UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
02 MDL Docket No. 1500 (SWK) ALL CASES LISTED ON IN RE AOL TIME WARNER, INC. EXHIBIT A SECURITIES & "ERISA" LITIGATION
AMENDED CONSOLIDATED CLASS ACTION COMPLAINT OF LEAD PLAINTIFF MINNESOTA STATE BOARD OF INVESTMENT ON BEHALF OF PURCHASERS AND ACQUIRERS OF AMERICA ONLINE, INC . AND AOL TIME WARNER, INC. PUBLICLY TRADED SECURITIE S
MEREDITH COHEN GREENFOGE L HEINS MILLS & OLSON, P .L.C. & SKIRNICK, P.C. 3550 IDS Center One Liberty Plaza, 35th Floor 80 South Eighth Street,, New York, NY 10006 Minneapolis, MN 55402 (212) 240-0020 (612) 338-460 5 (212) 240-0021 Fax (612) 338-4692 Fax
Attorneys for Lead Plaintiff Minnesota Attorneys for Lead Plaintiff Minnesota State Board of Investment and Local State Board of Investment and Lead Counsel for the Class Counsel for the Clas s
40699 .1 TABLE OF CONTENTS
1. INTRODUCTION ...... 1
II. NATURE OF THE ACTION ...... 1 1
III. JURISDICTION AND VENUE ...... 1 3
IV. PARTIES ...... 14
A. Plaintiffs ...... 14
1 . Lead Plaintiff ...... 14 2. Additional Plaintiffs...... 1 5
B . Defendants ...... 16
1 . AOL Time Warner, Inc...... 16 2. America Online, Inc...... 16 3 . Time Warner, Inc...... 17 4. The Individual Defendants ...... 17
a. Stephen M. Case ...... 1 8 b. Robert W. Pittman...... 1 8 c. J. Michael Kelly...... 19 d. David M. Colburn...... 19 e. Eric Keller ...... 1 9 f. Joseph A. Ripp ...... 20 g. Myer B erlow...... 20 h. Barry Schuler...... 20 i. Steven Rinder ...... 20 j. Kenneth J. Novack...... 2 1 k. Gerald M. Levin ...... 2 1 1. Richard D. Parsons ...... 2 1 M. Wayne H. Pace ...... 22
5. Additional Individual Defendants ...... 24
a. Paul T. Cappucio ...... 24 b. Miles R. Gilburne ...... 25 c. James W. Barge ...... 25 d. Daniel F. Ackerson ...... 25 e. Stephen F . Bollenbach...... 26 f. Frank J. Caufield ...... 26 g. Franklin D. Raines ...... 26
i 6. Ernst & Young LLP ...... 26
7. Underwriter Defendants...... 27
a. Morgan Stanley & Co...... 27 b. Salomon Smith Barney Inc...... 28 c. Citigroup, Inc ...... d. Banc of Ame rica Securities LLC ...... 30 e. J.P. Morgan Chase & Co ...... 3 1
V. CLASS ALLEGATIONS ...... 32
VI. SUBSTANTIVE ALLEGATIONS ...... 35
A. The Growth of AOL and Its Emphasis on Increasing Advertising Revenue ...... 35
B. The Constant and Increasing Pressure to Falsify Advertising Revenue ...... 41
C. The Creation of AOL Time Warner and the Additional Pressur e to Report Growing Advertising Revenue ...... 44
D. AOL's Pattern and History of Accounting Improprieties...... 46
E. Fraudulent Transactions and Improper Accounting Used t o Artificially Inflate AOL and AOL Time Warner Advertising Revenue...... 48
1 . Use of Sham Transactions and Improper Accounting Practices Regarding Round-Tripping, Back-to-Back, and Boomerang Deals ...... 56
2. Barter Transactions ...... 57
a. Exchange of Advertising for Goods and/or Services ...... 5 8
b. Warrants or Stock (equity) Received in Barter or Partial Barter Transactions ...... 61
c. Exchange of Advertising - "In Kind" Advertising ...... 62
(i) Homestore, Inc ...... 64 (ii) Sun Microsystems, Inc...... 68 (iii) Veritas Software Corporation ...... 70 (iv) Bertelsmann AG...... 72 (v) Gateway Inc. Roundtrip/Free Internet Service ...... 74 (vi) WorldCom Inc ...... 75
ii (vii) Qwest Communications ...... 77 (viii) Hughes Electronics Corporation ...... 78 (ix) Homestore-The 2000 House and Home Deal ...... 80 (x) Gateway Inc Stock Purchase ...... 82 (xi) Oxygen Media Inc. Stock Purchase ...... 84 (xii) PurchasePro.com, Inc. Advertising Swap ...... 85 (xiii) Monster.com ...... 87
3 . "Front Loading" or "Jackpotting" to Record Advertising Revenue ...... 88
(i) Catalina Marketing Corporation ...... 88 (ii) Telefonica SA ...... 89
4. Converting Legal Disputes into Advertising Revenue ...... 9 1
(i) 24dogs.com Arbitration Award ...... 91 (ii) Ticketmaster Legal Action ...... 92
5 . Booking Sales on a Gross Rather Than Net Basis to Inflate Advertising Revenue ...... 93
eBay ...... 94
6. Counting Repricing of Equity Stock Rights as Advertisin g Revenue...... 95
PurchasePro ...... 95
7. Converting Contract Termination Fees into Advertising Revenue...... 97
Dr.Koop.com ...... 98
8. "Cross-Platform" Deals to Inflate Advertising Revenue ...... 99
(i) The Golf Channel ...... 100 (ii) Oxygen Media-Carriage Deal ...... 102
F. The Company's Admissions of Materially Overstated Advertising Revenue and Violations of the Securities Laws ...... 103
G. The Materially False and Misleading Statements, Omissions of Material Fact and Devices , Schemes or Artifices to Defraud Regarding Artificially Inflated Advertising Revenue ...... 105
iii a. The Fiscal Quarter Ended December 31, 1998 ...... 106 b. The Fiscal Quarter Ended March 31, 1999 ...... 109 c. The Fiscal Quarter and Year Ended June 30, 1999 ...... 11 2 d. The Fiscal Quarter Ended September 30, 1999 ...... 11 5 e. The Fiscal Quarter Ended December 31, 1999 ...... 11 8 f. The Fiscal Quarter Ended March 31, 2000 ...... 123 g. The Fiscal Quarter and Year Ended June 30, 2000 ...... 128 h. The Fiscal Quarter Ended September 30, 2000 ...... 13 3 i. The Fiscal Quarter and Year Ended December 31, 2000 ...... 13 9 j. The Fiscal Quarter Ended March 31, 2001 ...... 149 k. The Fiscal Quarter Ended June 30, 2001 ...... 15 8 1. The Fiscal Quarter Ended September 30, 2001 ...... 163 M. The Fiscal Quarter and Year Ended December 31, 2001 ...... 165 n. The Fiscal Quarter Ended March 31, 2002 ...... 168 o. The Fiscal Quarter Ended June 30, 2002 ...... 169
H. The Materially False and Misleading Statements , Omissions of Material Fact and Devices, Schemes or A rtifices to Defraud Regarding AOL Time Warner's Goodwill ...... 173
I. Defendants' Course of Conduct is Revealed ...... 188
J. Scienter of the Individual Defendants ...... 194
The Individual Defendants Knew, or Recklessly Disregarded, that AOL and AOL Time Warner Were Engaged in Fraud and Were Motivated to Use and Cover Up the Use of Improper Accounting and Sham Transactions to Artificially Inflate Advertising Revenue ...... 194
a. The Individual Defendants Were Actively Engaged in the Company's Daily Activities Such That They Were Aware Of, Recklessly Disregarded, Controlled and/or Culpably Participated in the Fraudulent Activities of the Business Affairs Division ...... 195
b. The Nature of the Accounting Improprieties and Sham Transactions ...... 20 1
c. Whistleblowers Provide Further Evidence of Individual Defendants' Knowledge ...... 203
d. The Prior Pattern of Improper Accounting Practices...... 205
C. Defendants' Restatement of AOL's Advertising Revenue
1v and GAAP Violations Provide Evidence of Scienter ...... 206
f. The Individual Defendants ' Awareness of Improper Deals and Continued Denial of Any Wrongdoing After the Truth is Revealed...... 207
2. Motive and Opportunity of the Individual Defendants to Engage in Improper Accounting, Sham Transactions and Reporting o f Inflated Advertising Revenue ...... 208
a. Salaries, Bonuses, Stock Sales - The Culture of Greed Begins ...... 208
b. The Shift to Flat Rate Pricing and the Increased Importance of Advertising Revenue to AOL's Bottom Line ...... 209
c. A Culture of Recklessness and Greed ...... 21 0
d. The Importance of Initiating, Consummating and Successfully Implementing the Merger ...... 214
e. Defendants' Financial Incentives Related to the Merger ...... 217
f. The Individual Defendants Deny and Cover Up Problems Associated with Shrinking Advertising Revenue ...... 218
3. Individual Defendants' Compensation Incentives ...... 221
K. Scienter of Ernst & Young...... 226
1 . Ernst & Young's Work for AOL, Time Warner and AOL Time Warner ...... 227
2. Ernst & Young's Close Relationship with AOL Time Warner ...... 227
3 . Ernst & Young's Auditing Expertise and Industry Knowledge ...... 229
4. Ernst & Young's Actual Knowledge of Specific Transaction s and Accounting Thereof ...... 229
5. The Restatement of AOL's and AOL Time Warner's Financial Statements ...... 23 1
6. Ernst & Young's Past Involvement with Previou s Accounting Frauds ...... 232
v 7. Ernst & Young's Responsibilities as AOL's and AOL Time Warner' s Independent Auditor ...... 23 3
8. Ernst & Young's Violations of Accounting and Auditing Standards...... 234
a. Ernst & Young Failed to Properly Consider Fraud ...... 236
b. Ernst & Young Failed to Maintain Independence ...... 244
c. Ernst & Young Violated GAAS by Reporting that the Financial Statements Were Presented in Accordance with GAAP When They Were Not ...... 244
d. Ernst & Young Failed to Obtain Sufficient and Competent Evidential Matter ...... 245
e. Ernst & Young Failed to Exercise Due Professional Care and Professional Skepticism ...... 247
f. Ernst & Young Failed to Properly Plan and Supervise ...... 247
g. Ernst & Young Failed to Properly Evaluate Audit Findings ...... 249
h. Ernst & Young Failed to Properly Consider AOL an d AOL Time Warner's Lack of Internal Control ...... 250
L. The Materially False and Misleading Statements and Omissions of Material Facts In the Merger Registration Statemen t and Joint Proxy Statement-Prospectus ...... 25 1
M. The Materially False and Misleading Statements and Omissions of Material Facts in AOL Time Warner's Bond Registration Statement for the April 2001 and April 2002 Bond Offerings ...... 259
VII. APPLICABILITY OF PRESUMPTION OF RELIANCE : FRAUD-ON-THE-MARKET DOCTRINE ...... 265
VIII. NO SAFE HARBOR ...... 267
IX. COUNTS ...... 267
COUNT ONE...... 267
Against AOL Time Warner for Violations of § 11 of th e
vi Securities Act in Connection With the Merger Registration Statement ...... 267
COUNT TWO ...... 269
Against Defendants Case, Levin, Kelly, Cappuccio, Novack and Pittman for Violation of Section 11 of the Securities Act in Connection with the Merger Registration Statement ...... 269
COUNT THREE ...... 27 1
Against Ernst & Young for Violations of § 11 of the Securities Act in Connection With the Merger Registration Statement ...... 27 1
COUNT FOUR ...... 273
Against Morgan Stanley for Violations of § 11 of the Securities Act in Connection With the Merger Registration Statement ...... 273
COUNT FIVE ...... 274
Against AOL Time Warner for Violations of § 11 of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto ...... 274
COUNT SIX ...... 276
Against Defendants Akerson, Barge, Bollenbach, Cappuccio , Case, Caufield, Colburn, Gilburne, Keller, Kelly, Levin, Novack, Pace, Parsons, Pittman, Raines, Ripp and Schuler for Violations of § 11 of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto ...... 276
COUNT SEVEN ...... 278
Against Defendant Ernst & Young for Violations of § 11 of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto ...... 278
COUNT EIGHT...... 2 80
Against the Underwriter Defendants Morgan Stanley, Salomon Smith Barney, Citigroup, Inc., Banc of America, and J.P. Morgan for Violations of § 11 of the Securities Act in Connection with the Bon d Registration Statement and Prospectus Supplements Thereto ...... 280
COUNT NINE ...... 282
vii Against Defendant AOL Time Warner for Violations o f § 12(a)(2) of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto ...... 282
COUNT TEN ...... 283
Against Individual Defendants Levin, Kelly, Barge, Case, Caufield, Parsons, Pittman, Novack, Akerson, Bollenbach, Gilburne, Raines , Schuler, Ripp, Cappuccio and Pace for Violations of Section 12(a)(2) of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto ...... 283
COUNT ELEVEN ...... 285
Against Underwriter Defendants Morgan Stanley, Salomon Smith Barney, Citigroup, Inc., Bane of America, and J .P. Morgan for Violations of Section 12(a)(2) of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto ...... 285
COUNT TWELVE ...... 287
Against Defendants Case, Pittman, Kelly, Colburn, Ripp, Berlow, Schuler, Novack, Levin, Parsons and Pace for Liability Under § 15 of the Securities Act For Violations of § 11 of the Securities Act...... 287
COUNT THIRTEEN ...... 289
Against Defendants Case, Pittman, Kelly, Colburn, Ripp, Berlow, Schuler, Novack, Levin, Parsons and Pace for Liability Under § 15 of the Securities Act For Violations of § 12(a)(2) of the Securities Act...... 289
COUNT FOURTEEN ...... 29 1
Against AOL, Time Warner, and AOL Time Warner For Violation s of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With the Joint Proxy Statement-Prospectus ...... 291
COUNT FIFTEEN...... 293
Against Defendants Case, Levin, Kelly, Cappuccio, Novack and Pittman For Violations of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With the Joint Proxy Statement-Prospectus......
COUNT SIXTEEN ...... 295
viii Against Ernst & Young For Violations of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With th e Joint Proxy Statement-Prospectus ...... 295
COUNT SEVENTEEN ...... 296
Against Morgan Stanley For Violations of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With the Join t Proxy Statement-Prospectus ...... 296
COUNT EIGHTEEN ...... 297
Violations Of Section 10(b) Of The Exchange Act And Rule lOb-5 Promulgated Thereunder Against Defendants AOL Time Warner , AOL and Case, Pittman, Kelly, Colburn, Keller, Ripp, Berlow, Schuler, Rinder, Novack, Levin, Parsons and Pace ...... 297
COUNT NINETEEN...... 3 0 1
Against Ernst & Young for Violations of § 10(b) of th e Exchange Act and Rule l Ob-5 ...... 30 1
COUNT TWENTY ...... 306
Against Defendants Case, Kelly, Pittman, Colburn, Ripp, Berlow, Schuler, Novack, Levin, Parsons and Pace for Liability Under § 20(a) Of The Exchange Act For Violations Of § 10(b) Of The Exchang e Act And Rule lob-5 Promulgated Thereunder ...... 306
X. PRAYER FOR RELIEF ...... 308
XI. JURY TRIAL DEMANDED ...... 308
EXHIBIT A - Cases that Relate to Amended Complain t
EXHIBIT B - AOL Advertising and Commerce Revenue (overstated (as originally reported) vs . Actual Advertising and Commerce Revenue)
EXHIBIT C - Additional Plaintiffs and Their Respective Counsel
ix I. INTRODUCTION
1 . This action is brought on behalf of Lead Plaintiff Minnesota State Board of
Investment ("Plaintiff' or "MSBI") and all other persons and entities who purchased, exchange d or otherwise acquired publicly traded securities of America Online, Inc. ("America Online" or
"AOL") during the period January 27, 1999 through January 11, 2001, and persons or entities who purchased, exchanged or otherwise acquired publicly traded securities of AOL Tim e
Warner, Inc. ("AOL Time Warner" or "Company") during the period January 12, 2001 throug h
and including July 24, 2002 . The "Class Period" therefore runs from January 27, 1999 through
and including July 24, 2002, and the "Class" is comp rised of all persons and entities who
purchased, exchanged or otherwise acquired the securities referenced above during the Class
Period, and were damaged thereby . The illegal conduct detailed in this Amended Consolidate d
Class Action Complaint ("Complaint") was committed by, among others, senior officers an d
directors of AOL and AOL Time Warner, their outside auditor, Ernst & Young, LLP ("Ernst &
Young"), Time Warner' s financial advisor, Morgan, Stanley & Co. ("Morgan Stanley"), and
various underwriters, in violation of the Securities Act of 1933 (the "Securities Act") and the
Securities and Exchange Act of 1934 (the "Exchange Act") .
2. The MSBI brings this securities class action to redress numerous violations of th e
federal securities laws. Defendant AOL Time Warner, Defendant AOL, and other Defendant s
named herein, have engaged in, inter alia, a systematic and fraudulent scheme to materiall y
inflate advertising revenue reported in the companies' publicly disclosed financial statement s
and, in turn, the value of AOL and AOL Time Warner securities. To that end, during the Class
Period, Defendants overstated AOL's reported advertising revenue by at least a staggering 1 .7
billion through the use of sham transactions and improper accounting practices. This illegal
40699 .1 conduct was designed to capitalize on the "dot-com" stock market phenomenon and ensure th e
consummation of the merger between AOL and Time Warner, Inc . ("Time Warner"),
announced in January 2000.
3 . In 1985, AOL began as a small start-up company called Quantum Computer
Services. After going public in 1992, AOL grew rapidly and was one of "the nation's fastest-
growing commercial computer networks" by the end of 1993 . The AOL business consists
principally of interactive services, web properties, internet technologies and electronic
commerce services. As of September 30, 2002 , AOL had 26.7 million subscribers to its
domestic AOL-branded internet services, and 6.1 million subscribers to its European internet
services. Time Warner was created by multiple mergers over 75 years, including the
combination in 1996 of Time Warner Companies, Inc . and Turner Broadcasting System, Inc .
Time Warner's principal business is to create and distribute branded information an d
entertainment throughout the world. Its business interests include cable networks, publishing,
music, filmed entertainment, cable and digital media .
4. Investor expectations of the future prospects of publicly traded companies ha d
historically been based largely on reported corporate earnings and cash flows. However, during
the 1990s "Internet boom", many Internet companies had significant losses and negative cash
flow, and were not expected to generate earnings or positive cash flow for some time . As a
result, investors principally based their expectations for the probable future prospects of Internet
companies , like AOL, on multiples of reported revenue. These revenue multiples were
extraordinarily high by historical standards due to the perceived potential of businesses in thi s
new industry.
40699.1 2 5. AOL's stock price experienced a meteoric rise during the Internet boom of th e
1990s, with a resulting beneficial impact on the value of Individual Defendants' substantial
personal holdings of AOL stock and stock options and their AOL employee compensation. Due
in large part to huge increases in reported AOL revenue, in 1998 alone, the value of AOL stoc k
jumped 552%. From 1993 to 1998 the stock price increased by an annual compounded rate o f
135%. However, early in the Class Period, a key source of AOL' s recurring advertising revenue
-- Internet companies -- were facing significant concerns with, and eventually a fatal downturn
in, their business condition. In turn, AOL's advertising revenue from these sources was leveling
off, with future advertising revenue from Internet companies looking increasingly bleak fo r
AOL. In a deliberate attempt to hide that fact and continue its previous extraordinary gains i n
stock price, and thereby create even greater wealth for themselves, the Individual Defendant s
devised an illegal scheme to report materially inflated advertising revenue, a number which ha d
become increasingly important to the market in the late 1990s as AOL's subscription revenu e
waned.
6. AOL and Time Warner announced with much fanfare on January 10 , 2000 their
agreement to merge the two companies (the "Merger"), valuing the deal at $200 billion .
However, the value placed on AOL's stock for purposes of the Merger was based primarily on
AOL's purported advertising revenue, and the tremendous growth AOL touted as to thi s
revenue source . Indeed, Salomon Smith Barney Inc., the investment banking firm advising
AOL on the Merger, valued the "advertising and e-commerce" segment of AOL's business at a
multiple of between 44 and 171 times the reported estimates for fiscal year 2000 revenue, far
greater than the multiples attached to the other parts of AOL's business. In other words, it was
40699 .1 3 AOL's historical and projected advertising revenue and e-commerce which were driving its
value.
7. Consummation of the Merger, which the media described as "the deal of the
century," was delayed until January 11, 2001 (one year) due to its complexity and a review of
the transaction by the Department of Justice ("DOJ") for antitrust purposes . During that time,
the advertising market was continuing to soften and the dot-com bubble burst for many Interne t
companies . Analysts questioned whether AOL's advertising revenue was immune from this
development. In response, the AOL Individual Defendants assured the market that , unlike the
rest of the industry, AOL was unaffected . At the same time, however, internal AOL documents
and discussions between Defendants during the pendency of the Merger apprised Individual
Defendants to the contrary : AOL was at risk to lose at least $140 million in advertising revenue
for calendar year 2001 alone!
To avoid the fate of a rising number of other Internet companies, Individual
Defendants were intent on making sure the merger went through . As one AOL Senior Manager
was quoted by The Washington Post on July 18, 2002, in an article entitled "Unconventional
Transactions Boosted Sales, Amid Big Merger, Company Resisted Dot-Com Collapse:"
The bubble had clearly burst, but senior management was under enormous pressure to hit the [financial] numbers and close the Time Warner transaction, which would diversify the revenue base and lower the risk profile of the Company.
Accordingly , during the one year period before the Merger was finalized , AOL's publicly
reported advertising revenue was artificially inflated not only to boost the value of AOL stock,
but also to ensure the Merger. After the Merger, Individual Defendants continued to overstate
AOL Time Warner 's advertising revenue to bolster the Company' s stock price and make it
appear that both the Merger and the value of AOL stock exchanged in the Merger were justified .
40699] 4 Even when the advertising market eventually became so weak that the Company was forced to report decreases in advertising revenue, it nonetheless continued to artificially inflate its advertising revenue to soften the stock market's reaction to the reported revenue numbers .
Largely as a result of declining advertising revenue figures, AOL has been forced to write-down over $100 billion in goodwill -- the largest write-down in corporate history .
9. On July 18 and 19, 2002, The Washington Post published a two-part article reporting allegations that AOL before the Merger, and AOL Time Warner after the Merger, had substantially overstated publicly reported advertising revenue. Within hours after The
Washington Post first reported the story, Defendant Robert Pittman, AOL Time Warner's Chief
Operating Officer, a member of the Company's Board, the head of operations for the AOL division of the Company, and formerly the President and Chief Operating Officer of AOL prior to the Merger, abruptly resigned from the Company. At the same time, the Company and
Defendant Ernst & Young, AOL's and AOL Time Warner's independent auditing firm, emphatically denied any wrongdoing and reaffirmed the accuracy of AOL's and AOL Time
Warner's financial statements .
10. Soon thereafter, the Company began to trickle out information confirming its illegal conduct . After the close of the stock market on July 24, 2002, the Company acknowledged that the Securities and Exchange Commission ("SEC") was investigating AOL and the Company's accounting practices, driving AOL Time Warner's stock price down by almost 15.4% overnight . On July 31, 2002, the Company confirmed that the DOJ had commenced a criminal investigation of AOL and the Company's accounting practices.
11 . Two weeks later, in an August 14, 2002 press release and in its SEC Form 10-Q filing, the Company acknowledged that advertising revenue "may" have been overstated fo r
40699 .1 AOL in the amount of $49 million with respect to three transactions covering a period of six
quarters. The Company also stated that it was "continuing its review of these and other
transactions at the AOL division."
