The Securities and Exchange Commission filed civil fraud charges against eight former executives of AOL Time Warner Inc. for their roles in an accounting fraud that caused the company to overstate its advertising revenue by more than $1 billion.
The SEC alleges that during the two years between 2000 and 2002, John Michael Kelly, former CFO of AOL Time Warner; Steven E. Rindner, former senior executive in the company’s business affairs unit; Joseph A. Ripp, former CFO of the company’s AOL division; Mark Wovsaniker, former head of accounting policy, engineered, oversaw, and executed fraudulent round-trip transactions in which AOL Time Warner effectively funded its own advertising revenue by giving purchasers the money to buy online advertising that they did not want or need.
Kelly’s defense attorney, Jonathan Tuttle, responded to the government’s complaint by stating that his client “flatly denies the SEC’s claims and will vigorously defend himself in the courts. We are disappointed that the SEC has decided to make these allegations against Mr. Kelly, particularly given the significant length of time that has passed since the events in question.”
Similarly, Wovsaniker’s attorney, Steve Topetzes, told CFO.com that, “it is unfortunate that the SEC brought this action, particularly after the inordinate delay.” He continued: “Mark Wovsaniker engaged in no wrongdoing. Indeed, the federal government called him as a witness in several related cases to show that he actively sought to prevent inappropriate conduct by others, and that various persons acted contrary to his instructions.”
The SEC also settled charges against James F. MacGuidwin, a former controller of AOL Time Warner, and three former members of the company’s business affairs unit — David M. Colburn, the head of the unit, Eric L. Keller, former senior manager, and Jay B. Rappaport, former senior manager.
The commission asserted that online advertising revenue was a key measure by which analysts and investors evaluated the company. Referring to the individuals that have not settled with the government, the SEC noted that “The defendants made or substantially contributed to statements to investors that included the company’s fraudulent financial results.”
Kelly and Wovsaniker, both certified public accountants, also are charged with misleading the company’s external auditor about the fraudulent transactions.
The complaint seeks injunctive relief, disgorgement of ill-gotten gains plus prejudgment interest, civil monetary penalties, and officer and director bars against each of them. The SEC elaborated that from at least May 2000 through at least 2002, each of the four individuals — Kelly, Rindner, Ripp, and Wovsaniker — took part in at least one of three types of questionable advertising transactions.
The first deal cited by the SEC involved vendor transactions in which AOL agreed to pay inflated prices for, or forgo discounts on, goods and services it purchased in exchange for the vendors’ purchases of online advertising. The additional money AOL paid was equal to the markup or forgone discount.
The SEC also cited a “business acquisitions” transaction, in which AOL increased the price it paid to buy businesses in exchange for the sellers’ purchase of online advertising in the amount of the purchase-price increase. The final transaction was related to settlements of business disputes. In those deals, AOL converted the settlements of business disputes and legal claims into online advertising revenue.
“Those transactions deceived the investing public until at least the end of 2003 by masking the Company’s true financial results,” the SEC asserted in its complaint.
The investigation, launched six years ago, is tangentially related to two other fraud cases brought by the SEC against a pair of AOL vendors, the defunct software company PurchasePro.com and real estate listings site Homestore.com.
Topetzes and Ripp were both government witnesses in the PurchasePro trial, according to people familiar with the cases. In fact, both defendants reportedly had been called “white hats” by prosecutors because they blew the whistle on AOL vendor deals that did not properly recognize revenue and inflated sales.
For his part, Ripp, a Time Warner veteran, was sent to AOL after it merged with Time Warner in 2000. At the time, Ripp had about four-and-a-half years left on his five-year contract, and reportedly would not have a job at the newly merged company once his contract expired. “Joe Ripp is the last guy at AOL Time Warner that anyone should accuse of being responsible in a fraud. He was sent to the AOL division, and within a short time there, he initiated an internal investigation to expose fraud,” Ripp’s attorney David Geneson, told CFO.com.
According to Geneson, Ripp’s testimony led to two federal prosecutions. “He is the guy at AOL who was fixing problems, not creating them. There is no question that this lawsuit is just plain wrong,” asserted Geneson.
Mark Hulkower, the defense attorney for Rindner, had a similar reaction to the SEC complaint. “Mr. Rindner is a decent and honorable young man who conducted himself appropriately during his three years at AOL. While he is disappointed that the SEC has decided to pursue this unjustified course of action, he looks forward to the opportunity to clear his name.”
The four executives that settled with the SEC did so without admitting or denying the allegations in the complaint. All four agreed to permanent injunctions against future violations of certain securities rules and to pay disgorgement and prejudgment interest and civil penalties.
MacGuidwin will pay disgorgement and prejudgment interest of $2.1 million and a penalty of $300,000. He also agreed to be barred from serving as an officer or director of a public company for seven years. Colburn will pay disgorgement and prejudgment interest of $3.2 million and a penalty of $750,000. He also agreed to be barred from serving as an officer or director of a public company for 10 years.
Rappaport will pay disgorgement and prejudgment interest of $493,600 and a penalty of $250,000, while Keller will pay disgorgement and prejudgment interest of $699,900 and a penalty of $250,000.
In March 2005, Time Warner agreed to pay $300 million in civil penalties to settle similar charges that it overstated Internet subscribers and Internet advertising revenue. The media giant also consented to restate its results to reduce its online advertising revenues by roughly $500 million — in addition to the $190 million already restated at the time — for the fourth quarter of 2000 through 2002 and to properly reflect the consolidation of AOL Europe in the company’s 2000 and 2001 financial statements.
In addition, Time Warner agreed to hire an independent examiner to determine whether the company’s historical accounting for certain transactions conformed with generally accepted accounting principles.
In a separate administrative proceeding issued in 2005, three Time Warner finance executives — CFO Wayne H. Pace, controller James W. Barge, and deputy controller Pascal Desroches — consented to a cease-and-desist order that found them responsible for violations of the reporting provisions of the federal securities laws. The SEC said at the time that when approving Time Warner’s accounting for $400 million — paid to the company by Bertelsmann AG in two sets of transactions — as advertising revenue, the three finance executives “failed to pursue facts and circumstances that evidenced the true economic substance of the transactions.”
Even though others were responsible for negotiating the transactions, Pace, Barge, and Desroches “each were a cause” of Time Warner’s improper accounting for the $400 million, according to the commission. Time Warner, Pace, Barge, and Desroches agreed to settle without admitting or denying the allegations.
On Friday, PurchasePro founder Charles E. Johnson was convicted of stock fraud and obstruction of justice when he was found guilty of misleading investors by inflating revenue. Johnson’s lawyers criticized the judgment according to the Washington Post, calling two witnesses — other convicted PurchasePro executives — “unreliable.” It is unclear whether Johnson will appeal the conviction.