received infrequent deliveries, such as once a month or every other

month cW7> .

76. Indeed, the above noted improper practice was sanctioned by and approval by th e

highest levels of Aqua Cool's management . In fact, this former manager stated that he was forwarde d

an e-mail from the Vice President in charge of Aqua Cool's U.S. Operations which directed

the heads of each of Aqua Cool's thirteen offices across the U.S. to make delivery of

unordered water produ c ts to the Company's "customers." The former manager explained that the

extra deliveries were called "white-ticket deliveries" because deliveries were normally invoiced on

blue tickets . "We paid the drivers an incentive of about $1 dollar per ticket to get this done . If

customers complained we said 'It 's free.' If they didn't we charged them for it. We were

averaging about 400-to-500 bottles a day in extra bottles . " <W7>

77 . The former manger said that the above practice was ongoing for about six weeks an d

that he complained about the practice in an e-mail sent to the Vice President of Aqua Cool at it s

corporate headquarters . Although the vice president did not respond such e-mail, the former manage r

was reprimanded by his superiors and told "to never contact the vice president again . "<W7>

78 . Defendants caused Ionics' to engage in this practice even though the Company's publi c

accounting policies state "It is the Company'spolicy to require an arrangement with its

customers, either in the form of a written contract or purchase order containing all of the

40

terms and conditions governing the arrangement, prior to the recognition of revenue and that

if the Company determines that collectibility of the sales price is not reasonably assured,

revenue is deferred until such time as collection becomes reasonably assured, which is

generally upon receipt of payment from the customer ." < 1 0K2001 >

79 . In the fourth quarter of 2002, defendants announced a settlement of price adjustment s

with Nestle that reduced Aqua Cool's price by $13 million, or almost six percent, from the initially

reported sales price of $220 million . <10K2002> Indeed, a material amount of such adjustment i s

directly the result of defendants' overstatement of Aqua Cools's revenues and customer base throug h

the delivery of unwanted bottled water products to its retail customers during the Class Period . QB>

Ionics' Improper UtilizationOf Percentage-Of-Completion Accounting

80 . Defendants engaged in other wrongful conduct to inflate the Company's revenue an d

operating results during the Class Period . For example, the former Vice President of the Company' s

European Operations stated that during 2001 Ionics improperly recorded revenue on Desalcott, the

Company's Trinidad affiliate . The former Vice President of the Company's European Operation s

stated that Ionics' Vice President of Finance explained to him that such revenue was recorded to offse t

cost overruns beings experienced on the project . <W4, W5>

81 . In addition, former Ionics employees, including a former Asian Division controller, sai d

that the Company improperly recognized revenue on long-term contracts accounted for using the

percentage-of-completion method . <W3>

82. GAAP, in the American Institute of Certified Public Accountants ("AICPA") Statemen t

of Position ("SOP") 81-1, Accounting for Performance of Construction-Type and Certain Production-

41

Type Contracts, provides that companies may use the "percentage-of-completion method" to recognize

revenue as work on contracts progresses toward completion so long as the company can

reasonably estimate the extent of progress toward completion, the amount of contract revenues and

the amount of contract costs. When reasonably dependable estimates cannot be made or when

inherent hazards make estimates doubtful, revenue is to be deferred until the contract is completed . See

SOP 81-1, ~¶ .04, .25 . In order to determine the amount earned on a contract for a period prior t o

completion, a company must determine the difference between total estimated contract revenue and

total estimated contract cost . See SOP 8 1-1, ¶¶ .22- .25, .79. When current estimates indicate an

overall loss on a contract, a provision for the entire loss should be made in the period in which the y

become evident . SOP 81-1,T.85 .