12. On October 23, 2002, after the filing of the initial Complaint in this matter, th e
Company restated the financial statements of AOL and AOL Time Warner for eight consecutive
quarters (July 1, 2000 to June 30, 2002) during the Class Period, a clear admission of repeated
violations of the securities laws . In fact, in its October 23, 2002 Form 8-K filing with the SEC,
AOL Time Warner not only restated the companies' advertising revenue by reducing it in the
amount of $190 million, it also stated :
As a result of the restatement announced on October 23, 2002 by AOL and AOL Time Warner Inc. (the "Company"), the Company' s financial statements for the affected periods should no longer be relied upon, including the audited financial statements for 2000 and 2001 contained in the Company' s annual report on Form 10-K for the year ended December 31, 2001 .
(Emphasis added.) The largest quarterly restatement of AOL's advertising revenue , a reduction of $66 million, was for the last publicly reported fiscal quarter prior to the consummation of th e
Merger that Individual Defendants wanted to be effectuated at all costs .
13 . On March 28, 2003, just prior to the filing of this amended Complaint, th e
Company reported in its SEC Form 10-K filing that it may further restate AOL advertising revenue by reducing it in an additional amount of up to $400 million for the years 2001 and
2002. According to the Company, this possible restatement is attributable to two transactions with Bertelsmann AG, which are a subject of the SEC's investigation . The Company also stated that, in addition to the Bertelsmann transactions, "it is possible that further restatement of the
Company's financial statements may be necessary," with respect to "the range of other transactions" being investigated by both the SEC and the DOJ .
40699 .1 6 14. In the aggregate, the Company has thus far restated or acknowledged the possibility of restating advertising revenue for the Class Period by reducing the revenue in the amount of at least $477 million, with essentially all of the reduction attributable to AO L advertising revenue . However, this figure does not come close, either in magnitude o r timeframe, to all of the advertising revenue that was previously overstated by AOL and AOL
Time Warner during the Class Period. By Plaintiff's calculation set forth in detail in thi s
Complaint, Defendants have overstated AOL's advertising revenue during the Class Period b y at least $1 .7 billion. A chart reflecting the significant difference between the artificially inflated
AOL advertising revenue reported during the Class Period and the actual amounts of AO L advertising revenue is set forth below . (A full-size chart is attached hereto as Exhibit B . )
AOL Advertising and Commerce Revenue ( Overstated ( as Originally Reported) vs . g Actual Advertising and Commerce Revenue ) g 800
700
600
50o
400
300 -♦--Artificially Inflated Advertising and Commerce Revenue as Originally Reporte d 200 (Actual Advertising and Commerce Revenue Before Inflation " 100 Merger date
0
Quarters ende d These numbers may decrease as knowledge about AOLs improper accounting practices increases with formal discovery.
40699 .1 7 The Company claims that it continues to review the propriety of previously reported financial
statements. The SEC and DOJ investigations, which according to the Company, "have focuse d
on transactions involving the Company's America Online unit that were entered into after Jul y
1, 1999," are continuing and include numerous transactions referenced in this Complaint an d
people named as Defendants in this action .
15. Examples of Defendants' illegal conduct during the Class Period include, but are
not limited to, the following:
a. Sixteen separate sham transactions involving AOL and then AOL Time Warner, Homestore, Inc . and various third parties, whereby AOL Time Warner improperly reported significant advertising revenue. At least four Homestore executives have already plead guilty to criminal charges in connection with such transactions and AOL Time Warner executives are targets of the ongoing criminal investigation. In a related civil proceeding brought by Homestore shareholders, the court characterized the sham transactions as "a massive conspiracy driven by pure avarice ;"
b . Various other sham transactions, including one with PurchasePro.com, Inc., which was referred to in the July 19, 2002, Washington Post article as "science fiction." This sham deal involved a purported revision of the terms of AOL's equity interest in PurchasePro, and AOL and the Company fraudulently accounted for the transaction by reporting $27 .5 million in advertising revenue;
c. So-called "round-trip" deals with various companies such as Bertelsmann AG, Veritas Software Corporation, WorldCom, Inc ., Qwest Communications, Hughes Electronics Corporation, Gateway, Inc., Homestore, Inc., PurchasePro.com, Inc., Sun Microsystems, Inc ., Monster.com and Oxygen Media Inc., with respect to which AOL or AOL Time Warner improperly reported at least $1 .4 billion dollars in advertising revenue during the Class Period;
d. So called "jackpotting" where AOL and the Company impermissibly "squeezed" multiple on-line advertising banners purchased by the same customer onto the same screen and did so repeatedly during a short period of time at the end of a
40699 .1 reporting period in order to record the revenue in that particular reporting period;
e. Converting an arbitration award against MovieFone, Inc . and the settlement of litigation with Ticketmaster into $36.7 million of advertising revenue;
f. Booking gross, rather than net, revenue for advertising which AOL and AOL Time Warner sold on behalf of eBay as a broker, thereby allowing AOL and AOL Time Warner falsely to report substantially more advertising revenue than permitted by applicable accounting rules ;
g. Improperly converting contract termination fees from failing "dot- com" companies into advertising revenue;
h. Improperly accounting for cross-platform advertising deals (advertising services provided by more than one AOL Time Warner division), including the double-booking of advertising revenue;
i. Reporting materially overstated AOL advertising revenue in numerous AOL and Company press releases and financial statements;
j. Failing to disclose the true current and anticipated condition of AOL's advertising revenue and business, both before and after the Merger;
k. Misrepresenting as part of the Merger, AOL's advertising revenue and the value of "goodwill";
1. Failing to properly account for the vastly inflated goodwill associated with the AOL and Time Warner Merger; and
in. Falsely representing that AOL and AOL Time Warner' s financial statements were prepared in conformance with Generally Accepted Accounting P rinciples ("GAAP") and fairly represented the financial operation of the companies, and that certain of those financial statements were audited in compli ance with Generally Accepted Auditing Standards ("GAAS").
16. Defendants' illegal actions during the Class Period artificially propped up the
price of AOL and AOL Time Warner securities when they were purchased, exchanged or
40699.1 9 otherwise acquired by the MSBI and other Class members , causing the MSBI and the Class to
lose billions of dollars.
17. While AOL and AOL Time Warner investors lost huge amounts of money due t o
Defendants' fraudulent scheme, Individual Defendants reaped billions of dollars in proceeds
selling their own AOL and AOL Time Warner securities at artificially inflated prices. For
instance, Defendant Pittman sold at least $262 million of AOL and Company stock during th e
Class Period, and in the year preceding consummation of the Merger was awarded options for 4
million shares of stock . Defendant Case, the Company's Chairman of the Board, who
announced his resignation in Janua ry 2003, sold at least $555 million of AOL and AOL Time
Warner stock during the Class Period and, in the year prior to completion of the Merger, was
awarded options for about 5 million shares of stock . Moreover, a large portion of the insider
selling by Defendants was conducted during a four-month period just after consummation of the
Merger, during which time the Company was engaged in a $5 billion repurchase of its ow n
stock, serving to further inflate the stock while these Defendants sold millions of their own AOL
Time Warner shares. For instance, Defendants Pittman and Case sold 1 .5 and 2 million AOL
Time Warner shares, respectively, in early 2001, while the Company was mid-flight in its
massive stock buy-back program .
18. Even prior to the wrongful acts complained of here, which cover approximately a
3'h-year period beginning January 27, 1999, AOL' s accounting practices had come under SE C
scrutiny. At least as early as 1997, the SEC determined that AOL had improperly inflated
advertising revenue of the company . The SEC action resulted in AOL's restatement of the
financial reporting for its 1997 fiscal year third quarter, transforming an alleged profit into a
loss. In response to the SEC action, Defendant Case promised the investing public that AOL
40699.1 10 would adopt "new gold-standard accounting policies ." However, in the very next fiscal quarter,
through improper accounting, AOL reported a $10.9 million profit. The SEC again required
AOL to restate that qua rter' s results to reflect proper accounting standards , turning the reported
profit into an $11 .8 million loss . In the fall of 1998, the SEC identified further accountin g
improprieties of AOL and required AOL to revise its accounting for $316 million in acquisition
costs related to internet companies .
19. On May 15, 2000, the SEC issued an Order against AOL finding that it had
improperly accounted for $385 million in costs associated with AOL revenue production for th e
period spanning July 1, 1994-June 30, 1997 and required AOL to cease and desist from further
improper accounting practices and violations of the securities laws . As part of the SEC Cease
and Desist Order, AOL paid a $3.5 million fine and restated its earnings for the company' s
fiscal year 1995, 1996 and 1997 financial reports, again converting previously reported profit s
into losses .
20. Instead of complying with the SEC's Order, the Individual Defendants and Ernst
& Young chose to continue the illegal conduct to ensure consummation of the Merger and fo r
their own short-term personal gain to maximize the value of their AOL or AOL Time Warne r
securities holdings, options, bonuses, etc ., or fees to be made from the companies . As one
Company employee described the corporate mentality in the July 19, 2002 Washington Post
article, "The sheer arrogance, the feeling of being untouchable, was amazing."
II. NATURE OF THE ACTION
21 . The schemes alleged herein entailed, inter alia, the dissemination of materially
false and misleading information, and omissions of material facts, in AOL and AOL Tim e
Warner financial statements, press releases, and filings with the SEC ; the AOL Time Warner,
40699 .1 11 Inc. Registration Statement , filed with the SEC in connection with the Merger of AOL and Time
Warner consummated on January 11, 2001 ("Merger Registration Statement") ; the Joint Prox y
Statement-Prospectus filed with the SEC by AOL and Time Warner, distributed to their
respective shareholders and incorporated into the Merger Registration Statement ("Joint Proxy
Statement-Prospectus") ; the Bond Registration Statement and Prospectus Supplements theret o
("Bond Registration Statements "), for bonds issued by AOL Time Warner; and in statements of
Individual Defendants .
22. The material misrepresentations and omissions were designed to and did, inter
alia, inflate artificially AOL's and AOL Time Warner's publicly reported advertising revenue .
In turn, this created the illusion during the Class Period that such revenue -- the most significan t
qualitative measure by which the market evaluated the current and future financial health and
prospects of AOL and its touted synergies with Time Warner - was, as described by one stock
market analyst, the Company's "fastest growing revenue stream and a key element of growth
going forward." The material misrepresentations and omissions were also designed to and did
hide from the public the schemes used to falsely inflate advertising revenue, including th e
creation of sham transactions and use of improper accounting practices .
23 . Defendants were well aware that advertising revenue was material to th e
marketplace. During the Class Period, it became increasingly important for AOL and AOL
Time Warner to set themselves apa rt from the rest of an industry experiencing growing concerns
over declining advertising revenue and difficulties in meeting analysts' expectations . Motivated
by the desire to ensure consummation of the Merger and enhance their own wealth through
personal AOL and AOL Time Warner securities holdings, salaries, bonuses and stock options,
or fees to be earned from the companies, Defendants violated repeatedly the federal securities
40699 .1 12 laws during the Class Period . Indeed, the recent restatement of AOL's and AOL Time Warner' s
financial statements constitutes admissions of numerous violations of the securities laws .
24. Defendants' schemes were intended to, and in fact did, artificially inflate th e
prices of AOL and AOL Time Warner securities purchased or acquired by the MSBI and th e
Class causing them to suffer billions of dollars in losses .
25. The financial fraud described herein could not have been accomplished without
the knowing participation of Ernst & Young, the supposed "independent" auditor of AOL an d
Time Warner and later, of AOL Time Warner. Ernst & Young received millions of dollars in
auditing, consulting and other fees from the companies.
26. As the longstanding auditor of AOL and Time Warner, and after the Merger,
AOL Time Warner, Ernst & Young had knowledge of, or recklessly disregarded, the fraudulent
accounting practices and schemes engaged in by AOL and AOL Time Warner during the Class
Period, and lent its considerable reputation and credibility to AOL and AOL Time Warner's
financial statements . Those financial statements were materially misstated starting in 1998
through and including 2002, as a direct result of false adve rtising revenue which Ernst & Young
allowed AOL and AOL Time Warner to recognize .
III. JURISDICTION AND VENUE
27. Certain claims asserted herein arise under Sections 10(b), 14(a) and 20(a) of th e
Securities Exchange Act, 15 U .S .C. §§ 78j( b), 78n(a) and 78t(a), and the rules and regulations
promulgated thereunder, including SEC Rule lOb-5, 17 C.F.R. § 240.10b-5. Certain other
claims asse rted herein arise under Sections 11, 12 and 15 of the Secu rities Act, 15 U .S .C. §§
77k, 771( a)(2) and 77o . Claims asse rted against any Defendant under Sections 11, 12 and 15 of
40699 .1 13 the Securities Act and Sections 14 and 20 of the Exchange Act are not based in fraud, an d
should not be construed to be based in fraud .
28. The Court has jurisdiction over this action pursuant to Section 27 of the Exchange
Act, 15 U . S .C . § 78aa, and 28 U.S.C. § 1331 and Section 22 of the Secu rities Act, 15 U .S.C. §
77v.
29. Venue is proper in this District pursuant to Section 27 of the Exchange Act, and
28 U.S .C. § 1391(b) and Section 22 of the Securities Act, 15 U .S.C. § 77v. Defendant AOL
Time Warner is a corporation with its principal place of business in this District and many of the
acts, practices and transactions complained of herein, including the preparation, issuance an d
dissemination of materially false and misleading statements, occurred in substantial part in thi s
District.
30. In connection with the acts alleged in this Complaint, Defendants, directly or
indirectly, used the means and instrumentalities of interstate commerce, including, but not
limited to, the United States mails, interstate telephone communications and the facilities of the
national securities markets .
IV. PARTIES
A. Plaintiffs
1. Lead Plaintiff
31 . Plaintiff MSBI purchased, exchanged or otherwise acquired securities of AOL,
and AOL Time Warner during the Class Period and has suffered damages caused by
Defendants' violations of the federal securities laws . The MSBI is an agency established by
Article XI of the Minnesota Constitution and laws of the State of Minnesota for the purpose of
administering and directing investment of all state funds and pension funds. The funds managed
40699.1 14 by the MSBI include : the Basic Retirement Funds, the Post Retirement Fund, the Supplemental
Investment Fund, the Permanent School Fund, the Environmental Trust Fund, the Assigned Risk
Plan, and the State Cash Accounts. As of June 2002, the MSBI had approximately $44.6 billion in funds under management. The MSBI purchased or otherwise acquired approximatel y
3,073,050 shares of AOL stock during the Class Period, exchanged approximately 2,610,78 0 shares of Time Warner stock for AOL Time Warner stock pursuant to the Merger, and purchased approximately 5,769,839 shares of AOL Time Warner stock during the Class Period.
The MSBI also purchased approximately $44,679,246 worth of AOL Time Warner deb t securities pursuant to public offerings of the Company during the Class Period, including over approximately $20,458,807 of bonds in the April 19, 2001 Bond Offering ("the April 200 1
Offering") and approximately $24,220,439 of bonds in the April 8, 2002 Bond Offering ("th e
April 2002 Offering"). In addition, the MSBI purchased bonds in the secondary market that are traceable to the April 2001 and 2002 Offerings. On January 8, 2003, the Honorable Shirley W .
Kram, United States District Court Judge for the Southern District of New York, appointed th e
MSBI as Lead Plaintiff for this litigation and directed the MSBI to file an Amended
Consolidated Complaint .
2. Additional Plaintiffs
32 . The persons and entities listed on Exhibit C attached hereto are additional
Plaintiffs in this consolidated action . Their respective counsel are also listed. During the Class
Period, each purchased or otherwise acquired securities of AOL, or AOL Time Warner, and
suffered damages as a result of Defendants' violations of law .
40699.1 15 B. Defendants
1. AOL Time Warner, Inc.
33 . Defendant AOL Time Warner is a Delaware corporation with its headquarters in
New York, New York. AOL Time Warner claims to be the world's first fully integrated,
Internet-powered media and communications company. The Company was formed in
connection with the Merger of AOL and Time Warner, Inc . As a result of the Merger, AOL and
Time Warner each became wholly owned subsidiaries of AOL Time Warner. AOL Time
Warner is named as a Defendant in its own right for all liabilities of AOL Time Warner arising
in conjunction with or after the Merger and for all liabilities of AOL and Time Warner arising in
conjunction or after the Merger. AOL Time Warner is also named as a successor-in-interest for
all liabilities of AOL and Time Warner arising prior to or in conjunction with the Merger.
2. America Online, Inc.
34. Defendant AOL is a Delaware corporation with its principal place of business i n
Dulles, Virginia. It is a wholly owned subsidiary of AOL Time Warner . AOL began its
existence on May 24, 1985 as a small company called Quantum Computer Se rvices. AOL went
public on March 19, 1992 and, by the end of 1993, was one of "the nation's fastest-growin g
commercial computer networks ." The AOL business, based both before and after the Merger i n
Dulles, Virginia, consists principally of interactive services, web properties, interne t
technologies and electronic commerce services. Before the Merger, AOL operated on a fiscal
year ended June 30. Following the Merger, AOL has operated on AOL Time Warner's fisca l
year, which ends on December 31 . Currently, AOL operates two worldwide internet services .
As of September 30, 2002, AOL had 26 .7 million subscribers to its domestic AOL-brande d
internet services, including America Online, CompuServe, AOL MovieFone, Net Center,
40699 .1 16 AOL.com, ICQ and Digital City. As of the same date, there were 6 .1 million subsc ribers to its
European internet services. AOL is responsible for its liabilities resulting from this lawsuit,
whether arising before, in conjunction with, or after the Merger .
3. Time Warner Inc.
35 . Defendant Time Warner is a Delaware corporation with its headquarters in Ne w
York, New York . Time Warner is a wholly owned subsidiary of AOL Time Warner. Time
Warner was created in 1996 as a result of the acquisition of Time Warner Companies, Inc . and
Turner Broadcasting System, Inc. by TW, Inc., renamed Time Warner Inc. Time Warner' s
principal business is to create and distribute branded information and entertainment throughout
the world. Its business interests include cable networks, publishing, music, filmed
entertainment, cable and digital media. Prior to the Merger, Time Warner functioned as a
holding company deriving its operating income and cash flow from its investments in it s
subsidiaries, including Time Warner Entertainment Company, L.P., or "TWE," a Delaware
limited partnership formed in 1992 that owns a majority of Time Warner's interests in filme d
entertainment and cable television systems and a portion of its interests in cable networks .
Before the Merger, Time Warner operated on a fiscal year ended December 31 . Following the
Merger, Time Warner operates on AOL Time Warner's fiscal year, which also ends on
December 31 . Time Warner is responsible for its liabilities resulting from this lawsuit, whether
arising before, in conjunction with, or after the Merger .
4. The Individual Defendants
36. The following Defendants were Officers and/or Directors of AOL prior to the
Merger with Time Warner :
40699.1 17 a. Stephen M. Case. Defendant Stephen M . Case ("Case") co-founded AOL
in 1985 and served as its Executive Vice President from September 1987 to January 1991 and
Vice President of Marketing from 1985 to September 1987 . He became a Director of AOL when
it first became a public company in September 1992, Chief Executive Officer in April 1993 and
Chairman of the Board in October 1995, holding all of these positions until the Merger was
consummated on January 11, 2001 . Case was a signatory to the Joint Proxy Statement-
Prospectus incorporated into the Merger Registration Statement and to the Bond Registration
Statement. Upon the Merger, Case became an Affiliated Director and Chairman of the Board o f
AOL Time Warner . Case is also a member of the Board of Representatives of Time Warner
Entertainment Company, L .P. On January 12, 2003, Case announced his resignation from the
Company effective May 2003, noting that, among other things, the Merger had been a
"disappointment."
b. Robert W. Pittman. Before joining AOL, from 1990 to September 1995 ,
Defendant Robert W. Pittman ("Pittman") was President and Chief Executive Officer of Tim e
Warner Enterprises, a division of Time Warner Entertainment Company . Pittman moved to
AOL in November 1996, where he was President and Chief Executive Officer of AO L
Networks, a division of AOL, until February 1998 . From February 1998 until the Merger,
Pittman was President and Chief Operating Officer of AOL . He was a Director of AOL from
1995 until the Merger. Upon the Merger, January 11, 2001, Pittman became Co-Chief Operating
Officer of AOL Time Warner and an Affiliated Director of the AOL Time Warner Board o f
Directors. On April 19, 2001, Pittman also resumed his previous responsibilities for operation s
of the AOL subsidiary of AOL Time Warner. In May 2002, Pittman became the sole Chief
Operating Officer of AOL Time Warner. On July 18, 2002, the day The Washington Post
40699 .1 18 reported on various accounting improprieties regarding AOL advertising revenue, Pittman
abruptly resigned his position as Chief Operating Officer with AOL Time Warner an d
announced his intent to resign as acting head of AOL "after a new CEO is in place ." He resigned
from his AOL position shortly thereafter in July 2002. Pittman was a signatory to the Bond
Registration Statement .
c. J. Michael Kelly. From June 1998 until the Merger, Defendant J . Michael
Kelly ("Kelly") was Senior Vice President, Chief Financial Officer and Assistant Secretary of
AOL. Kelly was a signatory to the Merger Registration Statement and the Bond Registratio n
Statement. Upon the Merger, Kelly became Chief Financial Officer and Executive Vice
President of AOL Time Warner . On or about November 1, 2001, Kelly was appointed Chief
Operating Officer of the AOL subsidiary of AOL Time Warner. Kelly is now Chairman and
Chief Executive Officer of AOL International and Web Services .
d. David M. Colburn. From 1995 until the Merger, Defendant David M .
Colburn ("Colburn") was Senior Vice President of Business Affairs for AOL, who reported
directly to Defendant Pittman. Following the Merger, Colburn became Executive Vice-President
and President of Business Affairs and Development for AOL Time Warner and continued t o
report directly to Pittman . Colburn was AOL' s, and then AOL Time Warner' s chief deal-maker.
Colburn was terminated in August 2002 after he was identified as a subject of the SEC and DO J
investigations.
e. Eric Keller. Defendant Eric Keller ("Keller") was Senior Executive Vic e
President of Business Affairs and Development under, and reported directly to, Defendan t
Colburn at AOL. After the Merger, Keller remained Senior Executive Vice President o f
Business Affairs and Development and continued to work under, and report directly to, Colburn .
40699.1 19 Keller was the number two deal-maker at AOL and AOL Time Warner. Various media reports have identified Keller as a subject of the SEC and DOJ investigations .
f. Joseph A. Ripp. Defendant Joseph A. Ripp ("Ripp") was Executive Vice
President, Chief Financial Officer and Treasurer of Time Inc. until 1999. He then became the
Executive Vice President and Chief Financial Officer of Time Warner from 1999 until th e
Merger. On October 16, 2000, Ripp was named Executive Vice President, Chief Financia l
Officer and Treasurer of AOL subsidiary, effective upon the Merger . In September 2002, Ripp became Vice Chairman of AOL, a position he currently maintains. Ripp was a signatory to the
Bond Registration Statement .
g. Myer Berlow. Defendant Myer Berlow ("Berlow") was Vice President for
National Accounts at AOL. Subsequently, he became President of AOL's Worldwide Interactiv e
Marketing Division in the Business Affairs Department . Following the Merger, in August 200 1 he became President of the Global Marketing Solutions Group under the direction of "AOL Time
Warner's Advertising Council Body," which is comprised of the top sales executive in each of
AOL Time Warner' s divisions. In September 2002, Berlow became a Senior Advisor to th e
Company.
h. Barry Schuler. Defendant Barry Schuler ("Schuler") was President o f
AOL Interactive Services from 1998 until the Merger . Upon the Merger, Schuler became
Chairman and Chief Executive Officer of AOL. Schuler was a signatory to the Bond
Registration Statement .
