Federal authorities are investigating whether former America Online Inc. executives David M. Colburn and Eric Keller intentionally misled accountants and others about a series of deals involving Homestore Inc. that improperly helped AOL pump up revenue, sources familiar with the probe said yesterday.
Homestore executives with knowledge of the deals have told federal law enforcement officials that Colburn and Keller, formerly top officials of AOL’s business affairs unit, concealed the complex nature of the transactions to artificially boost revenue, sources said. Among their allegations is the claim that Homestore paid firms for a service or product that it had no use for, then persuaded the firms to buy a similar amount of advertising on AOL. AOL, in turn, would share the ad revenue with Homestore, a California-based provider of residential real estate listings.
The “triangular” deals enabled AOL to meet internal financial targets, benefiting Colburn and Keller, and permitted Homestore to meet the quarterly financial expectations of Wall Street analysts, executives with knowledge of the deals have told federal authorities.
The ongoing investigation, conducted by the Securities and Exchange Commission, the FBI’s Washington field office, and federal prosecutors, is focusing not only on the deals themselves but also on whether Colburn and Keller concealed relevant information from AOL accountants, causing the deals to be recorded improperly on AOL’s and Homestore’s financial statements.
The probes are part of a larger investigation by federal authorities into AOL’s accounting for a series of unorthodox deals that took place before and after its merger with Time Warner Inc. in January 2001. Colburn and Keller have since been forced out of AOL, and the company has acknowledged that it improperly inflated revenue by $190 million. AOL, however, has not identified which deals contributed to the overstatement.
Before he was fired by AOL this summer, Colburn maintained that he was unaware of the details of Keller’s dealings with Homestore, sources said. But a private lawsuit filed earlier this month against Homestore by the California State Teachers’ Retirement System, the nation’s third-largest public pension fund, alleged that Colburn and Keller both knew about wrongdoing involving AOL’s deals with Homestore. The lawsuit’s claims are based on information from executives who worked for Homestore, sources said.
“AOL knowingly participated with Homestore in the fabrication of revenue,” the lawsuit alleges. “This was enormously important to Colburn and Keller’s department, and their internal positions at AOL.”
Colburn’s attorney, Roger C. Spaeder of Zuckerman Spaeder LLP, did not return a phone call for comment yesterday. Keller’s counsel, Everett “Kip” Johnson Jr. of Latham & Watkins, declined to comment. AOL Time Warner Inc. officials have said they are cooperating fully with the SEC and criminal investigators, whose probe is likely to continue for months. Colburn served as president of the business affairs unit, and Keller served as its executive vice president. The unit, which had independent dealmaking authority, has been disbanded.
One question facing Colburn and Keller, as well as prosecutors in the U.S. attorney’s office in the Eastern District of Virginia, is whether the executives would face criminal charges that could send them to prison. For that to happen, prosecutors need to prove beyond a reasonable doubt that the former executives knew they were breaking the law. That could prove difficult in a probe of alleged white-collar fraud involving complex accounting issues, lawyers familiar with the case said.
The SEC, which can fine executives and bar them from serving on corporate boards, has no criminal powers and is required only to show that individuals engaged in wrongdoing, without regard for whether they did so intentionally.
While the SEC and federal investigators are examining numerous transactions and thousands of pages of documents, AOL’s deals with Homestore have become central to the larger probe because a number of Homestore executives pleaded guilty to criminal charges earlier this year. In an effort to live up to their plea agreements, the executives are cooperating with prosecutors, and some of them have provided information to the California teachers pension fund.
According to the pension fund’s lawsuit, Homestore entered into illegal triangular transactions “concocted” by Keller and a Homestore official, “with the knowledge and approval of Colburn,” that inflated Homestore revenue by $15 million in the first quarter of 2001.
“At their core, each of these illegal transactions is structured to buy revenue,” the lawsuit claims. “It was agreed by the participants in this transaction that AOL would not document the agreement by the third party vendors to buy advertising from AOL.”
Homestore and AOL, which provides Internet access to 25 million subscribers in the United States, allegedly continued the unusual deals to inflate revenue during the second quarter of 2001. AOL and Homestore allegedly each reported $12 million in phony revenue.
The lawsuit also alleged that there was a deal valued at $200 million in which Homestore provided home and real estate content to AOL beginning in 2000. AOL in turn received stock in Homestore, but the transaction was predicated on a threefold increase in Homestore’s stock price. The deal put pressure on Keller and Homestore executives to prop up Homestore’s stock through sham transactions, the lawsuit claims. After AOL auditors challenged the deal, Keller insisted that Homestore meet new conditions that would permit AOL to record $50 million in revenue annually, the suit claims.