83 . In its December 31, 2001 financial statements, Ionics' represented the following wit h

regard to its revenue recognition method :

For certain contracts involving customized equipment eligible for contract accountingunder American Institute of Certified Public Accountants ("AICPA") Statement ofPosition No. 81-1, "Accounting for Performance of Construction-Type and CertainConstruction-Type Contracts" (SOP 81-1), revenue is recognized using the percentageof completion accounting method based upon an efforts-expended method . The natureof these contracts and the types of products and services provided are considered indetermining the proper accounting for a given contract . Long-term, fixed-pricecontracts are recorded on a percentage of completion basis using the cost-to-costmethod of accounting where revenue is recognized based on the ratio of costs incurredto estimated total costs at completion . The Company follows this method sincereasonably dependable estimates of the costs of the total contract can be made . As ageneral rule, sales and profits are recognized earlier under the cost-to-cost method ofpercentage of completion accounting compared to the completed contract method .Contract accounting requires significant judgment relative to assessing risks, estimatingcontract costs and making related assumptions regarding schedules and technical issues .Due to the size and nature of the Company's long-term contracts, the estimation of costat completion is complicated and subject to numerous variables . Contract costs includematerial, labor, subcontracting and other related costs . Assumptions must be made

42

relative to the length of time to complete the contract . With respect to contract changeorders, claims or similar items, judgment must be used in estimating related amounts andassessing the potential for realization . Such amounts are only included in the contractvalue when they can be reliably estimated and realization is reasonably assured,generally upon receipt of a customer-approved change order. Given the significance ofthe judgments and estimation processes described above, it is likely that materiallydifferent amounts could be recorded if different assumptions were used or if underlyingcircumstances were to change . The Company closely monitors compliance andconsistency of application of its critical accounting policies related to contractaccounting. In addition, reviews of the status of contracts are performed throughperiodic contract status and performance reviews. In all cases, changes to tota lestimated costs and anticipated losses, if any, are recognized in the period in whichdetermined. <1OK2001>

84. Contrary to these representations and contrary to GAAP and SEC Rules Ionic s

improperly recognized revenue utilizing the percentage-of-completion method on long-term contract s

during the Class Period when it was unable to make reasonably determinable estimates of costs a t

completion and/or determine the costs its incurred on such contracts . (W 1, W2, W3> Indeed, as it

has now admitted and as noted in detail herein, (See ¶¶ 43-44) material internal control deficiencies at

Ionics were pervasive during the Class Period. <1OK2402> As a result of such deficiencies, th e

Company was unable to estimate the cost to complete contracts and/or determine costs it incurred on

such contacts . <W2, W3, IB>

85 . In fact, the Company's former Asian . Division controller stated that revenue o n

contracts utilizing worthless estimates from people in operations that were not reviewed are examine d

by controllers in the Company's Accounting Departments . <W3>

86 . Other former Ionics employees confirm the Company's inability to reasonably estimat e

costs on long-term contracts . A former Vice President of European operations stated that Ionics

signed a contract with EDF to build a plant for $2 .2 million in Rio Bravo, Mexico, and that the projec t

43

was two years behind schedule with costs more than double what Ionics originally estimated.

<W5>

87 . In furtherance of defendants attempt to distort the Company's true financia l

performance, Ionics improperly shifted costs from one long-term contract to another . In this way,

Ionics avoided recording losses on unprofitable contracts while, at the same time, recording additio n

revenue on unrelated projects . <W2>

88 . As noted above, Ionics was required to reasonably estimate total production costs fo r

all projects that utilized the percentage-of-completion method of revenue recognition . At the end of

each accounting period, the percentage to which each of the Company's contracts is complete must b e

computed based on production costs incurred to date as a percentage of total estimated production

costs. This percentage must then be multiplied by the contract's total value to calculate the sale s

revenue to be recognized, as follows :

PRODUCTION COSTSINCURRED TO DATE

TOTAL ESTIMATEDPRODUCTION COSTS

X TOTAL _ RECOGNIZABLECONTRACT VALUE SALES REVENUE

89. Contrary to its publically stated policy of revenue recognition and GAAP, Ionic s

improperly overstated the Company's apparent revenue and income growth by inflating costs expende d

on certain contracts (thereby increasing the "numerator" in the percentage-of-percentage formula) ,

leading to improperly inflated revenues and earnings. <W1, W2, W3, TB >

90. To the detriment of unsuspecting investors, Ionics' management directed or knowingl y

condoned and encouraged the process of improperly allocated costs to unrelated projects, thereby