Steven Rinder . Defendant Steven Rinder ("Rinder") was Senior Vic e
President of Business Affairs & Development in 2001 for the Company .
40699.1 20 j. Kenneth J. Novack. Defendant Kenneth J. Novack ("Novack") was Vice
Chairman of AOL from May 1998 until the Merger . He was a Director of AOL from January
2000 until the Merger . Upon the Merger, Novack was appointed an Affiliated Director of the
Company and became its Vice Chairman . Novack was a signatory to the Bond Registration
Statement. He is also a member of the Board of Representatives of Time Warner Entertainment .
37. Defendants Case, Kelly, Pittman, Colburn, Keller, Ripp, Berlow, Schuler, Rinde r
and Novack are sometimes collectively referred to herein as the "AOL Individual Defendants ."
38. The following Defendants were Officers and/or Directors of Time Warner prior to
the Merger with AOL:
k. Gerald M. Levin. From 1983 until January 1987 and from 1988 until the
Merger, Defendant Gerald M . Levin ("Levin") was a Director of Time Warner. From January
1993 until the Merger, Levin was Chairman and Chief Executive Officer of Time Warner . He served in multiple executive positions with Time Warner prior to 1993 . Upon the Company' s incorporation in February 2000, Levin was appointed Chief Executive Officer of AOL Tim e
Warner. Levin also became an Affiliated Director of AOL Time Warner's Board of Directors .
Levin was a signatory to the Joint Proxy Statement-Prospectus incorporated into the Merge r
Registration Statement and to the Bond Registration Statement . He is also a member of the
Board of Representatives of Time Warner Entertainment . Levin retired from the Company i n
May 2002.
Richard D. Parsons. Defendant Richard D . Parsons ("Parsons") was a
Director of Time Warner from 1991 until the Merger. From February 1995 until the Merger,
Parsons was the President of Time Warner. Upon the Merger, Parsons became Co-Chie f
Operating Officer at AOL Time Warner (along with Defendant Pittman ). Parsons also became
40699.1 21 an Affiliated Director of AOL Time Warner 's Board of Directors . Parsons was a signatory to the
Bond Registration Statement. Parsons became Chief Executive Officer of AOL Time Warner i n
May 2002, leaving his post as the Company's Co-Chief Operating Officer. He is Chairman-
Elect of the AOL Time Warner Board of Directors. He is also a member of the Board o f
Representatives of Time Warner Entertainment.
in. Wayne H. Pace. From July 1993 to March 2001, Defendant Wayne H .
Pace ("Pace") held multiple executive positions with Time Warner, including that of Chie f
Financial Officer. Following the Merger, in March 2001, Pace became Vice Chairman and Chie f
Financial and Administrative Officer of Turner Broadcasting System, Inc . In November 2001 ,
Pace became the Company's principal financial officer as the Executive Vice President and
Chief Financial Officer of the Company, a position he maintains at the present time. Pace was a signatory to the Bond Registration Statement .
39. Defendants Case, Kelly, Pittman, Colburn, Keller, Ripp, Berlow, Schuler, Rinder ,
Novack, Levin, Parsons and Pace, are sometimes collectively referred to herein as th e
"Individual Defendants ."
40. Due to the Individual Defendants' positions with AOL and/or AOL Time Warner,
they directly participated in management, and the day-to-day operations, of one or both of th e
companies during the Class Period . In addition, they had access to and/or were provided th e
adverse undisclosed information, including the adverse information detailed herein, about th e
business, operations, products, operational trends, financial statements, markets and present an d
future business prospects of AOL and AOL Time Warner . They had such access via internal
corporate documents (including the Company's and AOL's operating plans, budgets an d
forecasts and repo rts of actual operations compared thereto), conversations with other AOL and
40699 .1 22 AOL Time Warner corporate officers and employees, attendance at management and Board of
Directors meetings and committees thereof, and reports and other information provided to the m in connection therewith.
41 . The Individual Defendants, because of their positions of control and authority a s
officers and/or Directors of the Company and/or AOL, were able to and did control the conten t
of the various SEC filings, press releases and other public statements pertaining to the Compan y
and AOL during the Class Period . Each Individual Defendant was provided with copies o f
documents alleged herein to be misleading prior to or shortly after their issuance and/or had th e
ability and/or opportunity to prevent their issuance or cause them to be corrected . Accordingly,
each of the Individual Defendants is responsible for the accuracy of such public reports an d
releases detailed herein and is therefore primarily liable for the representations containe d
therein.
42. As Officers and controlling persons of publicly-held companies whose commo n
stock was, and is, registered with the SEC pursuant to the Securities Exchange Act, and trade d
on the New York Stock Exchange, and governed by the provisions of the federal securities laws ,
the Individual Defendants had a duty to disseminate promptly, accurate and truthful informatio n
with respect to the Company's and AOL's financial condition and performance, growth ,
operations, financial statements, business, products, markets, management, revenues, earning s
and present and future business prospects, and to correct any previously-issued statements tha t
had become materially misleading or untrue, so that the market price of the Company's an d
AOL's publicly-traded securities would be based upon truthful and accurate information. The
Individual Defendants' misrepresentations and omissions during the Class Period violated thes e
specific requirements and obligations.
40699 .1 23 43. The Individual Defendants participated in the drafting, preparation, and/or approval of the public statements, press releases , shareholder reports and other communications complained of herein, and were aware of, or recklessly disregarded, the misstatements containe d therein and omissions therefrom, and were aware of their materially false and misleading nature .
Because of their board membership and/or executive and manage rial positions with AOL Time
Warner and/or AOL each of the Individual Defendants had access to the adverse undisclosed information about AOL Time Warner' s and/or AOL's business prospects and financial condition and performance as particularized herein and knew (or recklessly disregarded) that these advers e facts rendered the representations made by or about AOL, AOL Time Warner and their busines s materially false and misleading.
44. It is appropriate to treat the Individual Defendants, and the AOL Individual
Defendants, respectively, as groups for pleading purposes and to presume that the false ,
misleading and incomplete information conveyed in the Company's and AOL's SEC filings ,
press releases and other publications and communications alleged herein, are the collectiv e
actions of the narrowly defined group of Defendants identified above .
45. Each of the above-referenced Individual Defendants is liable as a pa rticipant in a
fraudulent scheme and course of business that operated as a fraud or deceit on the Class b y
disseminating materially false and misleading statements and/or concealing material advers e
facts.
5. Additional Individual Defendants
46. The following are additional Individual Defendants :
a. Paul T. Cappucio. Defendant Paul T . Cappuccio ("Cappuccio") was an
Associate Deputy Attorney General at the U .S. Department of Justice from 1991 to 1993 . He
40699.1 24 was Senior Vice President and General Counsel of AOL from August 1999 until the Merger .
Upon the Merger, Cappuccio became Executive Vice President, General Counsel and Secretary of the Company. Cappuccio was a signatory to the Merger Registration Statement and the Bon d
Registration Statement .
b . Miles R. Gilburne. Defendant Miles R. Gilburne ("Gilburne") was AOL' s
"chief corporate strategist" as Senior Vice President of Corporate Development for AOL from
February 1995 until December 1999. As Defendant Colburn's mentor, Gilburne was instrumental in bringing Colburn to AOL. He was a Director of AOL from October 1999 until the Merger. Upon the Merger, Gilburne became Director of AOL Time Warner. Gilburne was a signatory to the Bond Registration Statement .
c. James W. Barge. From March 1995 until the Merger, Defendant Jame s
W. Barge ("Barge") was Assistant Controller for Time Warner. Following the Merger, Barg e
became the Company's "principal accounting officer" as the Senior Vice President and
Controller for AOL Time Warner. Prior to joining Time Warner, Barge was with E rnst &
Young as a regional and national Partner. While with Ernst & Young, Barge was a fellow in the
SEC's office of the Chief Accountant . While at the SEC, Barge advised the Chief Accountant
on a wide range of policy issues, including oversight of accounting and disclosure issues . Barge
later served as Ernst & Young's liaison with the SEC . Barge was a signatory to the Bond
Registration Statement .
d. Daniel F. Akerson . Defendant Daniel F . Akerson ("Akerson") was a
Director of AOL from 1997 until the Merger and a member of the AOL Audit Committee in
1998 and 1999 . Following the Merger, Akerson became a Director of AOL Time Warner as
40699.1 25 well as a member of the Company's Audit and Finance Committee . Akerson was a signatory to the Bond Registration Statement .
e. Stephen F. Bollenbach. From 1997 until the Merger, Defendant Stephen
F. Bollenbach ("Bollenbach") was a Director of AOL. Following the Merger, Bollenbach became a Director of AOL Time Warner and the Chair of the Audit and Finance Committee .
Bollenbach was a signatory to the Bond Registration Statement .
f. Frank J. Caufield. Defendant Frank J . Caufield ("Caufield") was a
Director of AOL from 1991 until the Merger. He was a member and former Chair of the AO L
Audit Committee. Following the Merger, Caufield became a Director of AOL Time Warner .
Caufield was a signatory to the Bond Registration Statement .
g. Franklin D. Raines. Defendant Franklin D. Raines ("Raines") wa s
Director of the U.S . Office ofManagement and Budget from 1996 to 1998. From September
1998 until the Merger, Raines was a Director of AOL and a member of the AOL Audit
Committee . Following the Merger, Raines became a Director of AOL Time Warner and a member of the Audit and Finance Committee. Raines was a signatory to the Bond Registration
Statement.
6. Ernst & Young LL P
47. Defendant Ernst & Young is a firm of certified public accountants that maintain s its headquarters in the Southern District of New York. At all times relevant to this action, Ernst
& Young provided auditing and accounting services to AOL and AOL Time Warner, including but not limited to, conducting audits of AOL and AOL Time Warner's year-end financial statements and, beginning no later than the qua rter ended March 31, 2000, reviewing AOL's and the Company's quarterly financial statements . In connection therewith, Ernst & Young issued
40699.1 26 unqualified audit reports related to AOL and AOL Time Warner's financial statements, for inclusion in each of AOL's annual reports for the fiscal years 1999 and 2000 and transition period ended December 31, 2000 on SEC Forms 10-K, in the Merger Registration Statement
and in the Bond Registration Statement . Ernst & Young also issued an unqualified audit report
for inclusion in AOL Time Warner's annual report for the years 2000 and 2001 on SEC Form s
10-K and in the Bond Registration Statement.
7. Underwriter Defendants
a. Morgan Stanley & Co.
48. Defendant Morgan Stanley & Co. ("Morgan Stanley") is a financial services
institution, that, through its subsidiaries and divisions, provides commercial and investmen t
banking services and advisory services. Its headquarters is located in New York, New York.
Morgan Stanley was a Joint Book-Running and Lead Manager for the April 2002 Bon d
Offerings. It sold over $1 .32 billion worth of bonds from the April 2002 Offering, as follows :
Note/Debenture Amount Due
5 .625% $220,000,100 2005
6.150% $220,000,100 2007
6.875% $440,000,000 201 2
7.70% $440,000,133 203 2
49. Morgan Stanley was also a Senior Co-Manager for the April 2001 Offering . It
sold over $34 million of bonds from the April 2001 Offering, as follows :
40699 .1 27 Note/Debenture Amount Du e
6.125% $34,000,000 2006
6.750% $0 201 1
7.625% $0 203 1
50. Morgan Stanley had in the past provided investment banking services to Time
Warner unrelated to the Merger. During 1998 and 1999, Morgan Stanley received
approximately $23 .8 million for these services .
51 . Morgan Stanley also served as Financial Advisor to Time Warner in connection
with the Merger with AOL. The Merger Registration Statement included, with Morga n
Stanley's consent, the Fairness Opinion of Morgan Stanley as Annex F . Morgan Stanley opined
in its Fairness Opinion that the exchange ratio for AOL and Time Warner stock provided in th e
Merger Agreement was fair to the shareholders of Time Warner .
52. Time Warner agreed to pay Morgan Stanley a financial advisory fee of $12 .5
million upon execution of the Merger agreement and, upon completion of the Merger, $47 . 5
million dollars plus a contingent amount, not to exceed $15 million dollars .
53 . Morgan Stanley is named in this Complaint as a Defendant due to its role as an
Underwriter with respect to the Company's April 2001 and 2002 Bond Offerings, and also as a
Financial Advisor to Time Warner in connection with the Merger .
b. Salomon Smith Barney Inc.
54. Defendant Salomon Smith Barney Inc. ("Salomon") is currently a subsidiary of
CitiGroup, Inc., a financial services institution that, through its subsidiaries and divisions,
provides commercial and investment banking services and commercial loans to corporate
entities. Salomon's headquarters is located in New York, New York . Salomon was the Joint
40699 .1 28 Lead Manager for the 2002 Bond Offering . It sold $300 million worth of bonds from the Apri l
2002 Offering as follows :
Note/Debenture Amount Due
5 .625% $50,000,000 2005
6.150% $50,000,000 2007
6.875% $100,000,000 201 2
7.70% $100,000,000 2032
55. Salomon was also a Joint Book-Running Manager for the April 2001 Offering. It
sold $936 million worth of bonds, as follows :
Note/Debenture Amount Du e
6.125% $234,000,000 2006
6.750% $234,000,000 201 1
7.625% $468,000,000 203 1
56. Salomon had in the past provided investment banking services to AOL unrelated
to the Merger. From January 1, 1998 through January 6, 2000, Salomon received approximatel y
$14.5 million for these services .
57. Salomon also served as financial advisor to AOL in connection with the Merge r
with Time Warner. AOL agreed to pay Salomon a financial advisory fee of $5 million upon the
execution of the Merger Agreement, $7 .5 million upon receipt of the requisite shareholder
approvals, and $47.5 million dollars upon completion of the Merger.
40699 .1 29 c. Citigroup, Inc.
58. Defendant Citigroup, Inc. ("Citigroup"), an international financial services company, was formed in 1998 by the merger of Citigroup and Travelers Group . Citigroup, which services more than 200 million customer accounts in more than 100 countries, is th e corporate parent and 100% owner of Defendant Salomon and reports Salomon's financial results in its consolidated financial statements . Through its corporate control over its subsidiary,
Salomon, Citigroup was able to control, and did control, Salomon during the Class Period.
d. Banc of America Securities LLC
59. Defendant Banc of America Securities LLC ("Banc of America") is a subsidiar y of Banc of America Corp ., a financial services institution that, through its subsidiaries an d divisions, provides commercial and investment banking services and commercial loans t o corporate entities , with principal offices in San Francisco, California, New York, New York an d
Charlotte, North Carolina . Banc of America was a Joint Book-Running and Lead Manager o f the April 2002 Offering and sold $1 .32 billion of bonds, as follows:
Note/Debenture Amount Due
5 .625% $220,000,100 2005
6.150% $220,000,100 2007
6.875% $440,000,000 201 2
7.700% $440,000,134 2032
60. Banc of America was also a Joint Book-Running Manager of the April 200 1
Offering. In connection with that Offering, it sold $936 million of bonds, as follows :
40699.1 30 Note/Debenture Amount Due
6.125% $234,000,000 2006
6.750% $234,000,000 201 1
7.625% $468,000,000 203 1
61 . Banc of America is also one of the banks obligated to lend money on an unsecured basis to AOL Time Warner pursuant to a $7 .5 billion bank credit agreement.
e. J.P. Morgan Chase & Co.
62. Defendant J.P . Morgan Chase & Co. ("J.P. Morgan") is a financial services institution that, through its subsidiaries and divisions, provides commercial and investmen t banking services and advisory services . J.P. Morgan whose, headquarters is in New York, New
York was a Joint Book-Running and Lead Manager of the April 2002 Offering . It sold $1 .3 2 billion of bonds, as follows:
Note/Debenture Amount Due
5 .625% $220,000,100 2005
6.150% $220,000,100 2007
6.875% $440,000,000 201 2
7.700% $440,000,000 2032
63. J.P. Morgan also was joint book- running manager of the April 2001 Offering. In connection with that Offering, J .P. Morgan sold $936 million of bonds, as follows :
40699.1 31 Note/Debenture Amount Du e
6.125% $234,000,000 2006
6.750% $234,000,000 201 1
7 .625% $468,000,000 203 1
64. J.P. Morgan, and Chase Manhattan, which merged in December, 2000, are two of
the banks obligated to lend money on an unsecured basis to AOL Time Warner pursuant to a
$7.5 billion dollar bank credit agreement.
V. CLASS ALLEGATION S
65. Plaintiff brings this action on its own behalf and as a class action pursuant t o
Rules 23(a) and (b)(3) of the Federal Rules of Civil Procedure on behalf of a Class of al l
persons and entities who purchased, exchanged, or otherwise acquired publicly traded securitie s
of AOL during the period January 27, 1999 through January 11 , 2001, and all persons or entities
who purchased, exchanged or otherwise acquired publicly traded securities of AOL Tim e
Warner during the period January 12, 2001 through and including July 24, 2002, and were
damaged thereby. Excluded from the Class are Defendants, Defendants' immediate families ,
and the legal representatives, heirs, successors or assigns of any Defendant, and any entity i n
which any Defendant has or had a controlling interest, and the senior Officers and Directors o f
AOL and the Company . Also excluded from the Class are Homestore, Inc ., PurchasePro .com,
Inc., and Veritas Software Corporation, their successors or assigns and any entity in which
Homestore, PurchasePro or Veritas has a controlling interest ; and the senior executives of
Homestore, PurchasePro, and Veritas, their legal representatives and heirs, successors o r
assigns, and the immediate families of the senior executives of Homestore, PurchasePro and
Veritas.
40699.1 32 66. The members of the Class are so numerous that joinder of all members i s
impracticable. Throughout the Class Period, AOL and AOL Time Warner common shares wer e
actively traded on the New York Stock Exchange (AOL through January 11, 2001, and AO L
Time Warner starting January 12, 2001), and AOL Time Warner debt securities were traded o n
various national and international securities markets, all of which were efficient markets .
Currently, AOL Time Warner has over 4 billion shares of common stock issued and outstandin g
and is reported to be the third most widely held stock in the United States . Approximately ten
billion dollars ($ 10,000,000,000) of debt securities were issued by AOL Time Warner, through
the Underwriter Defendants, during 2001 and 2002 . While the exact number of Class member s
is unknown to Plaintiff at this time and can only be ascertained through appropriate discovery ,
there are many thousands of members in the proposed Class. Record owners and other
members of the Class may be identified from records maintained by AOL Time Warner or its
transfer agent and may be notified of the pendency of this action by mail, using the form o f
notice similar to that customarily used in securities class actions .
67. Plaintiff's claims are typical of the claims of the members of the Class as all
members of the Class are similarly affected by Defendants' wrongful conduct in violation o f
federal law complained of herein.
68. Plaintiff will fairly and adequately protect the interests of the members of th e
Class and has retained counsel competent and experienced in class and securities litigation .
69. Common questions of law and fact exist as to all members of the Class an d
predominate over any questions solely affecting individual members of the Class . Among the
questions of law and fact common to the Class are :
40699.1 33 a. whether the federal securities laws were violated by Defendants' acts as
alleged herein;
b. whether statements made by Defendants to the investing public during th e
Class Period misrepresented, or omitted, material facts about the business, operations and
prospects of the Company and AOL ;
c. whether AOL and AOL Time Warner' s reported financial results during
the Class Period were materially misstated;
d. whether AOL and AOL Time Warner' s reported financial results during
the Class Period were in accordance with GAAP;
e. whether the Merger Registration Statement contained materia l
misstatements or omitted to state material information ;
f. whether the Bond Registration Statement, and Prospectus Supplement s
thereto, contained material misstatements or omitted to state material information ;
g. whether the Joint Proxy Statement-Prospectus contained materia l
misstatements or omitted to state material information;
h. whether Defendants acted with the requisite state of mind in
misrepresenting or omitting material facts ;
whether the market price of AOL and AOL Time Warner publicly traded
securities was artificially inflated due to the material omissions and misrepresentations
complained of herein ;
j. whether Defendant Ernst & Young's unqualified reports issued on AO L
and AOL Time Warner's financial statements during the Class Period materiall y
40699 .1 34 misstated that Ernst & Young's audits thereon were conducted in accordance with
GAAS ;
k. whether the Fairness Opinion of Morgan Stanley contained material
misstatements or omitted to state material information ; and
whether members of the Class have sustained damages and, if so, the
appropriate measure thereof.
70. A class action is superior to all other available methods for the fair and efficien t
adjudication of this controversy since joinder of all members is impracticable . Furthermore, as
the damages suffered by individual Class members may be relatively small, the expense and
burden of individual litigation make it impossible for members of the Class to individually
redress the wrongs done to them . There will be no difficulty in the management of this action as
a class action.
VI. SUBSTANTIVE ALLEGATIONS
A. The Growth of AOL and Its Emphasis on Increasing Advertising Revenue
71 . AOL, since its inception, has been a revenue-driven company. The stock market
historically valued companies based on earnings and free cash flows. Beginning in the 1990s,
however, there was an explosion of start-up Internet companies which repo rted net losses and
negative cash flows. Traditional valuation methods were not applied to determine the value of
these companies. Rather, due to the potential presented by the Internet, the market began to
value high-tech companies based upon revenues. As a result, there was an increasing pressure
on Internet companies, like AOL, to report substantial growth in revenue each reporting period
to maintain or increase stock market value.
72. Companies reporting revenue that disappointed the market's expectations, eve n
40699.1 35 narrowly, saw their share prices plummet. Given these circumstances, AOL and later AOL
Time Warner, and the Individual Defendants, have continually looked for ways to increase AO L
revenue in order to increase its market valuation, and the value of the Individual Defendants '
substantial personal holdings of AOL and AOL Time Warner securities. The focus on revenue
growth became even more acute when concern over the viability of dot-com companies surface d
in late 1999 and early 2000 .
73. During the dot-com boom AOL's stock price skyrocketed due to its reporte d
revenue growth. For example, a $100 investment in AOL stock in 1993 was worth $16,972 by
the end of 1998, a 135% compounded annual return. In turn, AOL employees becam e
fantastically wealthy. As reported by The Washington Post on July 19, 2002, in an article titled
"Creative Transactions Earned Team Rewards" : "Everyone [at AOL], it seemed was becoming
an instant millionaire at the Company's Dulles headquarters. There were a lot of Ferraris and
twenty somethings and secretaries retiring with seven-figure bank accounts after a few years o n
the job, thanks to the incredible windfall from stock options ."
74. However, for AOL stock to continue its extraordinary increase in value, it w as
imperative that company revenue continue to show impressive growth . Any weakness in AO L
revenue growth would mean that the company's phenomenal rise in its stock price could no t
continue. Accordingly, the Individual Defendants, first at AOL, and later at AOL Time Warner ,
devised various fraudulent schemes to artificially enhance advertising revenue to fraudulentl y
induce continued substantial increases in the companies' stock prices .
75. Historically, AOL has reported three main types of revenue : (1) subscription
services revenues ; (2) advertising and e-commerce revenues ; and (3) enterprise solution
revenues. Subscription services revenue is generated from customers subscribing to AOL's
40699 .1 36 internet services. Advertising and e-commerce revenue are non-subscription based and ar e generated from the company's base of subscribers and users as well as businesses who advertise on AOL internet sites. Enterprise solution revenues consist principally of product licensing fees and fees from technical support, consulting and training services . Of the three revenue sources,
AOL initially depended primarily on its subscription service revenue for the bulk of its revenu e and revenue growth.
