US federal stock market regulator Securities and Exchange Commission yesterday said eight former executives of AOL Time Warner Inc. fraudulently inflated the company's online advertising revenues by more than $1 billion between 2000 and 2002.
Four of the executives have agreed to settle the civil charges brought by the Securities and Exchange Commission (SEC) by paying a total of roughly $8 million in fines and returning allegedly ill-gotten gains. They are David Colburn, Eric Keller, Jay Rappaport and James MacGuidwin. Colburn had been head of the business affairs unit in which Keller and Rappaport also worked, while MacGuidwin had been company controller.
The quantum of punishment handed out to the four executives who settled varied widely. While MacGuidwin will pay $4 million and be banned from serving as a company director for 10 years, the corresponding figures for Colburn are $2 million and seven years. The relatively junior Keller and Rappaport have been fined $1 million each.
The SEC charges are pending against the other four: John Michael Kelly, former AOL Time Warner chief financial officer, Joseph Ripp, ex-chief financial officer of the AOL division, Steven Rindner, a former senior executive in the business affairs unit, and Mark Wovsaniker, former head of accounting policy.
The SEC alleged that between 2000 and 2002 the eight men had produced or contributed to financial statements that inflated advertising results. At that time, AOL had just bought Time Warner for $164.7 billion and the newly merged firm was under pressure to prove its financial viability, when the dotcom bubble had burst and similar firms were going bankrupt.
The SEC, which began investigating the firm in 2002, also claims that AOL Time Warner used various "elaborate accounting schemes" to boost online ad revenue figures. These included so-called "round trip" transactions, where the firm bought extra adverts for clients including Sun Microsystems, WorldCom, Veritas Software and Hewlett-Packard to try to boost figures further. In those agreements, AOL allegedly paid the companies to buy online advertising space from AOL, booking the proceeds as revenue.
The roundtrip tactics became known among executives as "BA Specials," a reference to the business affairs group run by Colburn, an eccentric star lawyer who was the company's chief dealmaker.
The lawsuits claim that the AOL Time Warner executives "knowingly or recklessly engineered, oversaw and executed a scheme to artificially and materially inflate the company's reported online advertising revenue".
The lawsuits were the result of a drawn-out investigation by the SEC that began in 2002 after a Washington Post report on a series of unconventional deals involving the online giant. In 2005, AOL's parent company, Time Warner, reached its own settlement with the SEC, agreeing to pay $300 million.
Additionally, it paid $210 million to resolve charges of criminal securities fraud in a separate investigation by the Justice Department. Time Warner also agreed to restate three years of financial results and to open its books to an independent examiner.
The restatements reduced Time Warner's profits by about $1 million in 2000 and $161 million in 2001, while increasing its profits by about $62 million in 2002, $18 million in 2003, $30 million in 2004 and $16 million in 2005. For the first six months of 2006, the restatement raised its earnings by $15 million.
The SEC, in a civil lawsuit filed in federal court in Manhattan, said the eight former executives either made or contributed to financial statements that distorted the company's results
"From our perspective, this is one of most egregious accounting frauds in recent memory," said Scott W Friestad, associate director of the SEC's enforcement division.
The SEC contended that all eight executives participated in the alleged shams and that the four who declined to settle - Kelly, Ripp, Rindner and Wovsaniker - took part in at least one of three types of accounting maneuvers.
In one alleged scheme, AOL is said to have offered to pay higher prices for goods and services from vendors, who in exchange promised to buy online advertisements on the Web site. Another tactic involved business mergers, in which AOL allegedly agreed to increase the price it paid to buy a company as long as the firm in turn agreed to buy advertisements on AOL's site. AOL also allegedly took proceeds from legal settlements and counted them as advertising revenue, according to the SEC.
Attorneys for defendants Kelly, Ripp, Rindner and Wovsaniker said the men did not settle with the SEC because they were not involved in the wrongdoing. Moreover, attorneys for Ripp and Wovsaniker tried to paint the two accused as collaborators in the investigation.
Ripp and Wovsaniker served as witnesses in separate federal cases against former AOL employees engaged in illegal accounting, which showed that the defendants tried to expose the malfeasance of other executives, their attorneys said.
However, the SEC said it has e-mails and other evidence to back up its allegations. One such piece of evidence is a note from Kelly to Wovsaniker in which he asks what "other round trips do you have coming down the line?" This was in May 2003, after which Kelly had talked about the inflated results, exposing his complicity in the matter, the SEC charged.