44

inflating reported revenue . In addition to inflating Ionics' reported revenue and earnings, this practice

provided the defendants with cover to avoid recording losses on those projects that were unprofitable a s

a result of cost overruns. <W2>

91 . For example, a former Ionics manufacturing engineer manager stated that the

Company's Treasurer and Executive Vice President admitted to routinely directing executive s

at the Company's operating units in the United States and abroad to "spread million s of dollars" of

purported sales revenues over various projects in differing years in order to make it appear that

the Company's operations were profitable . <W2>

92. This practice was confirmed by other former Ionics employees . For example, a former

Ionics' European Vice Presiden t estimated that five to six million dollars in losses on projects in

Kuwait and Trinidad were improperly charged to French and European operations . A former

French subsidiary controller stated that Ionics improperly transferred two million from the ED S

project in Trinidad to France . In addition, this former controller and a former Vice President o f

European operations each stated that tonics improperly transferred $4 million in costs on the EDF

project in Rio Bravo, Mexico to the Company's subsidiary in France . <W4, W5>

93. As a result of the accounting manipulations noted above, and its failure to comply wit h

GAAP and its publicly disclosed accounting policies, Ionics was able to falsely inflate its earnings during

the Class Period. <W1, W2, W3, W4, W5> Had Ionics complied with GAAP, its reported financial

results would have been materially d ifferent . <IB> In fact, Ionics has now admitted that its

operating income during the quarters ended March 31, 2002 and June 3 0, 2002 was overstated

by more than 53% and 41 %, respectively due to the incorrect recording of intercompany

45

transactions including project costs overruns related to the EDF project in Mexico .

<PR1 1/5/02, W4 , W5>

94. Indeed, Ionics' restatement of its Class Period financial statements is an admission that

the financial statements originally issued were materially false when made . Pursuant to GAAP, as se t

forth in APB Opinion No. 20, the restatement announced by Ionics was to correct material errors du e

to an oversight or misuse of facts which existed at the time the original financial statements were issued .

See APB No. 20 ¶ 13 .

95 . Moreover, since changes to accounting estimates do not give rise to restatements, th e

restatement of Ionics' financial statements issued during the Class Period is NOT an admission that the

Company incorrectly estimated the costs and/or revenues on the transactions at issue . Pursuant to APB

No . 20, ¶31, "a change in estimate should not be accounted for by restating amounts reported i n

financial statements of prior periods ." Thus, the restatement IS an admission by Ionics that the

financial statements it issued during the Class Period were incorrect based on information

known to defendants at the time and that the Company's previously issued financial results and it s

public statements regarding those results, including the Company's statements in its management

discussion and analysis section included in the Company press releases and Form 10-Q were materiall y

false and misleading. <B>

Ionics' Failure To Disclose Contingent

Liabilities And Significant Risks And Uncertaintie s

96. Defendants attempt to deceive investors during the Class Period is otherwise evidence d

by the failure of Ionics' financial statements to disclose its contingent liabilities and significant risks and

uncertainties in conformity with GAAP. <l OK2002, IB>

46

97. GAAP requires that financial statements disclose contingencies when it is at leas t

reasonably possible (ems., a greater than slight chance) that a loss may have been incurred . SFAS No .

5, ¶ 10. The disclosure shall indicate the nature of the contingency and shall give an estimate of the

possible loss, a range of loss, or state that such an estimate cannot be made . Id .

98. The SEC considers the disclosure of loss contingencies to be so important to a n

informed investment decision that it issued Article 10 -0 1 of Regulation S-X [17 C .F.R. § 214 .10-01] ,

which provides that disclosures in interim period financial statements may be abbreviated and need no t

duplicate the disclosure contained in the most recent audited financial statements, exce pt that "where

material contingencies exist, disclosure of such matters shall be provided even though a significant chang e

since year end may not have occurred . "

99. In addition, GAP requires that financial statements disclose significant risks an d

uncertainties associated with an entity's business . AICPA's SOP No . 94-6 .

100. In violation of GAAP, Ionics Class Period financial statements improperly failed t o

disclose the ongoing payment dispute between Ionics and its Desalcott affiliate in Trinidad . <10K2042>

Indeed, by June 30, 2001, Ionics had recorded millions of dollars in receivables with Desalcott .