76. As a result of increased competition, the increased use of the World Wide We b and increased popularity of browser software, AOL was forced to continually reduce p rices for its online services and in December 1996 dropped its pay-by-the-hour method of chargin g subscribers and adopted a "flat-rate" pricing plan .
77. Following the introduction of the flat rate plan for the AOL subscriber service in
December 1996, the company experienced a significant increase in both (1) subscriber usage , which was mainly due to the growth of the subscriber base, and (2) the average monthly usag e per subscriber as subscribers spent more and more time online . As the average usage levels increased, the company faced further pressures on its operating margins due to increase d network costs on both an absolute dollar basis, as well as a percentage of revenue basis . The increase in cost of revenues was primarily attributable to increases in data network costs, as wel l as personnel and related costs associated with operating the data centers, data network an d providing customer support, consulting, technical support/training and billing. According to
AOL's SEC Form 1O-Q for the quarter ended March 31, 1997, the company reported tha t overall average monthly online service revenue per AOL subscriber in fiscal 1997 was expected to be lower than in fiscal 1996, primarily due to the adoption of the flat-rate pricing plan i n fiscal 1997. As AOL began seeing its subscription revenue for the online service drop, th e
40699 .1 37 company looked for ways to increase advertising revenue .
78 . The growth of higher margin advertising revenue became increasingly impo rtant to AOL's business objectives . Advertising revenue grew in importance as the company continued to leverage its large, active and growing user base . This user base not only included the paying subscribers of the AOL and CompuServe services, it also included users of the company's other branded services such as AOL MovieFone, Net Center, AOL .com, ICQ an d
Digital City.
79. AOL's SEC Form 10-K for the fiscal year ended June 30 , 1997, described the importance of advertising revenue to AOL's success :
An important component of the company's business strategy is to increase non- subscription based revenues, including from advertising sales and transaction fees associated with electronic commerce, and the sale of merchandise, which the company believes are increasingly important to its growth and success . The company continues to establish a wide variety of relationships with advertising and electronic commerce partners in order to grow its non-subscription based revenues and to provide AOL subscribers with access to a broad selection of competitively priced, easy to order products and services .
(Emphasis added.)
80. Many of AOL's advertising deals involved various forms of partnerships or alliances. According to AOL' s SEC Form 10-K for the fiscal year ended June 30, 1999 :
The company offers its advertising and commerce partners a variety of customized programs , which may include premiere placement or select sponsorship of particular online areas or web pages for designated time periods . As merchants recognized the value in reaching the company's large, growing and active subscriber base and users of its web-based properties, the company has been able to earn additional revenues by offering selected merchants exclusive rights to market particular goods or services within one or more of the company's online services and properties . In those transactions, the company provides its commerce partners certain marketing and promotional opportunities and in return receives cash payments the opportunity for revenue sharin, cg ross promotions and competitive pricing and online conveniences for subscribers . Certain of the transactions with partners also include an equity component for the company . The company may receive a warrant to purchase stock or may purchase or acquire
40699.1 38 a direct equity interest in the partner. These equity investments are accounted for in accordance with company accounting policies . In addition, these equity investments can also represent an additional potential source of income or loss to the company upon their disposition.
(Emphasis added.)
81 . Beginning at least as early as May 1998, many of these alliances and partnership s
enabled AOL, and later AOL Time Warner, to artificially inflate revenue through, among other
means, the use of improper accounting practices regarding "round-trip" and barter transactions .
This was accomplished , in large part, through the emergence of AOL "portal" deals. A "portal"
can be viewed as a website playing the role of a "gate" that welcomes the user onto the interne t
and guides the user towards the information he or she is seeking .
82 . As reported in an October 30, 2000 article in the Industry Standard entitled
"AOL's Rough Riders:"
Never was [AOL's Senior Vice President of Business Affairs David] Colburn more valuable to AOL than when the portal deal was born , the offspring of necessity and opportunity. In December 1996, AOL, following the lead of its competitors, dropped its pay-by-the-hour method of charging customers in favor of a flat monthly fee, precipitating one of the many crises that AOL has faced in its relatively short life as a publicly traded company . The price change may have been great news for the company's millions of subscribers, but it meant a huge hit for AOL's bottom line and also its stock price . Deals with the company's many content providers, which had been based on AOL's per-hour fees, needed to be renegotiated, and alternative revenues had to be found. Back then there was plenty of talk about a wondrous new business model dubbed the "portal," but how a company might cash in on all those eyeballs they had attracted remained to be seen.
That's what David was responsible for doing," says a former Colburn lieutenant . "It largely fell on him to restructure all the existing deals and figure out, more importantly, how the company could make money as a portal ." The plan for dealing with content providers was a radical departure from the old model ; most would now have to pay for the privilege of providing news and information to AOL users . "It's not like an edict was handed down one Thursday and that was that," says David Ellington, CEO of NetNoir, an AOL stalwart since 1995 . "But on the other hand, it's not like they left us much room to negotiate ." Yet finessing relations with a few pissed-off content providers was hardly AOL's main concern .
40699.1 39 Terms such as "anchor tenancy" had been invented, or reinvented for the Web, and a new paradigm adopted : AOL was no longer a diverse community of users but an enormous online shopping mall visited by tens of millions of consumers.
(Emphasis added.)
83 . In addition to acquiring an equity stake in its advertisers, other alliance partner s
agreed to share revenue realized from deals, and online brokerages like E-Trade agreed to shar e
commissions from every trade initiated by all AOL secured customers. The need to strike deals
with AOL was particularly apparent with regard to start-up Internet companies, many of whom ,
believing their companies' survival depended on an AOL deal, made enormous upfron t
payments to AOL and gave up large portions of their companies. According to a former AOL
Vice President, fledgling companies that had just gone public or were on the verge of goin g
public and were in need of financing, were finding that in order to get the financing, investors
were asking "What sort of deal do you have with AOL?" If a company did not have a deal with
AOL, the investors refused to take the company seriously, saying they could not invest until the
company had an AOL deal .
84. According to a former AOL Chief Technology Officer, Product Manager and
Senior Business Manager, as AOL became a portal with an increasing number of millions o f
subscribers, the company had more power to demand what it wanted . It insisted that some of its
advertisers and content providers give AOL performance warrants or shares of their companie s
for as little as a penny a share. According to this source, "[i]nternally, the thinking at AOL was
that when we sign a deal with a company, the stock will go up, so we would try to capture the
full value of our deal."
85 . According to the same source, AOL used creative accounting when the company
began charging other companies for exposure to its subscribers.
40699.1 40 B. The Constant and Increasing Pressure to Falsify Advertising Revenue
86. Within AOL, and later AOL Time Warner , there was enormous pressure to sho w
increasing revenue each quarter and meet or exceed revenue targets . This was especially true
with respect to advertising revenue following AOL's shift in its business model to emphasize
this revenue source . A former AOL dealmaker in the October 30, 2000 Industry Standard
article entitled, "AOL's Rough Riders," confirmed that no matter how many advertising deals
AOL was generating, it was never enough: "Working there you were under pressure all of th e
time to make your quota, especially at the end of the quarter." "Colbum would be screaming at
people `Why the f _ _ aren't we hitting our numbers?"' Defendant Colburn was AOL's to p
dealmaker and chief architect of many of the transactions making up AOL' s fraudulent
advertising revenue. According to a former AOL senior executive also quoted in the "AOL
Rough Riders" article, "Colburn is the driver when it comes to deals at AOL . . .. He oversees all
of the dealmaking the Company does."
87. According to a former Senior Manager in AOL Time Warner's Interactive
Marketing Unit responsible for developing sales programs and strategic partnerships, wheneve r
a deal was structured, it was designed to help AOL make its quarterly numbers. According t o
this source, meeting quarterly revenue goals was the driving force behind the various accountin g
manipulations and fraudulent transactions undertaken by the Company. As this source stated :
"We were congratulating ourselves for being creative . In the long run, we are ultimately
providing value to our customers and our investors wanted to see revenue at all costs." But, the
source added : "Deep down we knew our accounting practices were not that secure . We knew
what we were doing wasn't conventional ." The Washington Post reported on July 19, 2002, i n
an article titled "Creative Transactions Earned Team Awards", that another AOL source
40699.1 41 described the culture at AOL as follows : "The lavish parties, the crazy antics - - it really
socialized you. You had to toe the line." (Emphasis added.)
88. According to a former AOL Vice President, the pressure was always on fo r
making deals that would catch Wall Street's attention . AOL executives wanted to do deals that
would give them a "big fat press release" that would cause AOL's stock to go up. For this
reason, as the same source stated, AOL entered into several deals that were not significant from
a cash flow standpoint, or, in fact, were a wash, but that ended up artificially inflatin g
advertising revenue and impressing shareholders. This witness described the pressure to
impress Wall Street as a predominant factor in AOL's corporate culture created primarily by
Defendants Pittman and Colburn. The pressure "was something that was always there, and i t
got even more intense" during the period before the Merger was completed and a week or tw o
before the end of every quarter. According to this witness, Colburn regularly told his peopl e
"you had better do it or else ." According to a former Senior Manager in AOL Time Warner' s
Interactive Marketing Unit, Colburn' s Business Affairs Division developed the improper deal s
in order to book revenue and make quarterly sales goals . The former Senior Manager said "Th e
idea in the back of their mind was to show revenue as ad revenue . Our value as a compan y
hinged on ad revenue and revenue growth . We were sales and revenue driven. There was a lot
of pressure to make quarterly numbers . We had a core number to hit."
89. The pressure to maintain continually impressive revenue growth and the need t o
artificially inflate that revenue through the improper methods described herein, increased eve n
more as many of the Internet companies that had given up enormous sums in dollars and equit y
to partner with AOL were achieving disappointing results . Many overvalued Internet
companies which took advantage of the Internet bubble were seeing their stock prices drop wel l
40699 .1 42 below their Initial Public Offering ("IPO") prices . Other Internet companies were seeing thei r
stock prices fall precipitously on concerns of not only declining advertising revenue, but o n
concerns that a majority of Internet companies would disappear altogether . Individual
Defendants knew that any indication of weakness in AOL's advertising revenue growth would
swiftly and severely impact its stock price.
90. Due to the critical importance of advertising revenue to AOL, this revenue source
was tracked closely by the companies and their top executives . According to a former AO L
Vice President, reports prepared by Robert O'Connor, Vice President of Finance for the
Business Affairs Unit, both before and after the Merger, showed every advertising deal tha t
AOL had and the amount of annual revenue recognition expected from the deal . These reports
indicated the amount of revenue initially expected on a deal and the revised lower amount o f
anticipated revenue if that advertiser was experiencing financial difficulty. Additionally, AO L
utilized a periodic "pipeline report" prepared by the Interactive Services unit, which repor t
described advertising deals in the pipeline and anticipated to generate revenue. The Individual
Defendants had access to such repo rts. Also, weekly business meetings were attended b y
"Colburn's people," including Colburn, Bob O'Connor and Eric Keller . During these meetings
various advertising deals, including the significant financial problems of existing customers tha t
jeopardized continuing revenue from those contracts were discussed .
91 . According to this same source, every Sunday morning, Colburn had telephon e
conference calls with top executives in which they discussed the status of advertising deals an d
revenue recognition. During the Sunday morning calls, Colburn would frequently ask Jay
Rappaport, who did many of the major deals in the Business Affairs unit, which "BA Specials"
were on the list. The "BA Specials", which consisted of deals that caused AOL's advertising
40699 .1 43 revenue to be improperly inflated, made up a substantial po rtion of AOL's advertising revenue,
especially at the end of a quarter . These Sunday calls also involved discussions of problem s
with dot-com companies that had advertising deals with AOL and the restructuring of
advertising deals in order to maximize advertising revenue for AOL .
92. By at least August 2000, internal company documents showed that AOL was a t
risk to lose substantial advertising revenue from existing customers the following fiscal year . In
September 2000, AOL documents estimated that AOL was at risk to lose $108 million in
advertising revenue in the 2001 fiscal year (July 1, 2000-June 30, 2001) due to the financial
difficulties of its advertising customers . In early October 2000, Defendant Pittman and othe r
AOL executives were told that as a result of many failing dot-com customers of the Company ,
AOL was at risk to lose $ 140 million in advertising revenue the following calendar year .
C. The Creation of AOL Time Warner and the Additional Pressure to Report Growing Advertising Revenue
93 . AOL's need to demonstrate substantial and continuing revenue growth took o n
even greater impo rtance when AOL and Time Warner discussed merging the two companies .
94. The proposed Merger was jointly announced by AOL and Time Warner with
much fanfare on January 10, 2000 . The media described the Merger as "the deal of th e
century."
95. On January 11, 2000, The Los Angeles Times reported that the deal came to
fruition when Time Warner was convinced that AOL's stock value was "real":
Levin and Case said they had worked carefully to strike a reasonable compromise on the values of their two companies.
"One of the creative breakthroughs was in the valuation," Case told The Times in a joint interview with Levin . He said the key to coming to a final deal was Time Warner's "recognition that these Internet values are real ." . . .
406991 44 96. The value of AOL's stock for purposes of the Merger was based p rimarily on
AOL's reported advertising revenue and historical growth in that revenue source . Morgan
Stanley, for example, which advised AOL on the Merger, valued AOL' s "advertising and commerce" business at a multiple of between 44 and 171 of estimated revenue for fiscal yea r
2000, far greater than the multiples applied to the other segments of AOL's business.
97. The pressure to report impressive advertising revenue and growth became even more intense after the Merger was announced . During the one year period between the Merger agreement and the deal's consummation, Individual Defendants were desperate to ensure tha t the deal went through, especially since the advertising market was weakening and the stoc k prices of many dot-com companies were plummeting . Indeed, at least months before th e
Merger was consummated, Individual Defendants were aware that AOL was at risk to lose substantial amounts of advertising revenue in the current fiscal year and the next calendar year .
As reported in the July 18, 2002 issue of The Washington Post, James Pattie, who during th e pendency of the Merger was a Senior Manager in AOL's Business Affairs division, stated,
"The bubble had clearly burst, but senior management was under enormous pressure to hit th e
[financial] numbers and close the Time Warner transaction, which would diversify the revenue base and lower the risk profile of the Company ."
98. On June 23, 2000, AOL and Time Warner announced that their respectiv e shareholders had voted to approve the Merger with AOL common shareholders to receive 1 share of AOL Time Warner common stock for each share of AOL they owned (then having a market price of $54.62 per share) and Time Warner common shareholders to receive 1 .5 shares of AOL Time Warner common stock for each share of Time Warner they owned (then having a market price of $79.50 per share). The Merger was finalized on January It, 2001 .
40699.1 45 D. AOL's Pattern and History of Accounting Improprietie s
99. The schemes desc ribed herein follow a familiar pattern for AOL. Even prior to
the start of the Class Period, AOL engaged in accounting improprieties, resulting in SE C
investigations, and restatements of previously reported financial results .
100. For example, in early 1997, after AOL reported a profit for its fiscal year 199 7
third quarter, the SEC conducted an investigation into AOL's accounting practices .
Specifically, the SEC alleged that AOL had improperly inflated advertising revenue regardin g
an AOL deal with Tel-Save Holdings, Inc. AOL improperly recorded as revenue $12 million
from the agreement with Tel-Save and the SEC required AOL to record $ 7 million of that sum
over the remaining term of the contract. The Company restated its 1997 fiscal year third quarter
earnings, which changed the previously reported profit to a loss. In response to the SEC action,
Defendant Case promised the public that AOL would adopt "new gold-standard accounting
practices."
101 . However, the very next fiscal quarter (ended June 30, 1998) AOL reported a
profit of $10.9 million based on more accounting improprieties . The SEC again required AOL
to restate the quarterly results, which caused AOL to report an $11 .8 million loss.
102 . In 1998, AOL attempted to immediately write-off two acquisitions totaling $31 6
million to avoid a drag on future earnings . In accordance with proper accounting standards, the
SEC forced AOL to write-off the acquisition over a period of six years . The next business day
after the SEC decision, then-Chairman of the SEC, Arthur Levitt, stated publicly his concerns
with "earnings management." As reported by The Washington Post on October 5, 1998, Levitt
referred to the "gray area where the accounting is being perverted" and earnings reports that
"reflect the desire of management rather than the underlying financial performance of the
40699.1 46 company." According to The Washington Post article, Levitt also said, in a not-so-veiled
reference to AOL, that these accounting improprieties are not limited to small companies, bu t
also occur "in companies whose products we know and admire ."
103 . The SEC separately investigated other AOL accounting practices that took plac e
during fiscal years 1995-1997 . This SEC investigation involved the Company's improper
allocation of hundreds of millions of dollars of costs associated with obtaining new subscriber s
over a period of years rather than accounting for the costs as they were incurred . This improper
accounting had the effect of inflating AOL's earnings for fiscal years 1995, 1996 and 1997 . If
AOL had properly accounted for the expenses, it would have posted losses rather than profits in
each of the years.
104. Based on its investigation, on May 15, 2000, the SEC ordered AOL to "Cease and
Desist" from further violations of the securities laws and required AOL to comply with
accounting rules in the future . As part of the SEC's action, AOL also paid a $3 .5 million fine
and restated its prior financial results for the reporting periods in question, again convertin g
alleged profits to losses. AOL agreed to abide by the SEC Order, including compliance with th e
securities laws and applicable accounting standards.
105. When the SEC disclosed the issuance of its Cease and Desist Order and $3 . 5
million fine against AOL in May 2000, then-SEC Enforcement Chief, Richard H . Walker,
publicly stated that "[t]his case underscores the importance we attach to financial reporting an d
should serve as a warning to others not to stretch the rules through aggressive accounting ."
106. Notwithstanding the SEC actions in 1997 , 1998 and 2000, as well as AOL's
agreement to abide by accounting rules and cease and desist from securities violations in the
future, Defendant Steve Case's promise on behalf of AOL to adopt "new gold-standar d
40699.1 47 accounting practices", SEC Chairman Levitt's comments regarding "perverted" accounting and
other SEC warnings regarding improper accounting practices, as detailed herein, AOL and AOL
Time Warner, and the Individual Defendants, with the blessing of the Company's auditor ,
Defendant Ernst and Young, continued during the Class Period to violate the securities laws by
reporting artificially inflated advertising revenue through the use of sham transactions and
improper accounting practices . This was done in order to make sure the Merger went through
and to increase the value of the companies' securities for their own short-term personal financial
benefit with respect to their holdings of the companies' securities and options, salaries, bonuses,
etc.
E. Fraudulent Transactions and Improper Accountint Used to Artificially Inflate AOL and AOL Time Warner Advertising Revenue
107. At all relevant times during the Class Period, AOL and AOL Time Warner
represented that their financial statements were prepared in conformity with GAAP, the uniform
rules, conventions and procedures that define accepted accounting practice . As set forth in
Statement of Financial Accounting Concepts ("SFAC") No. 1, Objectives of Financial
Reporting by Business Enterprises , one of the fundamental objectives of financial repo rting is
that it provide accurate and reliable information concerning an entity's financial performance
during the period being presented. SFAC No . 1, ¶ 42 states:
Financial reporting should provide information about an enterp rise's financial performance during a period. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors' and creditors ' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance.
108. GAAP is recognized and used by the accounting profession in order to define
acceptable accounting practices. Both annual and interim ( e.g., quarterly) financial statements
40699 .1 48 must be prepared in accordance with GAAP. The same GAAP applies to interim financial statements that apply to annual financial statements . The SEC has also endorsed GAAP in
Regulation S-X, 17 C.F.R. § 210.4-01(a)(1), which provides that financial statements filed both annually and quarterly with the SEC must comply with GAAP, except quarterly statements are
not required to have the same level of footnote disclosure. If the filings do not comply with
GAAP, they are presumed to be misleading and inaccurate, despite footnote or other disclosure .
109. GAAP is comprised of a hierarchy of authoritative literature. The highest
authority is comprised of FASB ("Financial Accounting St andards Board") Statements of
Financial Accounting Standards ("SFAS"), FASB Interpretations ("FIN"), APB Opinions
("APB"), and AICPA Accounting Research Bulletins ("ARB") . GAAP provides other
authoritative pronouncements including , among others, AICPA Statements of Position ("SOP"),
Consensus Positions of the FASB Emerging Issues Task Force ("EITF"), and the FAS B
Concept Statements ("CON").
110. Circumstances may require that analogies be drawn . AICPA Auditing Standards
("AU") Section 411 .09 states, "Because of developments such as new legislation or the
evolution of a new type of business transaction, there sometimes are no established accounting
principles for repo rting a specific transaction or event . In those instances, it might be possible
to report the event or transaction on the basis of its substance by selecting an accounting
principle that appears appropriate when applied in a manner similar to the application of a n
established principle to an analogous transaction or event ."
111 . AU Section 625 .08 also provides that to aid in forming a judgment, the reporting
accountant should perform the following procedures : (a) obtain an understanding of the form
and substance of the transaction(s); (b) review applicable GAAP ; (c) if appropri ate, consult with
40699 .1 49 other professionals or experts ; and (d) if appropriate, perform research or other procedures t o
ascertain and consider the existence of creditable precedent or analogies .
112. The responsibility for preparing financial statements that conform to GAAP rest s
with corporate management, as set forth in AU Section 110.03 of the AICPA Professional
Standards :
The financial statements are management 's responsibility . . . . Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control, that will, among other things initiate, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements. The entity's transactions and the related assets, liabilities , and equity are within the direct knowledge and control of management . . . . Thus, the fair presentation of financial statements in conformity with [GAAP] is an implicit and integral part of management's responsibility.
(Emphasis added.)
113 . Throughout the course of the quarterly and annual financial reporting during th e
Class Period, AOL, the Company and the Individual AOL and AOL Time Warner Defendants,
materially overstated AOL's and AOL Time Warner's advertising revenue through sham
transactions and improper accounting . Consequently, the financial statements were false and
misleading and constituted an extreme departure from GAAP, by violating the following GAAP
concepts and principles, among the many other principles identified herein :
a. APB 29. The principle that nonmonetary transactions should be accounted for based on the fair value of the assets (or services) involved which is the same basis as that used in monetary transactions . As more fully discussed below, AOL and AOL Time
Warner violated this accounting principle repeatedly when reporting round-trip/barter transactions, including deals with Homestore, Inc ., Sun Microsystems, Inc ., Veritas Software
40699.1 50 Corporation, Bertelsmann AG, WorldCom, Inc., Qwest Communications, Hughes Electronics
Corporation, Gateway, Inc ., PurchasePro, Monster.com, and Oxygen Media Inc .
b. EITF 99-17. The principle that exchanges of advertising services between
two companies should be accounted for at fair value only if the fair value is determinable based
on the entity' s own historical practice of receiving cash or cash equivalents for similar
advertising from buyers unrelated to the counterpa rty in the exchange. If the fair value is not
determinable within stated limits, "the transaction should be recorded at the car rying amount of
the advertising, which likely will be zero ." AOL and AOL Time Warner violated these
accounting requirements by overstating revenue in advertising "swaps" when there was no
ultimate realization in cash, including deals with Homestore, Inc., PurchasePro and
Monster.com.
c. EITF 99-19 . The principle that revenue should be recognized in ne t
amounts, rather than gross , when acting as an agent and not as p rincipal. In circumstances
where a company does not have the risks and rewards of a principal, earns a fixed amount or
percentage, and does not have credit risk, the company is an agent and should not recognize
revenue in a gross amount . AOL and AOL Time Warner violated this requirement in
connection with at least an arrangement with eBay when they improperly recognized revenue
for advertising, placed as an agent, at gross rather than at the net amount of the commissio n
actually earned.
d. CON 2 1 63. The concept of "representational faithfulness," which i s
defined as the "correspondence or agreement between a measure or description and th e
phenomenon it purports to represent . In accounting, the phenomena to be represented are
economic resources and obligations and the transactions and events that change those resource s
40699 .1 51 and obligations ." AOL and AOL Time Warner repeatedly violated this GAAP requirement in
connection with all of the deals discussed herein .
