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March 29, 2003
AOL Says S.E.C. Is Challenging Its Accounting
By DAVID D. KIRKPATRICK
AOL Time Warner disclosed yesterday that securities regulators investigating the company's accounting suspect that it improperly overstated its revenue by up to $400 million over two years, indicating that its accounting problems may be far worse than the company has previously acknowledged.
The figure in question is more than twice as large as a previous overstatement the company acknowledged last fall, potentially bringing the total to as much as $590 million.
Both the Securities and Exchange Commission and the Justice Department are investigating the possibility that the company's AOL Internet division fraudulently inflated its results, both before and after America Online's acquisition of Time Warner. The investigations have prompted several shareholder lawsuits contending that the company misled investors.
In a filing with the S.E.C. yesterday, AOL Time Warner disclosed that S.E.C. investigators had told the company that they think it improperly reported $400 million in revenue from a two-way deal with the German media conglomerate Bertelsmann. In 2000, America Online agreed to pay Bertelsmann $6.7 billion for its 50 percent stake in AOL Europe. As part of the deal, Bertelsmann agreed to buy $400 million in advertising from AOL, which acquired Time Warner in January 2001. The S.E.C. investigators contend, in essence, that the payment was more of a rebate on the larger payment than a genuine advertising sale and, thus, should have been deducted from the purchase price.
The allegations are significant, in part, because the agreement with Bertelsmann was negotiated at the top levels of both companies.
AOL Time Warner does not agree with the S.E.C.'s position on the Bertelsmann deal. In its filing, AOL Time Warner said:"The company and its auditors continue to believe that these transactions have been accounted for correctly. The company is engaged in ongoing discussions with the S.E.C." An AOL Time Warner spokesman declined to comment further yesterday.
AOL Time Warner has previously acknowledged overstating its results by about $190 million over six quarters by improperly accounting for a series of smaller transactions. In each case, AOL was both making payments to a business partner and receiving something in return, creating the potential to inflate the price it paid to get more back.
The practice, sometimes known as round-tripping, can improperly exaggerate both growth and earnings. Typically, round-tripping includes a hidden exchange; but both sides of the Bertelsmann deal were disclosed. At issue is the true value of the online advertising sold for $400 million.
Liz Young, a spokeswoman for Bertelsmann, said the company was not under investigation. She said the company was answering questions and cooperating with investigators.
In recent months, however, some current and former Bertelsmann executives have said on condition of anonymity that they questioned the company's deal with AOL. Executives at divisions of Bertelsmann, which operates BMG, the music company and mail order club, as well as the book publisher Random House and the magazine publisher Gruner & Jahr, have said that they were instructed by the company's headquarters to buy online advertising from AOL at inflated prices to fulfill the purchase commitment made as part of the larger transaction.
In a related investigation into accounting at the Internet company Homestore, one of the AOL division's business partners, some former Homestore executives have also told S.E.C. investigators that AOL executives talked about a pool of advertising spending from Bertelsmann, people involved in that investigation have said. The former executives of Homestore told investigators that their counterparts at AOL spoke of possibly allocating Bertelsmann's advertising spending to Homestore, which in turn paid money to AOL.
The company also disclosed that the S.E.C."is continuing to investigate a range of other transactions principally involving the America Online unit." AOL Time Warner had previously told investors that it did not expect any more restatements but could not predict the outcome of the S.E.C. investigation.
AOL Time Warner said that most of the disputed $400 million in the Bertelsmann deal was spent on online advertising. If AOL Time Warner lowers the reported advertising revenue of the AOL unit by $400 million for two years, through 2002, in addition to the previous reduction of $190 million over six quarters, it will erase a significant part of the division's profit. Online advertising revenue is almost all profit, and the AOL division reported an operating profit of $1.8 billion last year.
During 2001, the first year after the merger closed, AOL Time Warner portrayed the AOL division as the fast-growing engine that would supercharge the company's more traditional businesses. Since then, however, the AOL division's growth has collapsed. And its accounting problems have cast a shadow over the company as a whole.
In another filing yesterday, AOL Time Warner disclosed that Daniel F. Akerson, previously chairman of XO Communications, had resigned as a director. Mr. Akerson joined the Carlyle Group, the investment company. His resignation reduces the number of directors to 13 and the number of directors from the AOL side of the merger to 5.