Nonetheless, in violation of GAAP, Ionics financial statements improperly failed to disclose the existenc e

of such dispute or the potential adverse consequences to the Company resulting therefrom . < l OQ

6/30/02> Ultimately, after the Class Period, tonics admitted that "the Company resolved th e

outstanding payment matters that were in dispute with Desalcott relating to the construction

of the [desalination plant/facility. " < l OQ6 /30/03 > During an inves tor conference call on August

1, 2003, Douglas Brown, Ionics President and CEO, stated that the resolution of Ionics outstanding

47

payment d ispu te with Desalcott "hurt Ionics second quarter X2003] P&L. . . . "<FD8/ 1 /03>

101 . In addition, in an apparent attempt to mask evading U .S law, a former Ionics Vic e

President of European Operations stated that , Ionics form edfive to ten special purpose entities to

disguise payments made to Libya where the Company had transacted business for years . This

former employee stated that during thefourth quarter of 2001, lames wrote off about $lmillion

in bad debt that it accumulated over time for bribes and unpaid equipment delivered to Libya .

In addition, this former employee also stated that Ionics' office in Italy was "hiding payments

under the table to Iraq. "<W5 > Nonetheless, in violation of GAAP, Ionics financial statements durin g

the Class Period failed to disclose such contingent liabilities and significant risks and uncertainties or th e

potential adverse consequences ensuing therefrom .

102. As a result of the foregoing accounting improprieties, Ionics presented its financial result s

during the Class Period in a manner which violated numerous provisions of GAAP . In addition to the

accounting improprieties stated above, tonics presented its financial statements during the Class Perio d

in a manner which also violated at least the following provisions of GA .AP :

a. The principle that interim financial statements filed with the SEC are to b e

prepared in conformity with GAAP and "shall reflect all adjustments, which are, in the opinion necessar y

to a fair statement of the results for the interim periods presented ." (Article 10 of Regulation S-X [1 7

C.F.R. § 210.10-01]) ;

b. The concept that financial reporting should provide information that is useful t o

present and potential investors and creditors and other users in making rational investment, credit an d

similar decisions (Concepts Statement No . 1, ¶ 34) ;

48

c. The concept that financial reporting should provide information about the

economic resources of an enterprise, the claims to those resources, and the effects of transactions ,

events and circumstances that change resources and claims to those resources (Concepts Statement

d. The concept that financial reporting should provide information about ho w

management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for

the use of enterprise resources entrusted to it . To the extent that management offers securities of the

enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospectiv e

investors and to the public in general (Concepts Statement No . 1, ¶ 50) ;

e. The concept that financial reporting should provide information about a n

enterprise's financial performance during a period . Investors and creditors often use information abou t

the past to help in assessing the prospects of an enterprise . Thus, although investment and credi t

decisions reflect investors' expectations about future enterprise performance, those expectations are

commonly based at least partly on evaluations of past enterprise performance (Concepts Statemen t

No . 1, T 42) ;

f. The concept that financial reporting should be reliable in that it represents what it

purports to represent . That information should be reliable as well as relevant is a notion that is central to

accounting (Concepts Statement No . 2, 115 8-59) ;

g. The concept of completeness, which means that nothing is left out of the

information that may be necessary to ensure that it validly represents underlying events and condition s

(Concepts Statement No. 2, ~ 79) ;

49

h. The concept that conservatism be used as a prudent reaction to uncertainty to

try to ensure that uncertainties and risks inherent in business situations are adequately considered . The

best way to avoid injury to investors is to try to ensure that what is reported represents what it purports

to represent (Concepts Statement No . 2, 1195, 97) .

103 . In failing to file financial statements with the SEC which conformed to the requirements

of GAAP, Ionics repeatedly disseminated financial statements that were presumptively misleading and

inaccurate. Indeed, the numerous accounting violations detailed herein evidence the defendants intent t o

deceive investors during the Class Period and misrepresent the truth about the Company and it s

business, operations and financial performance to detriment of those who relied on them .