C. CON 6 IN 79 and 82 . The concept that in order for revenue to b e classified as revenue (versus gains), the company must deliver or produce goods, render services or perform other activities that constitute its ongoing major operations . Gains are defined as other events or circumstances which result from peripheral or incidental transactions to the company. AOL and AOL Time Warner violated this requirement when, for example, they characterized as advertising revenue cash inflows that were from sham or round-trip transactions
(kickbacks) and from real transactions such as litigation settlements, deal terminations and the modifications of terms of equity deals . As more fully discussed below, Defendants violated this standard with respect to several transactions, including those with Homestore, Inc ., Bertelsmann
AG, Gateway Inc ., 24dogs.com, Ticketmaster, Dr .Koop.com, and PurchasePro .
f. CON 5 ¶ 83. The concept that in order to recognize revenue, it must b e
earned, realizable or realized . In order to consider revenue to be earned, the company must
have "substantially accomplished what it must do to be entitled to the benefits represented by
the revenues." In order for revenue to be considered realizable or realized, "products (goods or
services), merchandise or other assets are exchanged for cash or claims to cash ." AOL and
AOL Time Warner violated this requirement, for instance, when it recognized revenue by
"jackpotting" (not earned) in deals with Telefonica and others and when it double-booke d
revenue (not realizable) in a deal with Oxygen Media Inc., in addition to deals with Homestore ,
Inc., Gateway Inc ., Dr.Koop.com, and PurchasePro .
g. SFAS 123, EITF 00-08; APB 29. The principle that companies which sell
goods and services in exchange for equity instruments issued by the purchaser should measure
40699 .1 52 the transaction at the fair value of the consideration received (given) or the fair value of th e
equity instruments issued, whichever is a more reliable measure . AOL and AOL Time Warner
violated this principle when they failed to report transactions based on the fair value of the
equity received (and held solely by AOL) by failing to adjust the amount of equity issued by
appropriate time value and marketability discounts . As more fully discussed below, these
standards were violated with respect to several deals, including transactions with Homestore,
Inc., Hughes Electronics Corporation, Gateway, Inc ., PurchasePro .com and Oxygen Media Inc.
h. EITF 00-08 , CON 2 163 . The principle that changes in fair value of th e
equity instruments received in exchange for goods or services may be recognized as additional
revenue from the transaction, if, on the measurement date, the quantity or terms of the equity are
dependent on the achievement of the counterparty's performance and changes in fair value
result from an adjustment to the instrument upon achievement of a performance condition .
AOL and AOL Time Warner improperly reported advertising revenue when, for instance ,
customers like PurchasePro adjusted the fair value of equity granted AOL through pricing
changes even though AOL was not entitled to such an adjustment under the terms of the o riginal
agreement and no further performance objectives were achieved .
APB 16, 1 88 . The principle that in an acquisition, the acquiring company
record receivables of the acquired company at present values of amounts to be received
determined at appropriate current interest rates, less allowances for uncollectibility an d
collection costs, if necessary (fair value) . AOL violated this principle in accounting for th e
24dogs.com deal when it failed to report litigation settlement proceeds owed to an acquire d
company as the satisfaction of a purchased receivable and instead reported the proceeds a s
advertising revenue.
40699.1 53 j . SOP 97-2, 1 10. The principle that if an arrangement includes multiple-
elements, the revenue should be allocated to the various elements based on evidence of fai r
value, regardless of any separate prices stated within the contract for each element . AOL and
AOL Time Warner violated this principle repeatedly when it improperly attributed revenue
from cable deals to its online division in transactions with Qwest Communications, Gol f
Channel, and Oxygen Media Inc ., and, in the case of Oxygen Media Inc ., double-booked the
same revenue in more than one division.
k. CON 1 1 34. The concept that financial reporting should provid e
information that is useful to present and potential investors, creditors and other users in makin g
rational investment, credit and similar decisions . AOL and AOL Time Warner violated this
requirement in connection with all the transactions discussed herein when it overstate d
advertising revenue in its financial statements.
CON 1 1 40. The concept that financial reporting should provide
information about the economic resources of an enterprise, the claims to those resources, and
matters that change such resources . AOL and AOL Time Warner repeatedly violated this
requirement by overstating the value of several of its va rious round-trip, barter and other
transactions .
m. CON 1 1 42. The concept that financial reporting should provid e information about an enterprise's financial performance during a time period . This information is often used by investors and creditors in order to assess the prospects of the company . AOL and AOL Time Warner repeatedly violated this requirement when they overstated their advertising revenue .
40699.1 54 n. CON 1 ¶ 50. The concept that financial reporting should provide
information about how management of an enterprise has discharged its stewardshi p
responsibility to owners (stockholders) for the use of enterp rise resources entrusted to it. AOL
and AOL Time Warner violated this requirement numerous times when it overstated adve rtising
revenue .
o. CON 2 ¶¶ 58-59. The concept that financial repo rting should be reliable
and relevant so that it represents what it purports to represent. AOL and AOL Time Warner
violated this requirement as to at least each of the transactions discussed herein .
p. CON 2 ¶ 79. The concept that financial reporting should be complete, in
other words, nothing material is left out of the information that may be necessary to insure tha t
it validly represents underlying events and conditions. AOL and AOL Time Warner violated
this requirement as to at least all of the transactions discussed herein, because they failed t o
report the underlying substance of the transactions .
q. CON 2 ¶¶ 95, 97. The concept that financial reports should b e
conservative. Preparers must adequately consider uncertainties and risks inherent in busines s
situations, reflect those issues in reports and insure that what is reported represents what i t
purports to represent. AOL and AOL Time Warner violated this requirement as to each deal
when they overstated advertising revenue .
114. AOL and AOL Time Warner improperly recognized revenue in violation of
GAAP during the Class Period as a result of multiple schemes which were specifically designe d
to and did artificially inflate advertising revenue . Certain of these advertising deals
incorporated multiple approaches utilized by AOL and AOL Time Warner to artificiall y
40699.1 55 manufacture advertising revenue . However, these schemes are each best described by one o f the following approaches conceived and commonly used by AOL and AOL Time Warner :
1. Use of Sham Transactions and Improper Accounting Practices Regarding Round-Tripping, Back-to-Back, and Boomerang Deals
115. One of AOL and AOL Time Warner's more creative ways of inflating advertising revenue was through the use of sham transactions and/or improper accounting in connectio n with "round-trip," "back to back" or "boomerang" deals. These deals involved, in some instances, the participation of multiple parties in elaborate advertising revenue schemes relating to AOL's purchase of goods, services, equity or some combination thereof from another party with the requirement of a reciprocal purchase of AOL's advertising services . These circular
"trades" or "swaps", as accounted for by AOL and AOL Time Warner, frequently gave the appearance that AOL or AOL Time Warner had entered highly profitable multi-year, multi- million dollar deals to sell advertising . Rather, AOL or the Company had really funneled, or
"round-tripped," the entire value of the revenue it received from these sales directly back to the original customer through simultaneous purchases of advertising, goods, services, or equity, resulting in no net gain to AOL or AOL Time Warner .
116. In May 2001, the SEC's former Chief Accountant, Lynn Turner, expressed th e
SEC's concern over such inherently fraudulent transactions when it appears that a company " . . . has taken $1 million out of its left pocket only to receive that $1 million back in its right pocket, and wants to record the $1 million in revenue. . . .The staff questions how these types of 'round- trip' arrangements result in revenue, and whether, in substance, they are sham transaction s engineered solely to inflate the revenue line in the income statement."
40699 .1 56 2. Barter Transaction s
117. Barter, a common practice of AOL and AOL Time Warner during the Clas s
Period, was one mechanism through which AOL conducted round-trip deals . Barter
transactions were often used by AOL and AOL Time Warner to lend an appearance of
legitimacy to those transactions. As described below, many of the improper transactions
included aspects of both round tripping and barter . However, barter deals involve an eve n
greater ability to manipulate the amount of advertising revenue ultimately reported .
118. The SEC has expressed great concern over the use of barter transactions to inflate
revenue. For example, on December 7, 1999, then-SEC Director of Enforcements, Richard
Walker, in a speech entitled "Behind the Numbers of the SEC's Recent Financial Fraud Cases "
given to the American Institute of Certified Public Accountants ("AICPA"), stated:
[C]ompanies are also using novel and creative methods to cook the books . For example, we are beginning to see an increase in the use of "barter" transactions, especially among high-technology companies, where the assets received in exchange for goods and services provided are greatly overvalued . We brought 4 barter cases last year.
(Emphasis added.)
119. Similarly, on December 8, 1999, Jane B . Adams, Deputy Chief Accountant of th e
SEC, also spoke to the AICPA and stated :
With the emergence of Internet companies as a significant part of the economy and for which investment decisions have been based on revenues rather than earnings, income statement classification and presentation has become a critical area. The staff is seeing a number of accounting issues for which the underlying objective seems to be the grossing up of the income statement . . . . Barter transactions also are pretty hot. For example, two Internet companies agree to provide banner advertisements on each other's websites, and record the arrangements as revenue and marketing expense.
The significant pressure to report larger revenues raises questions as to the quality of the information being provided . In the case of barter advertising, how has the value transferred or received been established? What evidence supported that
40699.1 57 amount? Was the amount recorded in the financial statements based on reliable and verifiable valuations? Did it meet a reality check that that amount could have been realized in a cash transaction?
(Emphasis added.)
120. In the case of AOL and AOL Time Warner, barter deals used to overstate
advertising revenue took at least three forms:
a. Exchange of Advertising for Goods and/or Services
121 . AOL and AOL Time Warner regularly bartered advertising for a variety of goods or services such as computers, telecommunication services and network devices .
According to a former Vice President for Business Development , AOL would typically target companies for barter deals who sold equipment or services to AOL, and particularly companies selling network devices, telecommunications services or computer equipment . These exchanges often were consummated at the end of a fiscal quarter to meet analysts' expectations . An August
26, 2002 Wall Street Journal article discussing AOL's practice of "squeezing" its suppliers fo r advertising revenue quoted Defendant Pittman : "If we're one of their big customers, we expec t them to be one of our big customers." AOL's and AOL Time Warner's accounting for these types of barter transactions often led to the artificial inflation of advertising revenues .
122. Accounting for revenues and profits resulting from non-monetary transactions ,
including barter, has always been highly regulated and scrutinized by the accounting professio n
and government through the FASB and SEC, respectively . The Emerging Issues Task Force has
also issued several consensus positions on revenue recognition matters . The accounting
principles applicable to corporate ba rter transactions are derived from APB 29. APB 29,
"Accounting for Non-Monetary Transactions," became effective for transactions occurring afte r
September 30, 1973 .
40699.1 58 123. APB 29, in effect, provides that non-cash transactions, which include barte r transactions, be recorded at the fair value of the assets (or services) given up or received, whichever is more clearly evident . APB 29, ¶ 25 states that "fair value of a non-monetary asse t transferred to or from an enterprise in a non-monetary transaction should be determined by referring to estimated realizable values in cash transactions of the same or similar assets, quoted market prices, independent appraisals, estimated fair values of assets or services received in exchange, and other available evidence . If one of the parties in a non-monetary transaction could have elected to receive cash instead of the non-monetary asset, the amount of cash that could have been received may be evidence of the fair value of the non-monetary asset s exchanged." Recording barter transactions based on the "full" or "list" price of assets received, violates APB 29 if not adjusted for any discount that would normally be received .
124. In December of 1999 , the SEC reiterated existing GAAP with the issuance of
Staff Accounting Bulletin 101, 17 C .F.R. § 211 ("SAB 101 "), which summarized the proper recognition, presentation, and disclosure of revenues in financial statements . Pursuant to SAB
101, revenues may not be recognized until they are "realized or realizable and earned ." In order for revenues to be considered "realized or realizable and earned," they must meet all of the following criteria : (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred o r services have been rendered, (iii) the seller's price to the buyer is fixed or determinable, and (iv ) collectibility is reasonably assured. As the SEC stated, SAB 101 "is not intended to change current guidance in the accounting literature." For example, before recognizing advertisin g revenue from a barter transaction a company must complete the "earnings process" by providin g services valued at the amount reported in the transaction.
40699 .1 59 125 . In addition to being "earned," revenues must not be self-generated . In this regard, the characterization of the transactions must demonstrate "representational faithfulness" and not subordinate the substance of the agreement to its form . CON 2 ¶ 160 . In the case of a barter transaction, this means both parties to the barter have purchased services, products or equity, at arms-length for reasons other than to artificially inflate revenue for one or both of the parties . A company selling advertising as part of a legitimate barter transaction can then only recognize advertising revenue in accordance with the requirements of APB 29 .
126. Further, "revenues" are earned through transactions which involve or reflect th e major ongoing operations and services of the entity . CON 6 ¶ 79 ; CON 5 ¶ 83 . By contrast,
"gains" are recognized when obtained through an entity's peripheral or incidental transaction s not arising from the core operations of the entity. CON 6 ¶ 82 .
127 . The SEC has also expressed concern over both round-trip and complex barter transactions in which revenues are generated only as a result of the counterparty's agreement t o reciprocate; i.e., but for the counterparty's agreement to pay for advertising services, th e company would not have purchased goods, services or equity from the counterparty . In such instances both parties must report the net, rather than gross, value of revenue derived from th e transaction.
128 . In this regard, former SEC Chief Accountant Lynn Turner, in a speech on Ma y
18, 2001, stated: "When an entity would not have entered into one of the separate contracts without all the contracts being negotiated and agreed to as a `package', it will often be difficult to identify a separable benefit being received and to establish reliable and verifiable fair values
for each element of the arrangement . In those instances, the facts and circumstances will often
40699 .1 60 dictate that the cash inflows and outflows be reported as a net revenue or cost amount, in th e
appropriate periods."
b. Warrants or Stock (equity) Received in Barter or Partial Barter Transactions
129. AOL and AOL Time Warner also regularly bartered advertising for warrants or
stock as one component of complex deals entered into with other companies . In several deals,
AOL and AOL Time Warner entered into such deals under the guise of making an investment ,
yet required the counter-party to recycle the funds by purchasing advertisements . The
companies would then report advertising revenue without using the underlying investment (th e
equity) as a basis for valuing the advertising revenue, resulting in revenue overstatements .
130. On March 16-18, 2000, the Emerging Issues Task Force of FASB reached
consensus (thereby making it a GAAP requirement) on the issues surrounding exchange o f
equity for services in accordance with APB 29 . In so doing, the Task Force issued EITF Issu e
No. 00-8, entitled "Accounting by a Grantee for an Equity Instrument to be Received i n
Conjunction with providing Goods or Services."
131 . Pursuant to EITF 00-8, 1 4 and APB 29, in transactions where a company receive s
equity (e.g., warrants or stock) as consideration or partial consideration for the services rendered
by the company, "the grantee should measure the fair value of the equity instruments using th e
stock price and other measurement assumptions" on the earlier of the date that a mutua l
understanding of the terms are established and a commitment to performance is reached or th e
date the grantee's performance is complete .
132. In addition, EITF 00-8, ¶ 10, requires that "companies should disclose, in eac h
period's financial statements, the amount of gross operating revenue recognized as a result o f
non-monetary transactions addressed by Issue 00-8" (those involving equity received i n
40699. 61 conjunction with providing goods or services) . EITF 00-8, ¶ 10 goes on to state : "Furthermore, the SEC Observer reminded registrants of the requirement under Item 303(a)(3)(ii) of
Regulation S-K to discuss known trends or uncertainties that have had or that a registrant reasonably expects to have a materially favorable or unfavorable impact on revenues ."
c. Exchange of Advertising - " In Kind" Advertising
133 . A typical barter transaction between internet companies involves trading advertising space and then assigning a value to both revenue and expense . No cash is exchanged between the parties .
134. AOL also improperly inflated its advertising revenue by reporting revenues on such "in kind" advertising whereby AOL would provide customers with advertising on its website and in return receive certain advertising services which usually consisted of rights t o advertise "America Online Keyword : [ ]" on a customer's product .
135. According to a former Company account manager, AOL and AOL Time Warner often made barter deals with their strategic partners towards the end of fiscal quarters involving the exchange of banner advertisements which effectively served as the principal currency for such deals. The deals involved a swap of banners on each others' sites . Both parties booked the
advertising impressions as revenue. If AOL and Company advertising customers complained
about the value of the advertising for which they had originally contracted, AOL's and AOL
Time Warner's response was typically to provide "bonus banners" to the client rather than
renegotiate a contract, a practice known as "make good ." According to this source, such
"banner swaps" also occurred between AOL Time Warner divisions following the Merger and
the AOL online division frequently posted "family banners" for Time Warner channels, such as
Turner Broadcasting, and booked the advertisements as revenue for AOL .
40699 .1 62 136. In early 2000, FASB stated, with respect to barter: "To the extent that revenues include barter transactions for which there is no ultimate realization in cash and no overall effec t on net income, the practice may lead to overstated revenues and artificially inflated marke t capitalization." (EITF 99-17, ¶ 2) . The FASB went on to rule that companies could book a barter advertisement as revenue only if they could compare it with a similar transaction with another company in which cash was exchanged within the previous six months . AOL and AOL
Time Warner failed to comply with FASB requirements and in fact utilized improper accounting for "in-kind" barter transactions to overstate advertising revenue.
137 . Accounting for "in kind" advertising transactions is governed by EITF Issue No .
99-17, "Accounting for Advertising Barter Transactions" and APB 29 . EITF 99-17 became effective for transactions entered into after January 20, 2000 .
138 . The necessity for EITF 99-17 is stated in the text of the rule :
It has become increasingly popular for Internet companies to enter into transactions in which they exchange rights to place advertisements on each others' web sites . In some of these transactions, no cash is exchanged between the parties . In other transactions, similar amounts of cash are exchanged between the two parties .
139. EITF 99-17, ¶ 4 states :
The Task Force reached a consensus that revenue and expense should be recognized at fair value from an advertising barter transaction only if the fair value of the advertising surrendered in the transaction is determinable based on the entity's own historical practice of receiving cash, marketable securities, or other consideration that is readily convertible to a known amount of cash for similar advertising from buyers unrelated to the counterparty in the barter transaction. An exchange between the parties to a barter transaction of offsetting monetary consideration , such as a swap of checks for equal amounts, does not evidence the fair value of the transaction . If the fair value of the advertising surrendered in the barter transaction is not determinable within the limits of this Issue, the barter transaction should be recorded based on the carrying amount of the advertising surrendered, which likely will be zero .
40699 .1 63 (Emphasis added.) This historical practice must be for a similar transaction in the six month s prior to the transaction in question, pursuant to the provisions of the EITF.
140. Examples of AOL and AOL Time Warner round-trip and barter deals that were improperly accounted for by AOL and AOL Time Warner include the following :
(i) Homestore Inc.
141 . Sixteen separate sham transactions with Homestore, Inc. ("Homestore") and AOL and then AOL Time Warner occurred in the latter part of 2000 and the first half of 2001 .
Although these Homestore deals are just some of the transactions devised by AOL or AOL
Time Warner to artificially inflate revenue, much is known about these deals because of an ongoing criminal investigation into the Homestore matter that has already resulted in publicl y disclosed guilty pleas to criminal offenses by four Homestore executives .
142 . The concept for the sham Homestore transactions was devised by Defendant Eri c
Keller, and approved by at least the person at AOL Time Warner to whom he directly reported ,
Defendant David M . Colburn. The sham deals were designed to work to the mutual benefit o f
Homestore and AOL Time Warner so that they could both report bogus advertising revenue . As discussed below, AOL Time Warner had a significant equity interest in Homestore, 3 .9 million shares of Homestore stock, and therefore the Company benefited from the sham deals when both it and Homestore reported artificially inflated advertising revenue.
143 . The Homestore deals involved "three legs". In the first leg Homestore paid a third-party for services and products that Homestore did not need, and for which it in fact, overpaid. The secret second leg required the third parties to purchase advertising from AO L
Time Warner with most or all of the money Homestore paid to the third parties. Under the third leg, AOL Time Warner purchased advertising from Homestore in the same amount that th e
40699 .1 64 third-party paid to AOL Time Warner for advertising. Accordingly, AOL Time Warner an d
Homestore secretly round tripped or purchased advertising revenue from themselves in sham triangular transactions.
144. As part of these sixteen fraudulent transactions, in 2001 the third parties paid
AOL a total of $45.1 million for advertising, with the agreement that AOL would funnel the monies back to Homestore, after deducting an approximate $9 million "commission ."
145. Homestore executives, and Keller and Colburn, agreed that the secret leg of the sham transactions would not be documented . The secret third parties included PurchasePro,
Inc., Investor Plus, FX Consultants, Classmates .com, Wizshop, and Easy Roomates .
146. In May 2001, Keller worked with Homestore's top dealmaker, Peter Tafeen, t o avoid detection by Homestore's auditing firm of the sham transactions that were to take place in the second quarter of 2001 . However, in June 2001, Keller was placed on administrative leave by AOL Time Warner.
147 . At that time, in June 2001, Defendant Joseph Ripp, then the Executive Vic e
President and Chief Financial Officer of AOL, who became AOL's Vice-Chairman on
September 13, 2002, and Defendant Steven Rinder, AOL's Senior Vice President for Busines s
Affairs and Development, handled the sham deals for AOL.
148 . Initially, Ripp and Rinder raised questions regarding documentation of the third- party leg of the deal. During mid-to late June 2001, by phone and e-mail, Ripp and Rinder told
Homestore that they had conce rns about the collectiblilty of money from the third parties. In
response, Homestore went to great lengths to resolve the collectibility issues, including
accelerating payments to the third pa rties so that AOL received its money during the second
quarter of 2001 .
40699.1 65 149. On June 29, 2001 , the last business day of the second quarter, AOL told
Homestore that it had not received confirming letters from some of the third parties regardin g
their purchase of adve rtising from AOL. Ripp and Rinder also said that Homestore could not b e
paid unless the confirming letters were received .
150. After the final confirming letters were subsequently received later on June 29 ,
2001, Homestore's Chief Executive Officer, Stuart Wolff, caused a phone call to be placed t o
Colburn who was not available. A message was left to have Colbu rn call Wolff. Instead, late in
the evening of June 29, 2001, Ripp returned the call to Wolff. Wolff and several Homestore
executives and Ripp and Rinder participated on the call . Wolff told Ripp and Rinder that Keller
had agreed to the deal long ago . Wolff threatened litigation . Ripp and Rinder said that Kelle r
was gone, but never denied that Keller agreed to the deal or that Keller did not have th e
authority to make the deal on AOL Time Warner's behalf. Wolff suggested that they should get
Keller on the phone, but Ripp and Rinder declined the offer . Another Homestore executive sai d
he confirmed that money had already been paid to certain of the third-party vendors and AOL
had received the payments for the advertising .
151 . That evening after the call, the Company sent to Homestore its confirmation o f
the deal.
152. The Company, and at least Ripp, Rinder, Colburn and Keller, were all aware o f
the round-trip and fraudulent nature of the deals . Indeed, Keller and Colburn concocted the
scheme and Ripp and Rinder clearly knew of the details of the deals, including where the money
AOL Time Warner received was actually coming from and that it was round-tripped back to
Homestore. Ripp and Rinder, however, covered up the sham deals to allow the Company t o
40699.1 66 inflate advertising revenue and avoid adverse publicity for both AOL Time Warner an d
Homestore, in which the Company had a significant equity interest .
