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December 15, 2004

AOL settles bubble accounting charges for $510 million

Time Warner Inc has said that it has settled, for over $510 million, long-running investigations by the US Department of Justice and Securities and Exchange Commission into improper accounting and abetting securities fraud at America Online in 2001.

By CBR Staff Writer

The charges relate, in the DoJ’s case, to accounting fraud allegedly committed at defunct B2B marketplace firm Inc and, in the SEC’s case, to the purchase of Bertelsmann AG’s stake in AOL Europe.

In both cases, the allegations center on a time when the online advertising market was taking a dive and AOL was struggling to keep its revenue up. The DoJ and SEC allege that the company tried too hard, unlawfully so.

The DoJ will file a criminal complaint against AOL over the alleged roles of some of its employees, not named, in accounting fraud and a subsequent cover-up at PurchasePro, which was an AOL business partner, in early 2000.

Under the settlement, AOL accepts responsibility for their conduct, pays a $60 million penalty, pays $150 million into a fund to settle shareholder litigation, and hires an independent monitor to review the company’s accounting controls.

In exchange, the DoJ will suspend prosecution for two years and then, if AOL has cooperated, drop it. If AOL fails to comply with the agreement, the deal is off and they are in a world of trouble, Deputy Attorney General James Comey told reporters.

Four PurchasePro executives have pleaded guilty to securities fraud charges and settled similar civil charges with the SEC over their role in the scam, which saw PurchasePro artificially boost revenue with the help of AOL employees.

According to the DoJ, PurchasePro, then one of an emerging group of hot B2B e-commerce brokers, paid AOL $70 million and one million warrants in March 2000 for a placement on AOL’s Netbusiness site.

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AOL would get a cut of sales it referred, but by September 2000 it had failed to send any revenue in PurchasePro’s direction, according to the DoJ’s complaint.

When the strategic partnership did not generate the expected revenues, AOL began to help PurchasePro meet its quarterly revenue objectives by directly buying products from PurchasePro that AOL did not want or need, the DoJ said.

In this way, AOL helped PurchasePro boost revenue falsely by $10 million in the last quarter of 2000 and $20 million in the first quarter of $10 million and AOL was able to record $20 million in the fourth quarter and $15m in the first quarter, the DoJ said.

According to the SEC complaint against the PurchasePro executives, PurchasePro engaged in at least three deals that were illegally accounted for due to reciprocal purchases or forged and post-dated contracts.

There was also a cover-up, the allegations continue, orchestrated by an un-named Senior Executive, that extended to the deletion of AOL-related emails, the shredding of documents, and the destruction of a laptop hard-disk, its remains raked into a garden.

Things started to fall apart for PurchasePro in early 2001. Its stock price halved in February that year after an article in Barrons made serious criticisms of its corporate governance and suggested that CEO Charles Johnson had ties to a convicted money launderer.

The company roundly denied the allegations, but Johnson quit in May 2001, following the period of the alleged fraud. His successor cut the firm’s workforce from 600 to 125 in his first two quarters. The firm went out of business in September 2002.

The settlements were not limited to these dodgy dealings with PurchasePro. Time Warner also settled with the SEC charges of improper accounting related to its buyout of AOL Europe, which included a reciprocal advertising deal with Bertelsmann.

AOL acknowledged in March last year that the SEC thought its accounting method here should have been to reduce the purchase price by the amount of advertising Bertelsmann agreed to buy, some $400 million, rather than as recording it as revenue.

In settling with the SEC, AOL pays a $300 million penalty into the SEC’s Sarbanes-Oxley-initiated Fair Fund investor compensation fund. It will also restate its 2001 and 2002 books to account properly for the revenue previously reported as ad sales.

The company also has to hire an independent examiner to look into ad transactions between 1999 and 2002 for evidence of further impropriety. The examiner would have to report back in six months. Further restatements then could be necessary.

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