104. The Company's Class Period Forms 10-K and 10-Q filed with the SEC were als o

materially false and misleading in that they failed to disclose known trends, demands, commitments ,

events, and uncertainties that were reasonably likely to have a materially adverse effect on th e

Company's liquidity, net sales, revenues and income from continuing operations, as required by Item 303

of Regulation S-K. <IB>

Undisclosed Adverse Informatio n

105. The market for Ionics' common stock was open, well-developed and efficient at al l

relevant times. As a result of these materially false and misleading statements and failures to disclose ,

Ionics' common stock traded at artificially inflated prices during the Class Period . Plaintiff and other

members of the Class purchased or otherwise acquired Ionics common stock relying upon the integrit y

of the market price of Ionics' common stock and market information relating to Ionics, and have bee n

damaged thereby. <IB, LPG

50

106. During the Class Period, defendants materially misled the investing public, thereb y

inflating the price of Ionics' common stock, by publicly issuing false and misleading statements an d

omitting to disclose material facts necessary to make defendants' statements, as set forth herein, not false

and misleading . Said statements and omissions were materially false and misleading in that they failed t o

disclose material adverse information and misrepresented the truth about the Company, its business an d

operations, as alleged herein. <IB, LP>

107. At all relevant times, the material misrepresentations and omissions particularized in thi s

Complaint directly or proximately caused or were a substantial contributing cause of the damage s

sustained by plaintiff and other members of the Class . As described herein, during the Class Period ,

defendants made or caused to be made a series of materially false or misleading statements about Ionics '

business, prospects and operations . These material misstatements and omissions had the cause an d

effect of creating in the market an unrealistically positive assessment of Ionics and its business, prospects

and operations, thus causing the Company's common stock to be overvalued and artificially inflated at al l

relevant times . Defendants' materially false and misleading statements during the Class Period resulted i n

plaintiff and other members of the Class purchasing the Company's common stock at artificially inflate d

prices, thus causing the damages complained of herein . SIB, LPG

Additional Scienter A llegations

108. As alleged herein, defendants acted with scienter in that defendants knew that the publi c

documents and statements issued or disseminated in the name of the Company were materially false an d

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 o f

5 1

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 regardin g

Ionics, their control over, and/or receipt and/or modification of Ionics' allegedly materially misleadin g

misstatements and/or their associations with the Company which made them privy to confidentia l

proprietary information concerning Ionics, participated in the fraudulent scheme alleged herein . <]B, LP G

Applicability Of Presumption Of Reliance:Fraud-On-The-Market Doctrin e

109. At all relevant times, the market for Ionics' common stock was an efficient market fo r

the following reasons, among others :

(a) Ionics' stock met the requirements for listing, and was listed and actively traded on

the NYSE, a highly efficient and automated market ;

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

NYSE ;

(c) Ionics regularly communicated with public investors via established market

communication mechanisms, including through regular disseminations of press releases on the nationa l

circuits of major newswire services and through other wide-ranging public disclosures, such a s

communications with the financial press and other similar reporting services ; and

(d) Ionics was followed by several securities analysts employed by major brokerag e

firms who wrote reports which were distributed to the sales force and certain customers of their

respective brokerage firms . Each of these reports was publicly available and entered the publi c

marketplace .

110. As a result of the foregoing, the market for Ionics' common stock promptly digested

52

current information regarding Ionics from all publicly available sources and reflected such information in

Ionics' stock price . Under these circumstances, all purchasers of Ionics' common stock during the Clas s

Period suffered similar injury through their purchase of Ionics' common stock at artificially inflated price s

and a presumption of reliance applies . <IB, LP>

NO SAFE HARBOR

111 . The statuto ry safe harbor pro v ided for forward- looking statements under ce rtain

circumstances does not apply to any of the allegedly false statements pleaded in this complaint . <LP>

Many of the specific statements pleaded herein were not identified as "forward-looking statements "

when made . <PF, PR> To the extent there were any forward-looking statements, there were n o

meaningful cautionary statements identifying important factors that could cause actual results to differ

materially from those in the purportedly forward-looking statements . <PF, PR> Alternatively, to the

extent that the statutory safe harbor does apply to any forward-looking statements pleaded herein ,

defendants are liable for those false forward-looking statements because at the time each of those

forward-looking statements was made, the particular speaker knew that the particular forward-looking

statement was false, and/or the forward-looking statement was authorized and/or approved by an

executive officer of Ionics who knew that those statements were false when made. <PF, PR, LP>

FIRST CLAIM

Vio lation Of Section 10(b) O fThe Exchange Act Against And Rule lOb -5

Promulgated Thereunder Agains t All Defendants

112. Plaintiff repeats and realleges each and every allegation contained above as if fully se t

forth herein. <LP>

53

113, During the Class Period, defendants carried out a plan, scheme and course of conduct

which was intended to and, throughout the Class Period, did : (i) deceive the investing public, includin g

plaintiff and other Class members, as alleged herein; and (ii) cause plaintiff and other members of th e

Class to purchase Ionics' common stock at artificially inflated prices . In furtherance of this unlawfu l

scheme, plan and course of conduct, defendants, and each of them, took the actions set forth herein .