153. The fraudulent Homestore transactions have been confirmed by the guilty pleas to criminal offenses of four Homestore executives in an ongoing DOJ investigation into th e
Homestore matter . Although the criminal charges and guilty pleas do not identify AOL Tim e
Warner by name, they refer to the company that engaged in these transactions with Homestor e as a "major media company." Furthermore, these documents describe the same three-legge d transactions referred to above and refer to the total of sixteen transactions and receipt by th e
"major media company" of $45 . 1 million in 2001 for advertising as part of these sham transactions.
154. Numerous press reports have identified the Company, and its executives , including Colburn and Keller, as targets of the DOJ investigation . In addition, Colburn, Keller and AOL Time Warner were named as defendants in a securities class action brought by
Homestore shareholders in the United States Court for the Central District of Californi a regarding the sham transactions. On March 7, 2003, the Honorable United States District Judge
Marsha J. Pechman, issued an Order Regarding Motions to Dismiss . In re Homestore.com, Inc.
Securities Litigation, No. C01-11115 MJP, 2003 WL 1227643 (C .D. Cal. March 7, 2003). In her Order, Judge Pechman recounted in substantially similar fashion the Homestore allegation s set forth herein, and the sham three- legged transactions involving the Company, Homestore, an d the third parties. The court reluctantly dismissed the Company, Colburn, Keller and the thir d parties because it concluded that no "aiding and abetting" liability of AOL as to Homestore shareholders existed under the securities laws . However, the court stated :
While this Court feels compelled to arrive at this result, it does so with reservation. The acts alleged in the [Complaint], which this Court must accept a s
40699 .1 67 true for purposes of this motion, describe a massive conspiracy driven by pure avarice. In particular, the detailed factual allegations describing the role of AOL and its agents in helping Homestore please Wall Street and in boosting its own revenues through bogus commissions give this Court great pause .
*** This decision does not mean that the wrongs of these aiders and abettors will necessarily go unchecked ; the PSLRA expressly granted the SEC the authority to bring civil actions against aiders and abettors of securities fraud, and it is this Court's understanding that some investigation is ongoing.
Id. at *24. (Emphasis added .)
155. On March 12, 2003, The Washington Post reported that the federal investigation
of AOL Time Warner had, indeed, been broadened to include the "aiding and abetting" of other s
by the Company, Colburn and Keller, both before and after the Merger .
156. The Company improperly reported advertising revenue from these phony deals .
The transactions were shams agreed to with Homestore in order to report advertising revenu e
that neither party "earned" as required by SFAC No. 5 ¶ 83 . In addition , the fraudulent
transactions were not "representationally faithful" as required by SFAC No. 2 ¶ 63 . Thus, even
if the Company only reported its bogus $9 million "commission" as advertising revenue, and
prorated it over the first two quarters of 2001, the Company's advertising revenue was
overstated by $4.5 million for each ofthe quarters ended March 31, 2001 and June 30, 2001 . Of
course, if the Company reported the entire $45 . 1 million as advertising revenue, the overstated
amount is even larger.
(ii) Sun Microsystems, Inc.
157 . In a barter transaction with Sun Microsystems , Inc. ("Sun"), AOL overpaid for
goods at list price when normally it would receive a discount , thereby overstating th e
consideration exchanged for AOL' s services in violation of APB 29. This transaction continued
40699.1 68 for three years and ultimately resulted in approximately $150 million of overstated advertisin g
revenue over the course of the deal.
158 . The Sun transaction was announced on November 24, 1998 and involved the
swap of advertisements for computer equipment . A September 1, 2002, a New York Times
article entitled, "Ouster at AOL, but Where Does Trail End?," reported that AOL agreed to buy
$500 million in computer equipment from Sun at list price, even though companies like AOL
typically buy at a discount of more than 30 percent. For its part, Sun agreed to pay AOL $350
million for advertising services . A contemporaneous agreement provided for Sun to pay AOL
more than $310 million per year as part of a three-year partnership called "iPlanet ." AOL
treated these payments from Sun as recurring revenue. Through this partnership, AOL was in
effect receiving back some of its own expenditures in order to artificially increase its own
advertising revenue and overstate income as a result. Furthermore, AOL and Sun would not
have entered into the transaction without the reciprocal purchases. Accordingly, under APB 29
revenue resulting from the deal should have been reported net of the overpayment rather than on
a gross basis.
159. A former AOL Chief Technology Officer, Product Manager and Senior Busines s
Manager confirmed AOL's improper barter deal with Sun. According to this source, the
announcement reporting the deal, which was signed by Jay Rappaport, was misleading becaus e
AOL did not realize the amount of revenue it was repo rting.
160. At a minimum , AOL's overpayment for Sun' s computer equipment , based on the
equipment 's fair market value, should have been recorded as a reduction of AOL's advertising
revenue resulting from the round-trip transaction . Instead, AOL recorded the transaction based
on an inflated list purchase price for the computer equipment, resulting in at least a 30%, o r
40699.1 69 $150 million, overstatement of advertising revenue. AOL therefore overstated its advertising revenue by at least $4 .2 million for December 1998 and at least $12 .6 million per quarter starting with the quarter ended March 31, 1999 through the quarter ended September 31, 2001 , and $8.4 million for the quarter ended December 31, 2001 . AOL's relationship with Sun woul d serve as a template for numerous other deals in which AOL bartered with other companies , round-tripping money and reporting advertising revenue at greatly inflated values, in violatio n of GAAP.
(iii) Veritas Software Corporation
161 . Ina classic case of round-tripping reminiscent of the earlier Sun swap, AO L negotiated a deal in September, 2000 to pay $50 million dollars for $30 million dollars worth o f software it purchased from Veritas Software Corporation ("Veritas") according to a former
Senior Contract Specialist at AOL. The extra $20 million dollars was then round -tripped back to AOL in a purported separate deal in which Veritas purchased online advertising from AOL .
162. AOL then overstated its advertising revenue by $20 million in violation of AP B
29. According to the above source, the Veritas deal came about after AOL's Business Affairs unit raised a "hue and cry" when it heard that AOL's network operations unit was planning to make a $30 million dollar purchase from Veritas without getting something in return . Veritas said it did not want to advertise on AOL and was not going to spend any money to do so .
Consequently, Defendant Colburn and a Business Affairs Director, Jeffrey Tyeryar , instructed the appropriate personnel to raise the contract amount to $50 million dollars and then structur e another deal in which Veritas would spend the extra $20 million dollars it had received for it s
software on AOL advertising . Business Affairs wanted the $20 million from Veritas so that i t
could be booked as revenue before the end of the last quarter of calendar year 2000, the last
40699 .1 70 quarter before the Merger . The source described the Veritas deal as being a "kick-back"
arrangement.
163 . More specifically, according to the above source , AOL's Jeff Tyeryar negotiated
a new dual contract arrangement and Colburn signed off on it for AOL 's Business Affairs Unit.
By using two different contracts, it was made to appear that the two transactions were unrelated
and that AOL had received $20 million dollars in advertising revenue when, in fact, AOL was
just getting back the $20 million dollars it had overpaid for the Veritas equipment and software .
Veritas, for its part, agreed to the deal only because it was anxious to book revenue from th e
AOL software sale before the end of 2000 . Mike Cahill, a Veritas Vice President, handled the
deal for Veritas .
164. In a Reuters news release dated November 14, 2002, Veritas reported that, i n
connection with the SEC's investigation of AOL's accounting, the SEC had subpoenaed
Veritas' records relating to transactions it entered into with AOL in September 2000 .
165 . On January 17, 2003, Veritas announced that, as a result of the SEC's
investigation, it was restating its financial results for fiscal years 2000 and 2001 , eliminating
$20 million in revenue previously booked as licensing and support fees paid by AOL . Further,
the Company announced that it would no longer record as an expense the $20 million it paid
AOL for advertising.
166. Then, on or about March 17, 2003, Veritas disclosed in an amended Form 10-K
filing with the SEC that the restatement resulting from the AOL deal was based on a
determination that the fair value of the goods and services purchased and sold in the deal could
not be "reasonably determined ." In addition, Veritas disclosed that it was further restating its
financials based on "two additional contemporaneous transactions involving software license s
40699.1 71 and the purchase of on-line advertising services" to reflect additional reductions in revenue.
Veritas' auditor at the time of these transactions, Defendant Ernst & Young, was replace d
following the audit of the Company's year 2000 financial statements .
167. AOL's and AOL Time Warner' s improper accounting for the Veritas deal
resulted in an overstatement of advertising revenue by at least $4 million per quarter from th e
quarter ended December 31, 2000 through the quarter ended December 31, 2001 .
(iv) Bertelsmann AG
168. In a roundtrip transaction with Bertelsmann AG ("Bertelsmann"), AOL overstated
advertising revenue by nearly $400 million when it bought out Bertelsmann's interest in a joint
venture. Rather than take advantage of the discount being offered by Bertelsmann on the buy-
out price if paid in cash, AOL arranged to have Bertelsmann round-trip or rebate that portion of
the buy out price which would have constituted the discount amount back to AOL through the
purchase of advertising services . This transaction continued for two years and ultimately
resulted in AOL overstating advertising revenue by $400 million over the course of the deal in
violation of APB 29.
169. In the first quarter of 1998, Bertelsmann paid AOL $75 million for a 50% interes t
in a joint venture to operate the CompuServe European online service . Each company invested
an additional $25 million in this joint venture. In August 1999, AOL Europe introduced
Netscape Online in England and in May 2000, AOL Europe introduced CompuServe Office in
Germany.
170. In March 2000, AOL and Bertelsmann announced plans to restructure their AO L
Europe joint venture and to undertake a new strategic alliance . The restructuring consisted of a
put and call arrangement for AOL to purchase, in two installments , Bertelsmann's 50% interes t
40699 .1 72 in AOL Europe for consideration approximating $6.7 billion .
171 . According to a March 31, 2003 Wall Street Journal article, "A person familiar with the situation said that when Bertelsmann initially asked AOL to be paid in cash for its AOL
Europe stake, it had offered a discount on the sale price in exchange . The person said AOL' s response was that it wasn't interested in a cash discount, but wanted a bigger ad deal .
Bertelsmann accounted for the advertising as a cost of the sale, the person said ."
172. A March 29, 2003 article entitled, "AOL Says SEC is Challenging it s
Accounting," The New York Times reported:
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 article went on to state that "the agreement with Bertelsmann was negotiated at the top levels of both companies" and also noted that, "current and former Bertelsmann executives" had recently revealed that not only had they questioned the deal, but that they were instructed by Bertelsmann's headquarters "to buy online advertising from AOL at inflated prices to fulfill the purchase commitment made as part of the larger transaction ."
173 . The article also pointed to a connection with the sham transactions between AOL
and Homestore:
In a related investigation into accounting at the internet company Homestore, one of the AOL's 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 advertisin g
40699 .1 73 spending to Homestore, which in turn paid money to AOL.
174. Under the requirements of APB 29, AOL was obligated to report the deal at its
fair market value and any overpayment should have been recorded as a reduction of the revenue
that was recognized in connection with this deal . Since AOL would have received the discount ,
AOL overstated its advertising revenue during the Class Period by $16 .3 million, $65.5 million,
$39.8 million, $0.5 million, $80.3 million and $84.4 million per quarter, starting with the quarter
ended March 31, 2001 through the quarter ended June 30, 2002, respectively . The fact that
Bertelsmann recognized the advertising purchase as a cost of the sale provides even furthe r
evidence that the Company improperly reported advertising revenue in connection with th e
Bertelsmann deal.
(v) Gateway Inc. Roundtrip /Free Internet Service
175. In yet another round-trip transaction, AOL improperly accounted for the bundling
of its internet services on Gateway Inc .'s ("Gateway") computers, thereby overstating
advertising revenue by $470 million in violation of the directives set forth in APB 29 .
176 . In or about late 1999 or early 2000, AOL and Gateway entered into a n
arrangement pursuant to which Gateway agreed to promote AOL's internet service to
purchasers of its computers . Each time a Gateway computer purchaser subsc ribed to the AOL
service, Gateway would receive a fee or "bounty" from AOL . According to an April 2, 2003
Washington Post article entitled "Gateway to Amend Financial Reports - SEC Had Raised
Concerns Over AOL Deal," at the same time AOL paid a "bounty", Gateway in turn paid AOL
for providing a free year of internet service on its computers.
177 . Since there was no substance to the transaction other than swapping checks, AOL
should have reported the transaction at its zero value instead of improperly reporting the
40699.1 74 amounts as sales and corresponding costs of sales . As a result, AOL overstated its advertising revenue by $340 million in 2000 and $130 million in 2001 by recognizing the fees paid by
Gateway as revenue, despite the fact that AOL was cycling the same amount back to Gateway in the form of a "bounty" payment .
178 . On or about April 1, 2003, Gateway announced that it was restating previousl y reported revenue from its agreement with AOL in response to accounting concerns raised by th e
SEC, which had been investigating Gateway's accounting since at least November, 2002 . An
April 2, 2003 Washington Post article reporting on the announcement stated:
In 2000 and 2001, Gateway's method of reporting its dealings with America Online artificially boosted revenue because it failed to deduct the payments it made to AOL from the revenue it received . Because money was moving back and forth between the companies, Gateway said it intends to restate its financial results by reducing its revenue, a change that will more appropriately reflect the net amount of cash it received .
The revision is related to how the company accounted for bundled AOL Internet services, which it previously had reported on a gross basis, Gateway said in a statement. Current management has determined that it is more appropriate to present such amounts on a net basis .
Gateway said the reduction of revenue on its books from restating deals with America Online would be about $340 million, or 3.5 percent of revenue, in 2000, and $130 million, or 2 .2 percent of revenue, in 2001 .
(Emphasis added .)
179. AOL and AOL Time Warner's improper accounting for the Gateway internet deal resulted in an overstatement of advertising revenue, on a prorated basis, by at least $85 millio n per quarter beginning with the quarter ended March 31, 2000 through the quarter ende d
December 31, 2000, and $130 million for the quarter ended March 31, 2001 .
(vi) WorldCom Inc.
180. Beginning in 1998, WorldCom Inc . ("WorldCom") and AOL entered into a
40699.1 75 "multi-year, multi-million dollar agreement" pursuant to which AOL paid at least $900 million
dollars a year to WorldCom to carry the bulk of its internet traffic, and AOL becam e
WorldCom's largest customer . In July 2001, WorldCom and AOL Time Warner struck a
massive roundtrip/barter deal in which WorldCom agreed to buy more than $200 million dollar s
in advertising across all AOL Time Warner properties in exchange for AOL Time Warner
continuing to keep its network traffic on WorldCom's network . While not disclosed in the press
releases announcing the deal, AOL Time Warner also agreed to buy internet capacity from
UUNet, a unit of WorldCom, to expand AOL Time Warner's online network . The reciprocal
transactions were used by AOL Time Warner as a vehicle to improperly recognize advertising
revenue of at least tens of millions of dollars in violation of APB 29 .
181 . An August 22, 2002 Wall Street Journal article entitled, "Questionabl e
AOL Revenue Has WorldCom Link," noted the close relationship between the two companies
(Defendant Case held a seat on WorldCom's Board of Directors and AOL was WorldCom' s largest customer) and pointed out that, according to people familiar with the SEC's investigation of AOL Time Warner, a substantial portion of the $49 million of overstated advertising revenue initially reported by the Company involved revenue inappropriately booked from the WorldCom deal:
The money stemmed from the particularly close relationship Ame rica Online and WorldCom developed during the past few years, in which AOL became WorldCom's biggest customer, paying the telecommunications firm at least $900 million a year to carry the bulk of its Internet traffic. Most recently, in July 2001, the two companies struck a massive deal in which WorldCom agreed to buy more than $200 million in advertising across AOL properties in exchange for AOL continuing to keep its network traffic on WorldCom's network .
People close to the situation said the latest deal was negotiated in part by David M. Colburn, a top AOL deal maker who was ousted two weeks ago, and Scott Sullivan, WorldCom's former chieffinancial officer, who has been charged with
40699 .1 76 securities fraud after the company, now in bankruptcy-court proceedings, found a total of $7.2 billion in improper accounting .
182. In its SEC Form 10-Q for the quarter ended June 30, 2002, AOL Time Warner
revealed that the initial reported overstatement amount of $49 million impacted the quarte r
ended December 31, 2000 through the quarter ended March 31, 2002 . As a result, AOL Tim e
Warner's improper accounting for the WorldCom deal resulted in an overstatement o f
advertising revenue by at least $12.7 million for the quarter ended December 31, 2000, $5 .3
million for each of the quarters ended March 31, June 30 and September 30, 2001 , $11 .8 million
for the quarter ended December 31, 2001 and $8 .5 million for the quarter ended March 31 ,
2002 .
(vii) Owest Communications
183. In or about July, 2001, AOL Time Warner entered into a reciprocal transaction
with Qwest Communications ("Qwest") . Under the deal, AOL reportedly agreed to use Qwest' s
network and to purchase digital subscriber lines and network transport capacity . In return,
Qwest agreed to advertise in the Company's media properties including magazines, televisio n
programming, and online services. In a related round-trip transaction, AOL agreed to bu y
network capacity in Europe from KPNQwest, a Qwest affiliate, in return for which Qwes t
agreed to purchase AOL advertising.
184. AOL Time Warner violated GAAP by failing to account for the transaction base d
on the fair market value of the underlying instruments, either the network services or th e
advertising services, whichever was more reasonably and readily determinable . Thus, the
reciprocal transactions were used by AOL as a vehicle to improperly recognize millions o f
dollars of advertising revenue in violation of APB 29.
40699 .1 77 185. On August 23, 2002, The New York Times reported that another of the three deal s
being examined by AOL Time Warner in connection with the Company 's initial report of $49
million in improperly reported revenue was the swap deal between the Company and Qwest .
(viii) Hughes Electronics Corporation
186. AOL improperly accounted for a June 21, 1999 round-trip/barter transactio n
involving AOL's receipt of restricted stock in Hughes Electronics Corporation ("Hughes") in
exchange for adve rtising which allowed AOL and AOL Time Warner to overstate advertising
revenue. By overvaluing the stock received, AOL artificially inflated its advertising revenue by
nearly $ 50 million per quarter over a 2 'Y2 year period .
187. The June, 1999 transaction expanded upon a preexisting partnership, entered int o
on May 11, 1999, by the two companies to develop a combination set-top box that would make
DirecTV and AOL TV available to customers. Under the expanded alliance, AOL invested $1 . 5
billion in General Motors ("GM") Series H 6 .25% automatically Convertible Preferred Stock.
GM immediately invested the $1 .5 billion received from AOL in the stock of its subsidiary ,
Hughes. In return, Hughes committed to increase its sales and marketing expenditures to AOL
over the next three years by approximately $1 .5 billion dollars .
188. As included in its June 29, 1999 SEC Form 8-K, a GM press release regarding th e
AOL and Hughes deal stated that "the investment would be non-dilutive to earnings ."
Similarly, a June 21, 1999 Internetnews.com article reported that "AOL said the investment will
not have a negative impact on its earnings." AOL made this statement because it knew th e
invested funds were to be round-t ripped back to AOL and accounted for by AOL as advertising
revenue . However, the bartered services (advertising revenue) were overstated in violation o f
GAAP, particularly APB 29, SFAS 123 and EITF 00-08, since AOL did not properly value th e
40699 .1 78 barter instrument (stock) exchanged for them . More specifically, while AOL entered into th e
round-trip/barter deal under the guise of making an investment, the underlying instrument, no t
the money to be exchanged, should have provided the basis for valuation .
189. Despite the amounts of money swapped (i.e., $1 .5 billion from AOL for G M
Series H preferred stock in exchange for Hughes' commitment to purchase $1 .5 billion i n
advertising from AOL), the underlying round-trip/barter deal was essentially an exchange of
GM Series H preferred stock for AOL advertising services. AOL's recognition of advertising
revenue at the full purpo rted value of the stock violated GAAP. Since the stock was not
publicly-traded but was a class of stock created only for AOL and was not convertible until June
2002 (three years later), the value of the stock at the time of the transaction was not $1 .5 billion,
and thus the associated AOL advertising services recorded based on that inflated amount over
the period of the deal was improper . Though the stock tracked Hughes' common stock (GM
Series H common stock), the stock's value three years in the future should, at a minimum, have
had a time value and marketability discount applied to it. As a result, applying conservative
factors for time value and a marketability discount , AOL's and AOL Time Warner's advertising
revenue was overstated by at least $ 16 million for the quarter ended June 30, 1999, $48 million
per quarter beginning in the quarter ended September 30, 1999 through the qua rter ended March
31, 2000, and $32 million in the quarter ended June 30, 2000.
190. In its Form 10-K for the fiscal year ended December 31, 2001, filed on March 25 ,
2002, the Company reported a charge of "approximately $270 million to reflect an other-than-
temporary decline in the carrying value of AOL Time Warner's investment in Hughes
Electronics Corp . ("Hughes"), an available-for-sale investment ." Three months after the close
of the Class Period, AOL Time Warner acknowledged its material false statements relative t o
40699 .1 79 the value of its investment in Hughes. In its SEC Form 10-Q for the quarter ended Septembe r
30, 2002, filed on November 14, 2002, the Company reported:
Included in the non-cash pretax charges for three and nine month pe riods ended September 30, 2002 are charges related to the w ritedown of AOL Time Warner' s investment in Hughes Electronics Corp. ("Hughes") of $505 million for both the three and nine month periods.
191 . Finally, in January 2003, AOL Time Warner sold its 8 .4% stake (80 millio n
shares) in Hughes for approximately $800 million, resulting in a total writedown of $700
million, or approximately 47% . According to a Hughes SEC Form 8-K, filed on March 3, 2003,
Hughes and AOL entered into an agreement terminating their entire strategic alliance . Under
the termination, Hughes was released from its commitment to spend $1 billion in additional
sales, marketing, development and promotion efforts to support the companies' joint products
and services.
(ix) Homestore - The 2000 House and Home Deal
192. In May 2000, AOL and Homestore entered into a five-year agreement whereb y
AOL artificially inflated advertising revenue by approximately $26 .5 million per year by
improperly accounting for the value of stock it received in the deal . As part of the agreement,
Homestore became the exclusive distributor of home-buying and moving services across AOL
properties and AOL created the "House and Home" channel on its website . Homestore was th e
exclusive content provider for the site . AOL and Homestore also agreed that they would share
revenue generated from the House and Home channel. In return, AOL received 3 .9 million
shares of Homestore common stock, at a guaranteed value of $68 .50 per share, and $20 million
in cash.
40699 .1 80 193 . Just prior to the announcement of the AOL/Homestore agreement, Homestore' s stock price was $18 .25 a share, and immediately after the announcement it rose to $22 .875 a share, a 25% increase.
194. As part of the deal, AOL also received a $90 million letter of credit tha t
Homestore could draw upon up to a $50 million cap if Homestore's stock price did not reach th e guaranteed price.
195. On May 1, 2000, Business Wire reported on the Homestore/AOL alliance:
America Online, Inc . (NYSE: AOL), the world's leading interactive services company, and Homestore .com, Inc. (Nasdaq: HOMS), the world's leading home and real estate network on the Internet, today reached a new five-year multifaceted content, e-commerce and distribution alliance valued in excess of $200 million, to provide the most comprehensive source of home and real estate content to several key AOL brands .
Under the terms of the agreement, America Online, Inc . will receive approximately 3 .9 million shares of Homestore .com common stock, which Homestore.com is required to guarantee meet certain performance targets throughout the term of the agreement . As part of the guarantee, Homestore.com will issue a $90 million letter of credit, which will be drawn upon only if Homestore.com's common stock does not meet the performance targets . AOL will also receive $20 million in cash as part of the agreement .