<LP>

114. Defendants (a) employed devices, schemes, and artifices to defraud ; (b) made untrue

statements of material fact and/or omitted to state material facts necessary to make the statements not

misleading; and (c) engaged in acts, practices, and a course of business which operated as a fraud an d

deceit upon the purchasers of the Company's common stock in an effort to maintain artificially high

market prices for Ionics' common stock in violation of Section 10(b) of the Exchange Act and Rul e

IOb-5 . All defendants are sued either as primary participants in the wrongful and illegal conduct charge d

herein or as controlling persons as alleged below . <LP>

115 . 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, operations and futur e

prospects of Ionics as specified herein . <LP>

116. These defendants employed devices, schemes and artifices to defraud, while i n

possession of material adverse non-public information and engaged in acts, practices, and a course o f

conduct as alleged herein in an effort to assure investors of Ionics' value and performance and continue d

substantial growth, which included the making of, or the participation in the making of, untrue statement s

54

of material facts and omitting to state material facts necessary in order to make the statements mad e

about Ionics 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 Ionic s

common stock during the Class Period . <LP>

117. Each of the Individual Defendants' primary liability, and controlling person liability, arise s

from the following facts : (i) the Individual Defendants were high-level executives and/or directors at th e

Company during the Class Period and members of the Company's management team or had contro l

thereof; (ii) each of these defendants, by virtue of his responsibilities and activities as a senior office r

and /or director of the Company was privy to and participated in the creation, development and repo rt ing

of the Company's internal budgets, plans, projections and/or reports ; (iii) each of these defendant s

enjoyed significant personal contact and familiarity with the other defendants and was advised of and had

access to other members of the Company's management team, internal reports and other data and

information about the Company's finances, operations, and sales at all relevant times ; and (iv) each of

these defendants was aware of the Company's dissemination of information to the investing public whic h

they knew or recklessly disregarded was materially false and misleading . <IB, based on PFD

118 . The defendants had actual knowledge of the misrepresentations and omissions o f

material facts set forth herein, or acted with reckless disregard for the truth in that they failed to ascertai n

and to disclose such facts, even though such facts were available to them . Such defendants' material

misrepresentations and /or omissions were done knowingly or recklessly and for the purpose and effect

of concealing Ionics' operating condition and future business prospects from the investing public an d

55

supporting the artificially inflated price of its common stock. As demonstrated by defendants '

overstatements and misstatements of the Company's business, operations and earnings throughout the

Class Period, defendants, if they did not have actual knowledge of the misrepresentations and omission s

alleged, were reckless in failing to obtain such knowledge by deliberately refraining from taking those

steps necessary to discover whether those statements were false or misleading . <LP>

119 . As a result of the dissemination of the materially false and m isleading information an d

failure to disclose material facts, as set forth above, the market price of Ionics' common stock wa s

artificially inflated during the Class Period. <LP> In ignorance of the fact that market prices of Ionics '

publicly-traded common stock were artificially inflated, and relying directly or indirectly on the false and

misleading statements made by defendants, or upon the integrity of the market in which the commo n

stock trades, 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 ,

plaintiff and the other members of the Class acquired Ionics common stock during the Class Period a t

artificially high prices and were damaged thereby . SIB, LP>

120. At the time of said misrepresentations and omissions, plaintiff and other members of th e

Class were ignorant of their falsity, and believed them to be true . Had plaintiff and the other members o f

the Class and the marketplace known the truth regarding Ionics' financial results, which were no t

disclosed by defendants, plaintiff and other members of the Class would not have purchased o r

otherwise acquired their Ionics common stock, or, if they had acquired such common stock during th e

Class Period, they would not have done so at the artificially inflated prices which they paid . SIB, LPG

121 . By virtue of the foregoing, defendants have violated Section 10(b) of the Exchange Act ,

56

and Rule 10b-5 promulgated thereunder. <LP>

122. As a direct and proximate result of defendants' wrongful conduct, plaintiff and the other

members of the Class suffered damages in connection with their respective purchases and sales of th e

Company's common stock during the Class Period . <LP>

SECOND CLAIM

Violation Of Section 20(a) O fThe Exchange Act Against the Individual Defendant s

123. Plaintiff repeats and realleges each and every allegation contained above as if fully set

forth herein . <LP>

124. The Individual Defendants acted as controlling persons of Ionics within the meaning o f

Section 20(a) of the Exchange Act as alleged herein . <LP> By virtue of their high-level positions, an d

their ownership and contractual rights, participation in and/or awareness of the Company's operation s

and/or intimate knowledge of the false financial statements filed by the Company with the SEC an d

disseminated to the investing public, the Individual Defendants had the power to influence and contro l

and did influence and control, directly or indirectly, the decision-making of the Company, including th e

content and dissemination of the various statements which plaintiff contends are false and misleading .

<PF> The Individual Defendants were provided with or had unlimited access to copies of th e

Company's reports, press releases, public filings and other statements alleged by plaintiff to b e

misleading prior to and/or shortly after these statements were issued and had the ability to prevent th e

issuance of the statements or cause the statements to be corrected . <IB>

125. In particular, each of these defendants had direct and supervisory involvement in the

day-to-day operations of the Company <PF> and, therefore, is presumed to have had the power to

57

control or influence the particular transactions giving rise to the securities violations as alleged herein, and

exercised the same . <LP>

126. As set forth above, Ionics and the Individual Defendants each violated Section 10(b )

and Rule I Ob-5 by their acts and omissions as alleged in this Complaint . By virtue of their positions a s

controlling persons, the Individual Defendants are liable pursuant to Section 20(a) of the Exchange Act .

As a direct and proximate result of defendants' wrongful conduct, plaintiff and other members of th e

Class suffered damages in connection with their purchases of the Company's common stock during th e

Class Period . SIB, LP>

WHEREFORE , plaintiff prays for relief and judgment, as fol lows :

(a) Determining that this action is a proper class action, certifying plaintiff as a clas s

representative under Rule 23 of the Federal Rules of Civil Procedure and plaintiffs counsel as Lea d

Counsel ;

(b) Awarding compensatory damages in favor of plaintiff and the other Class members

against all defendants, jointly and severally, for all damages sustained as a result of defendants '

wrongdoing, in an amount to be proven at trial, including interest thereon ;

(c) Awarding plaintiff and the Class their reasonable costs and expenses incurred in this

action, including counsel fees and expert fees ; and

(d) Such other and further relief as the Court may deem just and proper . <LP>

58

JURY TRIAL DEMANDED

Plaintiff hereby demands a trial by jury . <LP>

Dated: August 25, 2003BThomas G. ShapirdW6 #454684Theodore M. Hess-Mahan BBO #557109SHAPIRO , HABER & URMY75 State StreetBoston MA 0210 9(617) 439-3939

Liaison Counsel

CAULEY GELLER BOWMAN& RUDMAN, LLP

Samuel H. RudmanRussell J . Gunyan200 Broadhollow Road, Suite 406Melville, NY 11747(631) 367-7100

Lead Counsel

1 t ; CERTIFY THATA TRUE COPY ~FTHE ABO VEDOCUMENT WASSM IFO OFFOR EACH Oit1E~~R~[Il~ tai

59

Appendix A

WITNESSES CODE

Former Ionics Employee #1 - manufacturing engineering manager nW lthe Pittsburgh office from March 2000 to May 200 1

Former Ionics Employee #2 financial controller in the Pittsburgh W 2division from November 1990 to December 2000

Former Ionics Employee #3 - financial controller in the Asia divisi IW3from February 2001 to March 200 3

Former Ionics Employee #4 - financial controller of Ionics, S .A. W4until November 2002

Former Ionics Employee #5 -vice president of Ionics Europe W5from July 1998 to April 2002