196. This deal was orchestrated by Keller at AOL and Peter Tafeen at Homestore, with
Colburn having extensive involvement in the transaction.
197. Keller told Joe Shew, a Homestore executive, in March or April 2000 that AOL' s
auditors had looked at the deal and that the $20 million cash payment, the letter of credit an d certain termination provisions, were included in the agreement so that AOL could recogniz e revenue . These provisions were not initially part of the agreement . Keller told Shew that
40699 .1 81 Colburn was directly involved in the negotiations of these terms . Keller also told Shew that
AOL would be recognizing $50 million per year in revenue from the agreement.
198. When the agreement was implemented, Homestore was very disappointed wit h the deal. Homestore believed that it did not receive enough "hits" through the AOL interne t properties and Peter Tafeen regularly complained to Colburn about his disappointment with th e deal.
199. AOL reported the value of the deal to be $287 million, or about $57 million per year over the five-year term of the deal . AOL, however, failed to properly account for the consideration at its fair value , and thus violated APB 29, SFAS 123 and EITF 00-08, which would have included discounts for time value and marketability (transfer) restrictions. As a
result, the Company improperly overstated adve rtising revenue by at least $4.4 million for the
quarter ended June 30, 2000 and $6.6 million per quarter for the quarter ended September 30,
2000 through the quarter ended June 30, 2002, the last reported quarter during the Class Period.
(x) Gateway Inc. Stock Purchase
200. AOL again improperly accounted for a round-trip/barter transaction involving the
purchase of stock in a round-trip deal ori ginally entered into with Gateway beginning on o r
about October 10, 1999 . The stock was held only by AOL and unmarketable for three years .
201 . According to a former AOL Vice President for Business Development, the deal
"was not arm's length " and was misrepresented by AOL to the marketplace . AOL agreed to
invest approximately $800 million in Gateway, acquiring a 4.5% stake in the company in
Gateway stock and warrants . The source reported that, in return, the agreement provided that
Gateway would use the entire $800 million dollars it received from AOL for advertising and
other strategic partnerships on AOL' s service. These Gateway investments included an online
40699 .1 82 retail store joint venture of AOL and Gateway in which Gateway invested $75 million. Both
AOL and Gateway's stock went up as a result of the publicity about this deal which wa s
presented in press releases as being mutually beneficial to the companies . According to the
source, the deal was, in fact , a roundtrip/barter transaction in which AOL, through improper
accounting, overstated advertising revenue.
202 . Similar to the Hughes and Homestore House and Home transactions describe d
above, AOL failed to use the underlying instrument (stock ), as opposed to the money
exchanged, as a basis for valuing the amount of advertising revenue to be recognized in the deal .
As was its practice, in or about December, 2001, AOL invested $ 200 million in a class of stock -
50,000 shares of non-voting Series A convertible preferred stock - that only AOL held . The
Gateway stock was thus restricted and would not convert until 2002 and beyond (usually thre e
years from the transaction date) depending on the trading prices on those dates. Consequently ,
proper valuation of the stock was critical to AOL's recognition of adve rtising revenue in the
Gateway deal. APB 29 required that a fair market value calculation be applied upon issuance o f
the stock and that the advertising revenue reported by AOL be discounted accordingly . AOL
did not do so, thus violating APB 29, SFAS 123 and EITF 00-08, which required that the
transaction be valued at the fair value of the instruments swapped, including time value and
marketability discounts . By failing to properly value the Gateway stock, AOL and AOL Tim e
Warner overstated advertising revenue by at least $3 million in December, 2001 and $9 million
per quarter for the quarter ended March 31, 2002 through the quarter ended June 30, 2002, th e
last reported quarter during the Class Period .
40699.1 83 (xi) Oxygen Media Inc. Stock Purchase
203 . AOL Time Warner again improperly accounted for a round-trip/barter transaction involving the purchase of stock in a deal entered into with Oxygen Media Inc . ("Oxyge n
Media") in April, 2001 . While not fully disclosed to the marketplace, AOL invested $30 to $5 0 million dollars in Oxygen Media which operates a cable channel . As part of the deal, Oxygen
Media's cable channel would be carried on the Company's cable systems and Oxygen Medi a would purchase $100 million in advertising mostly from the AOL division of the Company .
According to a former AOL account manager, the AOL deal with Oxygen Media was a n instance of "round tripping" or a "reinvestment deal ."
204. The deal itself was announced on April 4, 2001, in a Wall Street Journal article entitled, "AOL Time Warner Reaches Deal to Boost Stake in Oxygen Media ." The articl e stated:
AOL Time Warner Inc . is boosting its minority stake in struggling Oxygen Media Inc., the closely held cable-television and online company, in a move that reflects the growing control of AOL executives over Time Warner's far-flung operations .
AOL Time Warner also will send a certain amount of online traffic to Oxygen's four Web sites by weaving Oxygen' s content into AOL's various online channels. AOL Time Warner declined to disclose the size of its cash investment in Oxygen or the size of its equity stake in the business.
205. On August 26, 2002, in an article entitled, "Officials Probe AOL's Actions Wit h
Partners," The Wall Street Journal reported on the Company's round-trip/barter deal with
Oxygen Media:
For America Online, investing in companies that then advertised on the Internet service was about as crucial to its growth as taking in oxygen . Literally.
Last year, AOL invested $30 million to $50 million in Oxygen Media Inc . and arranged for the women-focused cable channel to be carried on parent AOL Time Warner Inc .'s cable systems. At the time, Oxygen agreed to buy about
40699 .1 84 $100 million in ads that mostly ran on America Online--a hefty amount for a start-up media company.
The Oxygen trades were one of the many complex deals that were a way of life at the America Online unit--and many other technology companies--during the boom years . At AOL, these deals sometimes included an investment . Other times, AOL squeezed its suppliers for advertising revenue . Either way, the deals weren't much of a secret--AOL was proud of its ingenuity in crafting the arrangements and expected AOL partner companies to buy ads on AOL . "If we're one of their big customers, we expect them to be one of our big customers," Robert Pittman, the since-departed chief operating officer, said in an interview last year .
206. The Oxygen Media carriage deal was unusual for not including a launch fee .
Networks like Oxygen Media routinely pay cable operators substantial launch fees to obtai n favorable channel positions on cable systems . Instead of paying the Company such a fee, whic h could have been as much as $100 million dollars, Oxygen Media purchased advertising , principally from the Company's AOL online division. To compensate Time Warner's cable division for not receiving revenue from Oxygen Media in the form of a launch fee, the AOL online division bought advertising on Time Warner cable . According to a Wall Street Journal report on October 7, 2002 entitled, "SEC Probes AOL-Oxygen Pact For Double-Booking o f
Revenue," Defendant Pace, AOL Time Warner' s Chief Financial Officer, told a group of investors that the SEC inquiries into AOL's accounting included AOL's involvement with othe r
AOL Time Warner divisions and singled out the Oxygen Media deal as an example. By failin g to properly account for its round-trip deal with Oxygen Media, AOL Time Warner overstated
AOL advertising revenue by at least $19.8 million per quarter for the five quarters ended June
30, 2001 through the quarter ended June 30, 2002 .
(xii) PurchasePro.com, Inc. Advertising Swap
207. AOL and AOL Time Warner improperly accounted for an "in kind" advertising deal with PurchasePro .com, Inc. ("PurchasePro"), which AOL used as a vehicle to improperl y
40699 .1 85 inflate advertising revenue by at least $13 .9 million during the Class Period . At that time ,
PurchasePro was a start-up business-to-business software firm. According to PurchasePro' s
SEC Form 10-K for 2000 and its SEC Form 10-Q for the second quarter 2001, pursuant to th e
marketing agreement, PurchasePro bought advertising space from AOL and, in two transactions ,
AOL purchased promotional subscriptions for use with AOL customers for $13 .9 million.
AOL's purchase of $4.9 million (in 2000) and $9.0 million (in 2001 ) of PurchasePro' s
subscriptions for AOL's customers and PurchasePro's purchase of adve rtising from AOL were
round-tripped revenues. Rather than ea rned, the revenues were effectively self-generated.
Thus, the cash transactions failed to demonstrate "representational faithfulness" an d
subordinated the substance of the agreement to its form in violation of Statement of Financia l
Accounting Concepts No . 2.
208. Since AOL exchanged its advertising services for the PurchasePro subscriptions ,
AOL should have recognized the advertising revenue in accordance with the requirements o f
APB 29 . APB 29 states that the fair market value of the instruments (subscriptions and
advertising services) should be used as the basis of the transaction . If unable to determine the
fair market value, the recorded amounts (costs) should be used to value the transaction (APB 29 ,
par. 26), which would be minimal to zero. EITF 99-17 provides additional requirements as to
the valuation of advertising services using the past six months cash transaction for similar
amounts and similar terms as a basis . AOL overstated its advertising revenue by at least $4.9
million for the quarter ended December 31, 2000 and $9 million for the quarter ended June 30,
2001 because the fair value and cost of the PurchasePro subscriptions and AOL advertising was
virtually nothing.
40699 .1 86 (xiii) Monster.com
209. AOL improperly accounted for another "in kind" advertising deal entered into
with Monster.com in late 1999, used by AOL to overstate advertising revenue by over $29
million during the Class Period . On December 2, 1999, Business Wire reported on AOL' s
"$100 million relationship" with Monster.com:
America Online, Inc. (NYSE :AOL), the world's leading interactive services company, and Monster. com, the leading global careers network and the flagship brand of TMP Worldwide Inc. (NASDAQ:TMPW), today announced a four- year, exclusive $ 100-million relationship to bring Monster.com's career management resources directly to cyberspace's largest consumer audience across seven America Online brands.
210. According to a former AOL Vice President for Business Development, th e
transaction entered into between AOL and Monster.com was a "profitless deal" in which AOL
promoted Monster.com and Monster.com agreed to promote AOL by exchangin g
advertisements with each other .
211 . Similar to the PurchasePro deal discussed above, because AOL exchanged or
swapped its advertising services for the Monster .com advertising, AOL should have recognized
the advertising revenue in accordance with the requirements set forth in APB 29 and EITF 99-
17. APB 29 states that the fair market value of the instruments (advertising services) should be
used as the basis of the transaction. If unable to determine the fair market value within th e
limits of EITF 99- 17, the barter should be recorded based on the carrying amount of the
advertising surrendered, which would be zero . EITF 99-17 also provides additional directives
as to the valuation of advertising services using the past six months cash transaction for similar
amounts and similar terms as a basis . Further, applying the standards set forth in SFAC 2, the
transaction would be properly characte rized as a sham and the substance would be a net zer o
transaction despite its form. No "real" revenue was reportable. By failing to comply with AP B
40699 .1 87 29 and EITF 99-17, AOL and AOL Time Warner overstated advertising revenue by at least
$2 .08 million for the quarter ended December 31, 1999 and $6.24 million for each quarte r
beginning with the quarter ended March 31, 2000 through the quarter ended June 30, 2002, the
last quarter reported in the Class Period .
3. "Front Loading" or "Jackpotting" to Record Advertising Revenu e
212 . Another category of deceptive advertising deals involved the practice o f
manipulating the timing and placement of advertisements to report the revenue generated fro m
those advertisements in a particular quarter, thereby meeting internal goals or external earning s
estimates . According to a former AOL Associate Project Manager in the Sales Planning
Operations Division, who was responsible for booking revenue and implementing sales o n
AOL's website, the overall practice of flooding the website with advertisements at the end o f
the month through this method of so-called "front loading" or "jackpotting" was common .
Millions of dollars were "frontloaded" or "jackpotted" at the end of each quarter and man y
advertisers were in the dark about this practice .
213 . A Washington Post article dated July 19, 2002 said that interviews with former
AOL employees revealed that the term "jackpotting" referred to gambling slot machines where,
for example, three cherries in a row wins . In AOL's case, jackpotting meant it would run the
same ad three times on a single web page, often on the bottom of the screen, where it was less
visible.
(i) Catalina Marketing Corporatio n
214. According to a former Chief Technology Officer, Product Manager and Senior
Business Manager who worked for AOL, the Company often engaged in "jackpotting", an
example of which took place in the first quarter of 1998, even before the Class Perio d
40699 .1 88 commenced, in connection with Catalina Marketing Corporation ("Catalina") . Catalina had
signed a $10 million dollar two year contract to run supermarket adve rtising online with AOL.
Even though the food section of AOL was not ready to run the advertising, AOL executive s
made sure the ads ran before the end of the quarter and in advance of the contractual obligation
so AOL could book the revenue . According to this source, the rule of thumb at AOL at the time
was that AOL would book 25% of the value of the contract in the quarter the advertising began .
215 . The fact that AOL generated numerous advertisements in a sho rt time frame,
allegedly many times on the same page (to the point that some customers complained o f
excessiveness), to an earnings process does not alleviate the requirement of CON 5, p. 83 which
states, "Revenues are not recognized until earned . An entity's revenue-earning activities involv e
delivering or producing goods, rendering services, or other activities that constitute its ongoin g
major or central operations, and revenues are considered to have been earned when the entit y
has substantially accomplished what it must do to be entitled to the benefits represented by th e
revenues." (Emphasis added .)
216. When AOL engaged in "jackpotting" in connection with, inter alia, Catalina
Marketing, it overstated advertising revenue - by "squeezing" or "jackpotting" multipl e
advertising impressions or banners, AOL did not perform under the contract . In other words,
when the ads began to run in such a fashion under this, and other similar deals, there was n o
"earnings process" taking place with regard to the superfluous or excessive advertisement s
because AOL had not "substantially accomplished" the substance of the contract/agreements .
(ii) Telefonica SA
217. According to a July 19, 2002 article in The Washington Post, an example of
"jackpotting" occurred just prior to the Merger in connection with a Business Affairs deal to sell
40699.1 89 $15 million dollars in online ads to Telefonica, SA, ("Telefonica") a large Spanish telecommunications company. Confirming the existence of the relationship between AOL and
Telefonica, the Dow Jones International News Service reported on December 19, 2000 that
Telefonica Datacorp, the business telecom unit of Spanish telecommunications company
Telefonica SA (TEF) had signed a "multimillion dollar" strategic agreement with AOL fo r
several years.
218. In order to book revenue from the Telefonica deal in the quarter ended Decembe r
31, 2000, AOL needed to run the advertising during that month . According to the July 19, 200 2
Washington Post article:
But with so little time left, AOL had to place the ads in high-traffic areas of AOL, such as its welcome screen, the first Web page people see when they use the service. More consumers saw ads on the welcome screen and AOL could get faster credit for running the promotions.
AOL officials didn' t care that the Telefonica link from AOL' s English-language welcome screen took its users to a Spanish-language site , said AOL sources familiar with the deal. Nor did it matter to [AOL] that Telefonica' s computer servers couldn't handle all of the customer traffic from AOL, they said .
AOL succeeded in running the Telefonica ads fast to book the revenue before December 31, as accounting rules required.
219. Under GAAP, however, AOL did not substantially accomplish what it would be
required to do in order to recognize revenue . As a result, AOL's advertising revenue was
overstated by $15 million for the quarters ended December 31, 2000 and March 31, 2001 ,
respectively.
220. According to a former AOL Vice President for Business Development, AOL
regularly engaged in this type of "jackpotting" towards the end of each quarter in order to mee t
targets similar to the "jackpotting" that occurred with respect to Telefonica. Specifically, this
40699 .1 90 source stated that similar "jackpotting" also occurred with regard to transactions with Gateway
and Cisco.
4. Converting Legal Disputes into Advertising Deals
221 . Another impermissible accounting practice engaged in by AOL and AOL Time
Warner involved the improper conversion of a legal dispute into an advertising deal. To that
end, AOL demanded that its litigation opponent purchase advertising in settlement of a dispute.
This revenue was then improperly reported as advertising revenue .
(i) 24dogs.com Arbitration Award
222. AOL improperly converted a $22 .8 million arbitration award into advertising
revenue . MovieFone Inc . ("MovieFone"), an online ticketing firm, had won an arbitratio n
award against a Wembley PLC subsidiary. When AOL purchased MovieFone a year later i n
1999, it turned the $22 .8 million arbitration award, plus interest, into online advertising revenue ,
recognized in AOL' s fiscal quarter ended September 30, 2000. In return, AOL agreed that this
purchase of advertising would satisfy the prior arbitration award. In a deal reached just days
before the end of the quarter ended September 30, 2000, when AOL knew it was short of it s
targets for advertising revenue, Wembley agreed to purchase $23 .8 million in advertising for its
online greyhound racing website, 24dogs .com. The importance of meeting revenue targets was
even more critical because the consummation of the Merger with Time Warner was only month s
away. Accordingly, AOL quickly put together advertisements and ran enough of them to boo k
$16.2 million of advertising revenue in the quarter ended September 30, 2000 .
223. However, to book the advertising revenue in that qua rter under this improper
conversion scheme, AOL needed to run the advertising before September 30, 2000. Without
Wembley' s knowledge, AOL created banner and button advertisements out of Wembley' s
40699.1 91 24dogs.com website and started running advertisements . In this case of "jackpotting" similar to
Telefonica, AOL ran as many as three or four Wembley advertisements on a single webpage .
According to the July 18, 2002 Washington Post article, within about an hour of posting the
greyhound ads, Wembley's unfinished website crashed from an overload of customer traffic
from AOL. Such "jackpotting" overstated advertising revenue because there was no "earnings
process" taking place with regard to the superfluous or excessive advertisements because AOL
had not "substantially accomplished" the substance of the Wembley deal .
224. Even more significant from an improper accounting standpoint, applicabl e
accounting standards do not allow for an arbitrary conversion of one type of revenue into
another. This is because the initial recording of income (such as the MovieFone arbitration
award) gave rise to the receivable in the first place . AOL's conversion of this receivable int o
advertising revenue is subordinating the substance of the transaction to its form . APB 16 ¶ 87
and SFAS 141 ¶ 37 require that assets of an acquired company (MovieFone) be recorded on the
opening balance sheet at the time of the acquisition . The subsequent collection of that
receivable would therefore have no income statement impact . Here, the overall impact of
AOL's accounting manipulations was to overstate advertising revenue by $16 .2 million and
$7.5 million for the quarters ended September 30, 2000 and December 31, 2000, respectively .
(ii) Ticketmaster Legal Action
225. In the same fiscal quarter ended September 30, 2000, AOL improperly converte d
another pending litigation, with Ticketmaster, into $13 million in advertising revenue. By
settling its action against Ticketmaster in exchange for Ticketmaster buying advertising fro m
AOL, a settlement payment was made and should have been recorded as other income, no t
advertising revenue . CON 6 ¶ 82, and CON 5 ¶ 83 require that income resulting fro m
40699 .1 92 peripheral or incidental transactions be treated as gains rather than revenue because they do not
arise from a company's central operations . The settlement of the Ticketmaster litigation did no t
constitute AOL's ongoing major or central operations . AOL's attempt to improperly
characterize the litigation settlement as advertising revenue violates the requirements of CON 2
¶ 160 which states, "The quality of reliability and, in particular, of representational faithfulness
leaves no room for accounting representations that subordinate substance to form." Here, the
reporting of Ticketmaster transaction failed to demonstrate "representational faithfulness" and
subordinated the substance of the agreement to its form in violation of CON 2. The impact of
this accounting manipulation was to overstate advertising revenue by $13 million for the quarter
ended September 30, 2000.
5. Booking Sales on a Gross Rather Than Net Basis to Inflate Advertising Revenue
226. Another deceptive practice of AOL and AOL Time Warner was it s
misrepresentation to investors of the nature of its agency relationship with particular customers .
With respect to certain deals, AOL Time Warner served as an advertising broker for a customer
and then represented all (gross amounts ) of the resulting revenue to be AOL's and AOL Time
Warner's own advertising revenue, rather than reporting only the percentage of revenu e
properly accruing to AOL and the Company as a commission from the sale .
227. Reporting gross revenue as a p rincipal versus net revenue as an agent wa s
highlighted by EITF Issue No . 99-19, which became effective for financial statements for fiscal
periods beginning after December 15, 1999 . EITF 99-19 is intended to resolve any issue about
whether a company should report revenue based on (a) the gross amount billed to a customer
because it has earned revenue from the sale of the goods or services or (b) the net amount
retained (that is, the amount billed to a customer less the amount paid out, i .e., to a supplier who
40699 .1 93 has earned a commission or fee) . As the FASB notes in EITF 99-19, "How companies report
revenue for the goods and services they offer has become an increasingly important issue
because some investors may value certain companies on a multiple of revenues rather than a
multiple of gross profit or earnings ." (Emphasis added.)
228. The accounting requirements of EITF 99-19 are consistent with SAB 101 . SAB
101 states:
In asserting whether revenue should be reported gross with separate display of cost of sales to arrive at gross profit or on a net basis, the [SEC] staff considers whether the registrant :
1 . acts as principal in the transaction ; 2. takes title to the products ; 3. has risks and rewards of ownership, such as the risk of loss for collection, delivery, or returns ; and 4. acts as an agent or broker (including performing services, in substance, as an agent or broker) with compensation on a commission or fee basis .
If the company performs as an agent or broker without assuming the risks and rewards of ownership of the goods, sales should be reported on a net basis.
eBay
229. AOL and AOL Time Warner had an agreement with the internet auction
company, eBay, to sell advertisements on eBay's behalf. In the process, the companies
improperly booked the sale of eBay's ads as AOL's own advertising revenue . AOL served as
an advertising broker or agent for eBay, and received a commission on the sales it made for
eBay. AOL, however, did not simply record its earned commission, but recorded all of the
eBay advertising revenue as if it were AOL's revenue . As reported in the July 18, 2002
Washington Post, according to an internal AOL document, "AOL recognizes all revenue
generated from eBay inventory sales on a topline basis ." As a result of this improper recognitio n
40699 .1 94 of revenue, AOL was able to report a larger amount of advertising and commerce revenue than
it was entitled to.
230. Like most internet companies, AOL and AOL Time Warner' s valuation was
based on multiples of revenues rather than multiples of ea rnings. More specifically, AOL and
AOL Time Warner's advertising was a key factor in the market's valuation of the companies .
Consequently, accurate advertising revenue presentation for AOL and AOL Time Warner was
of paramount impo rtance. However, AOL and the Company overstated AOL's advertising
revenue from the eBay deal because AOL was acting as an agent and not the principal (by
earning a commission on the sale of the advertising) . As such, AOL and AOL Time Warner
should have only recorded the commissions earned as the companies' revenue, not the gros s
revenue amounts . AOL and AOL Time Warner's failure to do so is a clear violation of GAAP,
specifically CON 5 ¶ 83, and EITF 99-19, which require that agents repo rt only thei r
commissions netted as revenue rather than the revenue earned by the seller as their own. AOL
and AOL Time Warner therefore overstated advertising revenue by at least $16.8 million for
each quarter beginning with the quarter ended September 30, 1999 through June 30, 2001 and
$12.75 million for the quarter ended September 30, 2001 .
6. Counting Repricing of Equity Stock Rights as Advertising Revenue
231 . AOL and AOL Time Warner also fraudulently recognized advertising revenue
when they revised the terms of their respective equity investment in existing advertisin g
customers in violation of applicable accounting principles .
PurchasePro
232. AOL improperly accounted for its marketing deal with PurchasePro by
recognizing advertising revenue with respect to stock rights AOL held in PurchasePro . A July
40699 .1 95 19, 2002 Washington Post article recounts Defendant Colburn arrogantly describing thi s
PurchasePro deal as "science fiction ."