Former Ionics Employee #6 - customer service and accounts W6receivable clerk at Baltimore-DC Aqua Cool division from Apri l1990 to December 2001

Former Ionics Employee #7 - former operations manager at Bosto W 7office of Aqua Cool from July 2001 to February 200 2

PUBLICLY DISSEMINATED DOCUMENTS CODE

Fair Disclosure Wire - Earnings Conference Call Transcript dated FD 1 1/5/02November 5, 2002

Fair Disclosure Wire - Earnings Conference Call Transcript dated FD8/110 3August 1, 2003

SEC FILINGS Code

Ionics' Public Filings with SEC (non-specific) PF

Ionics' Form 10-K for the year 2001 filed on March 29, 2002 1OK200 1

Ionics' Form 10-K for the year 2002 filed on March 31, 2003 10K2002

Ionics' Form 10-Q for the quarter September 30, 2001 filed on 10Q 913010 1

November 13, 2001

Ionics' Form 10-Q for the quarter March 31, 2002 filed on May 15 10Q3/31/02

2002

Ionics' Form 1Q-Q for the quarter June 30, 2002 filed on August 1 , 1 OQ6130/02

2002

Ionics' Form 10-Q for the quarter June 30, 2003 filed on August 1 , 10Q 6/30103

2003

Ionics' Form 8-K filed on J anuary 15, 2002 SK1/15/02

PRESS RELEASES Code

Ionics' Press Releases (non-speci fic) PR

Ionics' Press Release on October 25, 2001 PR10/25/0 1

Ionics' Press Release on December 3, 2001 PRI2/3/0 I

Ionics' Press Release on March 7, 2002 PR3/7/0 2

Ionics' Press Release on May 6, 2002 PR5/6/02

Ionics' Press Release on August 1, 2002 PR8/1/0 2

Ionics' Press Release on November 5, 2002 PR1 1/5102

Ionics' Press Release on March 14, 2003 PR3/14/03

APB, FASB & AICPA PRONOUNCEMENTS Code

Financial Accounting Standards Board Statement of Concepts Na . FASBNo. l

Financial Accounting Standards Board Statement of Concepts Na . FASBNo. 2

Financial Accounting Standards Board Statement of Concepts No . FASBNo. 5

Statement of Financial Accounting Standards No . 5 SFAS 5

Statement of Financial Accounting Standards No . 48 SFAS48

Accounting Research Bulletin No. 43 ARB43

Accounting Principles Board Opinion No. 10 APB10

Accounting Principles Board Opinion No. 20 APB20

American Institute of Certified Public Accountants Statement o f

Position 51-1 SOP81-1

American Institute of Certified Public Accountants Statement o f

Position 94-6 SOP94-6

SEC BEGS.

Regulation S-X SX

SEC Staff Accounting Bulletin No . 101 SEC101

MISCELLANEOUS CODE

Yahoo Historical Stock Price Report YHO

Public Information independently verifiable P I

Legal Proposition not requiring citation LP

Inference pleaded on Information and Belief and supported by IB

accompanying facts and investigation of counse l

Personal Knowledge PK

Plaintiffs' Trading Confirmation Slips TC

SHAPI P,o HABE R, V U P MY. LL P

Thomas G . Shapiro

Edward F. Haber

Thomas V . Urmy, Jr .

M i chelle H. Blauner

Theodore M . Hess-Mahan

Christine E . Morin

Todd. S . Heyman.

Matthew L . Tuccill o

VIA HAND DELIVERY

Bonnie Smith, Deputy ClerkUnited States District Court1 Courthouse WayBoston, MA 0211 0

Re : Deckler v. Ionics, Inc., et al.C . A . No: 03-CV-7 0393 (WGY)

Dear Bonnie :

, . ~

August 25, 2003

Counsel

Lawrence D. Shubow

Alfred J . O'Donovan

E-mail :

tshapiro@shulaw .com

I enclose herew i th for fi l ing the lead plaintiffs ' Amended Complaint .

Thank you for your attention to this mat ter .

Enclosurecc: Brian Pastuszenski (w/enclosure)

Sincerely yours ,

Theodore M . Hess- ahan

75 State Street, Boston, Massachusetts 02109 ( 617) 439-3939 Fax (617) 439-013 4

Attorn ey s at Law