233. Pursuant to an agreement entered into in or about March, 2000, AOL agreed to distribute software for PurchasePro and, in exchange, received tens of millions of dollars in performance warrants . The warrants, which are similar to stock options, gave AOL the right t o buy PurchasePro stock for $63 .26 per share. PurchasePro subsequently accelerated the vestin g schedule for three million of the warrants and adjusted the exercise price down to .01 a share.
Based upon the change in the vesting schedule for and pricing of these 3 million PurchasePro warrants, the Company improperly booked $20 .5 million dollars as advertising revenue in the quarter ended December 31, 2000 and another $7 million in the quarter ended March 2001 .
234. When PurchasePro reduced the exercise price of the warrants from $63 .26 to
$0.01, AOL should have recognized the change in value as a gain , rather than as advertising revenue. CON 6 ¶ 82 states that "gains are increases in equity (net assets) from peripheral or
incidental transactions of an entity and from all other transactions and other events an d
circumstances affecting the entity except those that result from revenues or investments by
owners." CON 6 ¶ 78 states that "revenues are inflows or other enhancements of an entity o r
settlements of its liabilities (or a combination of both) from delivering or producing goods,
rendering services, or other activities that constitute the entity's ongoing major or centra l
operations." Since the adjustment in price was not attributable to additional services provided
by AOL or achieved milestones previously set in an agreement, as provided for in EITF 00-8,
the reduction in price has no correlation to performance. Thus, AOL and AOL Time Warner
violated GAAP and overstated advertising revenue by at least $20 .5 million for the quarter
ended December 31, 2000 and $7 million for the quarter ended March 31, 2001 .
40699.1 96 7. Converting Contract Termination Fees into Advertising Revenue
235 . Another category of false reporting of advertising revenue involved th e
renegotiation of certain long-term advertising contracts . This situation arose in cases wher e
companies , especially internet companies, with long-term advertising agreements with AOL and
AOL Time Warner were facing financial difficulties and were at risk of not fulfilling their
contracts. Rather than taking these companies to court to enforce the contracts and ris k
attracting negative attention to the health of AOL' s advertising business , AOL renegotiated th e
deals and required the companies to pay a fee for shortening the deal. AOL then improperly
treated that fee--a renegotiation or termination fee-as advertising revenue .
236. A former AOL Chief Technology Officer , Product and Senior Business Manager
confirmed that when a dot-com company could no longer meet the terms of its contract ,
Defendant Colburn and others would put pressure on it to pay up and then restructure the deals .
237. According to a former Account Services Manager in the Interactive Marketin g
Division of AOL, approximately 60% of the dot-com contracts that person was responsible for
were renegotiated in the aforementioned manner . According to this source, the contracts with
dot-com companies were renegotiated because the customers determined at some point du ring
the contract period that they would not be able to make payments to AOL. Account se rvices
managers at AOL called customers who wanted to cancel their contracts customer "kills." If a
customer contacted an account services manager or sales representative, the customer file wa s
pulled and forwarded to Business Affairs, which would then establish new terms for th e
customer in order to prevent a default on the contract .
238. According to a July 18, 2002 Washington Post article :
In some instances, AOL said in its written response to the Post, it would renegotiate a struggling dot .coms ad deal to shorten the term of the contract . The
40699.1 97 dot.com would pay AOL a fee for breaking the deal early, and that fee would be incorporated into the new, shorter-term ad deal, effectively creating a balloon payment. AOL would count all of the revenue, including the fee for renegotiating a shorter-term deal, as ad revenue .
From July 2000 through March 2001, AOL said, it booked $56 million dollars from dot-com deals that were terminated or restructured, about 3% of its $2 .1 billion dollars in overall ad and commerce revenue during that time . In each quarterly earnings report during the period, the terminated and restructured deals range from 1 .5 to 4.4% of AOL's advertising and commerce revenue .
(Emphasis added.)
Dr.Koop.com
239. An example of a termination fee improperly recorded as advertising revenue by
AOL is the $9 .625 million termination fee paid by Dr.Koop.com ("Dr.Koop") when it cancelled
its contract with AOL. Dr.Koop entered into an $89 million four-year deal with AOL in July
1999. In April 2000 the deal failed, and according to Dr.Koop's 2000 SEC Form 10-K, the
original agreement between Dr.Koop and AOL was amended. In exchange for 3.5 million
shares of Dr.Koop common stock, Dr.Koop was, in turn, relieved of any further cash payment
obligations to AOL and all existing warrants (vested and unvested) were cancelled . AOL and
Dr.Koop agreed to reduce carri age on AOL for a twelve-month period subject to the terms o f
the amended agreement. The value of the shares given to AOL to terminate the deal was placed
at approximately $9 .6 million.
240. AOL and AOL Time Warner violated GAAP by improperly recording the fees
received to shorten or terminate these contracts, including the Dr .Koop deal, as advertisin g
revenue from ongoing operations , rather than gains . More specifically , CON 6 ¶ 82, require s
that income resulting from peripheral or incidental transactions be treated as a gain rather tha n
revenue because it does not arise from the central operations of the company. AOL and AOL
40699.1 98 Time Warner also violated CON 5, which requires that revenue be ea rned through major
ongoing operations, and CON 2, which requires representational faithfulness . The termination
or renegotiation fees did not result from the central operations of the Company. Consequently,
AOL and AOL Time Warner overstated advertising revenue by at least $9.6 million by failing
to properly treat contract cancellation fees as gains . The improperly reported Dr.Koop
advertising revenue was reported for the quarter ended June 30, 2000 .
8. "Cross-Platform" Deals to Inflate Advertising Revenu e
241 . Time Warner clients soon learned that the "cross-promotions" and "synergies"
once touted as an inherent benefit of the Merger resulted in new deals with Time Warner
divisions that now required the purchase by the customer of advertising from the AOL division
as well . After the Merger of AOL and Time Warner, the two companies used their combined
strength to increase AOL's online adve rtising revenue by pressuring Time Warner clients to
convert purchases of, inter alia, cable programming into purchases of online advertising . And,
in at least one instance, the same advertising revenue was booked at more than one division .
242 . In advertising deals involving so-called cross-platforms (including on-air, online
and print media, or any combination thereof) the various elements must be recorded based o n
the relative fair value of each (as determined by "vendor specific objective evidence") . Though
AOL Time Warner's cross-platform promotion /advertising transactions were not software sales,
accounting literature relative to SOP 97-2 entitled "Software Revenue Recognition" most
closely and reasonably provides accounting standards for such multiple-element deals. In
December 1998, the AICPA issued SOP 98-9, "Modification of SOP 97-2, Software Revenu e
Recognition, with Respect to Certain Transactions ." SOP 98-9 clarifies certain provisions o f
40699.1 99 SOP 97-2, and effectively deferred the required adoption of those provisions until the fiscal yea r beginning January 1, 2000 .
243 . SOP 97-2, ¶ 10 states:
"If an arrangement includes multiple elements, the fee should be allocated to the various elements based on vendor-specific objective evidence of fair value, regardless of any separate prices stated within the contract for each element . Vendor-specific objective evidence of fair value is limited to the following :
The price charged when the same element is sold separately ;
For an element not yet being sold separately, the price established by management having the relevant authority ; it must be probable that the price, once established, will not change before the separate introduction of the element into the marketplace .
244. In cases where AOL Time Warner attributed revenue from cross-platform deals t o the AOL division, that revenue must be calculated in accordance with SOP 97-2 . "Vendor specific objective evidence" for advertising must be cash or cash received historically in a similar transaction (as defined in EITF 99-17, ¶ 4-6) and even then, it must be further compare d with the relative fair values of the other elements bundled in the transaction, rather than th e stated prices within the contract for each element .
245 . In those instances where the online advertising is not even desired, but added as a required term of the deal, the relative fair market value of such online services would be very low. At a minimum, the added online advertising would be a sales incentive for the actua l desired services, and would not constitute earned revenue.
(i) The Golf Channe l
246. In June 2001, the Golf Channel agreed to pay AOL Time Warner $200 million fo r advertising over five years in order to have its programming shown on Time Warner Cable .
After hearing about this deal, the AOL division weighed in and asked for a piece of the deal .
40699.1 100 According to the July 18, 2002 Washington Post article, Time Warner cable successfull y
pressured the Golf Channel into spending about $15 million of the $200 million on online
advertising with AOL. This amount helped the online division to report increased advertising
revenue for the quarter ended September 30, 2001 . According to The Washington Post, AOL
sources acknowledged that the Golf Channel had "few options" : "We told them where and
when" the ads ran . . . "They didn't have a choice." The $15 million transferred from the $20 0
million cable deal was not legitimate AOL advertising revenue under SOP 97-2, ¶ 10, because
there was no relative fair value in the AOL advertising for the Golf Channel .
247 . In a May 18, 2001 speech at the 33rd Rocky Mountain Securities Conference ,
then SEC Chief Accountant Lynn E . Turner stated, ". . . in order to report these types of
arrangements on a gross basis, the company must receive from its customer a separatel y
identifiable benefit that the company could have obtained from a third party, and there must b e
sufficient, competent and verifiable evidence of the fair value of the benefit received . When an
entity would not have entered into one of the separate contracts without all of the contracts
being negotiated and agreed to as a `package,' it will often be difficult to identify a separabl e
benefit being received and to establish reliable and verifiable fair values for each element of the
arrangement. In those instances, the facts and circumstances will often dictate that the cas h
inflows and outflows be reported as a net revenue or cost amount, in the appropriate periods."
Because the Golf Channel would not have agreed to spend money on online adve rtising in the
absence of the requirement that it do so as part of a larger advertising "package," AOL Time
Warner overstated AOL's advertising revenue by $15 million for the quarter ended September
30, 2001 .
40699 .1 101 (ii) Oxygen Media - Carriage Deal
248. In a Wall Street Journal article dated October 24, 2002, concerning AOL Tim e
Warner's decision to restate its financial results for two years and reduce advertising revenue b y
$190 million, it was disclosed that certain of the improper transactions involved divisions other
than the AOL online unit. One of the deals identified in the article was AOL's deal wit h
Oxygen Media and the report of "double booking" the same revenue at more than one Compan y
division. According to the article :
Oxygen's deal called for Time Warner's cable systems to agree to carry the channel, and instead of paying a fee for this carriage, Oxygen spent about $100 million in advertising on AOL properties, mostly on the online service. People familiar with the situation say AOL engineered intercompany ad transactions so that the revenue was effectively reflected in the divisional numbers of both the online and cable units.
249. In the course of employing cross-platform marketing to generat e
advertising revenue for the Company, AOL Time Warner overstated advertising revenue
for its online division by including revenue from other media platforms . In addition, the
Company, "double-booked" revenue received from Oxygen Media in more than one
business segment, i .e., it recorded the same revenue in two sets of books beginning in
the quarter ended June 30, 2001 through the quarter ended June 30, 2002 (the time
period during which the advertising ran) .
250. In addition, like Golf Channel, Oxygen Media would not have agreed t o
spend the $100 million on advertising in the absence of the cable carriage agreement .
As described above, Oxygen's carriage deal was unusual for not including a launch fee,
even though cable networks routinely pay significant launch fees to obtain favorable
channel positions . Instead of paying the Company such a fee, which could have been as
much as $100 million dollars, Oxygen Media purchased advertising, principally fro m
40699.1 102 the Company's AOL online division . To compensate Time Warner's cable division for
not receiving revenue from Oxygen Media in the form of a launch fee, the AOL online
division bought advertising on Time Warner cable .
251 . For AOL, the $100 million commitment represented 3.4% of AOL's
advertising over the five quarters the deal ran - second quarter of 2001 through second
quarter of 2002 . For Oxygen Media, the deal came just four months after the Company
had cut the number of web sites it operated from more than a dozen to four. Following
announcement of the deal, Oxygen Media reduced its web presence even further, to just
two sites and eventually acknowledged that "The deal was less lucrative than originally
anticipated." As reported in an August 26, 2002 Wall Street Journal article discussing
the deal, when asked whether Oxygen media would have bought advertising if it was not
seeking carriage, the company's chief operation officer stated it was a three-way deal
and "I wouldn't separate" any of the elements . As stated above, Oxygen Media would
not have agreed to spend the $100 million on online advertising in the absence of th e
carriage deal being an inseparable part of the "package ." Accordingly, AOL Time
Warner overstated advertising revenue by at least $19 .8 million per quarter over the five
quarters beginning with the quarter ended June 30, 2001 through the quarter ended June
30, 2002.
F. The Company's Admissions of Materially Overstated Advertising Revenue and Violations of the Securities Law s
252. Subsequent to the MSBI's filing of its initial Complaint, the Company restated it s
advertising and commerce revenue in the amount of $190 million for the eight consecutive
quarters ended September 30, 2000 through June 30, 2002, with the restatement reducin g
AOL's advertising revenue by $168 million. According to the Company, the remainin g
40699.1 103 overstated amount of $22 million "represents a reduction in revenues from certain transaction s
related to the AOL segment in which the advertising was delivered by other AOL Time Warner
segments."
253. According to the Company's SEC Form 8-K filed on October 23, 2002, th e
restatement by quarter of AOL' s advertising and commerce revenue is as follows:
QUARTER RESTATED Quarter Ended ($66 million) 9/30/00 Quarter Ended ($22 million) 12/31/00 Quarter Ended ($13 million) 3/31/01 Quarter Ended ($28 million) 6/30/01 Quarter Ended ($16 million) 9/30/01 Quarter Ended ($17 million) 12/31/0 1 Quarter Ended ($6 million) 3/31/02 Quarter Ended - 6/30/02
254. In addition, at the same time the Company restated its financial results, it publicl y
stated:
As a result of the restatement announced on October 23, 2002 by AOL and AOL Time Warner Inc. (the "Company"), the Company 's financial statements for the affected periods should no longer be relied upon, including the audited financial statements for 2000 and 2001 contained in the Company's annual report on Form 10-K for the year ended December 31, 2001 .
(Emphasis added .)
255. Under GAAP, restatement of previously issued financial statements is the mos t
serious step, reserved only for circumstances where no lesser remedy is available. Under APB
20, Accounting Changes, restatements are only permitted, and are required, to correct materia l
40699.1 104 accounting errors or irregularities that existed at the time the financial statements were prepared .
By restating AOL and AOL Time Warner's financial statements, the Company admitted tha t each document publishing the original financial statements contained untrue statements and/or omissions, of material fact . Similarly, by restating, the Company also conceded that each of th e press releases disseminated to the investing public and each of the annual and quarterly report s on Form 10-K and Form 10-Q that were filed with the SEC, contained untrue statements of material fact, and/or failed to disclose material facts .
256. On March 28, 2003, the Company reported that it may have to restate up to another $400 million in advertising revenue for the years 2001 and 2002, regarding transaction s with Bertelsmann AG. The Company also reported on March 28, 2003, that further restatement of advertising revenue was "possible" due to the "range of other transactions" that were th e subjects of the continuing SEC and DOJ investigations.
G. The Materially False and Misleading Statements, Omissions of Material Fact and Devices, Schemes or Artifices to Defraud Regarding Artificially Inflated Advertising Revenue
257. The sham transactions and improper accounting practices of the Company an d
AOL, and the Individual Defendants, which Ernst & Young permitted, caused the financial statements of AOL and the Company for various fiscal periods, the press releases relate d thereto, pro forma and statements of Individual Defendants, to be materially false an d misleading, and to omit material facts . Such conduct, including the sham transactions, also constituted schemes, devices or artifices to defraud the public.
258 . These material misrepresentations and omissions and devices, schemes or artifices to defraud had the desired effect of manipulating stock market analysts to favorably comment
40699.1 105 on the companies and causing investors to purchase or otherwise acquire AOL, and later AO L
Time Warner, stock at artificially inflated prices .
259. During the Class Period, AOL and AOL Time Warner reported tremendous
growth in AOL advertising revenue based on phony numbers. Near the end of the Class Period,
when the advertising market was so weak that the Company was forced to report decreasin g
AOL advertising revenue, it still continued to artificially inflate the reported advertisin g
revenue.
260. As detailed previously in this Complaint, AOL and the Company overstated AOL
advertising revenue by at least $1 .7 billion during the Class Period . This artificially inflated
AOL advertising revenue was typically included as part of the companies' periodic reporting of
AOL "advertising and commerce", or AOL "advertising, commerce and other" revenue. Prior
to the Merger, AOL also typically reported "advertising and commerce backlog" whic h
represented "the contract value of advertising and commerce agreements signed, less revenue s
already recognized from these agreements" .
a. The Fiscal Quarter Ended December 31, 199 8
261 . The Class Period begins on January 27, 1999, when AOL reported artificially
inflated advertising revenue for the quarter ended December 31, 1998. On January 27, 1999,
just prior to release of AOL's quarterly results, the Dow Jones News Service reported on the
high market expectations created by AOL :
America Online, Inc . (AOL) could beat the consensus estimate of 14 cents a share for its fiscal second quarter by a penny or two, but analysts said the company is unlikely to exceed projections by much more than that .
*** William Blair & Co. analyst Abhishek Gami estimates AOL will post service revenue, which is revenue from the company 's $21 .95-a-month subscription fee, of $765 million . He estimates the company will post "other" revenue, which
40699 .1 106 includes revenue from advertising and electronic commerce on the service, of $163 million .
AOL reported service revenue of $483 million, and other revenue of $109 million, in the year-ago quarter.
(Emphasis added.)
262. Later that day, January 27, 1999, the AOL Individual Defendants caused AOL t o
issue a press release reporting its financial results for its fiscal quarter ended December 31 ,
1998, that exceeded analyst's projections of the company's advertising and commerce revenu e
and beat analysts ' earnings predictions by 3 cents per share. As reported in Business Wire:
America Online, Inc . (NYSE :AOL) today announced results for its fiscal second quarter of 1999, ended December 31, 1998, setting new records in total revenues, advertising, commerce and other revenues , net income and membership growth.
The Company's net income totaled $88 million, or $0 .17 per diluted share, on a fully taxed basis for the 1999 second quarter, a 340% increase over last year's second quarter fully taxed net income of $20 million, or $0.04 per diluted share.
Total revenues increased by 62% over the same quarter last year to $960 million . Advertising, commerce and other revenues reached $181 million, up 66% over last year's second quarter .
Steve Case, Chairman and Chief Executive Officer of America Online, said : "With this quarter's record results, we continued to build excellent momentum throughout our operations and across our brands . In 1998, the Internet truly came of age and became even more integral to people's everyday lives . As the industry leader, America Online is better positioned than ever to continue delivering strong profit growth on a consistent, predictable basis . "
Mr. Case added: "Electronic commerce is changing forever the way businesses sell and consumers buy goods and services . We're excited about the opportunities presented by our pending combination with Netscape as well as our alliance with Sun Microsystems to drive the growth of this new medium and serve new customers and markets in valuable and innovative ways . "
Bob Pittman, President and Chief Operating Officer, said : " . . . With advertising and commerce revenues more than doubling mainstream marketers increasingly see the superior value of reaching cyberspace's biggest audience through our brands. "
40699.1 107 -- Advertising and Electronic Commerce Revenues : Revenues from advertising and commerce climbed to $ 126 million, an increase of 133% over the $54 million in last year 's second quarter and 22% above the $103 million recorded during the first quarter.
-- Advertising and Electronic Commerce Backlog : The Company grew its backlog of advertising and electronic commerce revenues from $598 million on September 30 1998 to $729 million on December 31, 1998 .
(Emphasis added.)
263 . On January 27, 1999, the Dow Jones News Service reported that AOL declared a two-for-one stock split.
264. On or about February 10, 1999, the AOL Individual Defendants caused AOL to file its SEC Form 10-Q for the company's fiscal quarter ended December 31, 1998 . The Form
10-Q was signed by Defendants Case and Kelly. It contained substantially the same financial information as the January 27, 1999 press release, including $126 million in advertising and
commerce revenue, an increase of 133% over the year ago quarter, and $729 million i n
advertising and commerce backlog, up from $320 million in the year ago quarter. The Form 10-
Q also stated that advertising and commerce revenue for the six month period ended December
31, 1998 was $229 million, an increase of 134% over the six month period ended December 31,
1997 . In addition, the Form 10-Q assured investors that the Company's financials wer e
prepared in accordance with GAAP :
The accompanying unaudited condensed consolidated financial statements, which include the accounts of America Online, Inc . (the "Company") and its wholly and majority owned subsidiaries, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X .
265 . In fact, AOL's reported advertising and commerce revenue for the qua rter and six
months ended December 31, 1998 was overstated by at least $4.2 million as a result of AOL' s
40699 .1 108 improper accounting for the Sun deal , as discussed above. Further, AOL's representation to the
public in its press release and related SEC Form 10-Q filing that its advertising revenue backlog
as of December 31, 1998 was $729 million was false because, due to AOL's imprope r
accounting for the Sun deal, the actual backlog was overstated by at least $147 million, or by at
least 25%. Moreover, without this overstatement of the advertising backlog, the backlog woul d
have decreased from the prior quarter.
b. The Fiscal Quarter Ended March 31, 1999
266. On February 25, 1999 The Wall Street Journal reported that AOL's advertising
and commerce revenue was even more important to market analysts' views of the Compan y
than its earnings :
AOL began reporting consistent profits in 1997 and showed a profit in every quarter of 1998. For its most recent full fiscal year, ended June 30, 1998, AOL reported net income of $91 .8 million, or 17.5 cents a share adjusted for a two- for-one stock split earlier this week, on $2 .6 billion in revenue. Analysts estimate AOL's fiscal 1999 earnings will amount to about 33 cents a share, according to a survey by First Call .
But analysts y an even more pertinent indicator is AOL's revenue from advertising and electronic commerce, which totaled $126 million in the second quarter ended Dec. 31, up from $54 million a year earlier. That revenue carries a substantially higher profit margin than the revenue from members' subscription fees.
(Emphasis added.)
267. On April 27, 1999, the AOL Individual Defendants caused AOL to issue a press
release reporting its financial results for its fiscal qua rter ended March 31, 1999. AOL
announced "record" advertising and commerce revenue of $210 million for the quarter and
advertising and commerce backlog of $1 .3 billion . As reported in Business Wire:
America Online, Inc. (NYSE:AOL) today announced results for its fiscal third quarter ended March 31, 1999, setting new records for total revenues, advertising
40699.1 109 and commerce revenues, fully taxed net income before one-time events, and AOL membership growth .
Revenues reached nearly $1 .3 billion, representing a 66% increase over the combined AOL and Netscape revenues in last year's March quarter. Advertising, commerce and other revenues reached $275 million, up 94% over last year's third quarter.
*** Mr. Pittman added : "We have moved quickly to integrate Netscape and reorganized the Company to take advantage of new opportunities in this fast- moving environment . With virtually all companies seeking to put their businesses on the Internet, our strategic alliance with Sun will aggressively develop and market a full suite of e-commerce solutions for our partners and other customers . Both MovieFone and When .com will make the online experience of ou r members and other Internet consumers even more valuable to their everyday lives. We will continue to be opportunistic as our industry consolidates, taking advantage of our focus, efficiency and scale, and we are confident our business momentum will continue."
Key operating metrics from the quarter include . . . Revenues from advertising and commerce climbed to $210 million, increasing 119% over last year's corresponding _quarter . . . . The consolidated backlog of advertising and commerce revenues grew to approximately $1 .3 billion at the end of this quarter, from $804 million at the end of the last quarter .
AOL also expanded its strategic relationship with eBay, the largest online person-to-person trading community . Through a new $75 million , four-year agreement, eBay will have prominent presence across the Company 's brands . . . . AOL will be entitled to all advertising revenues generated by these sites, and may act as the exclusive third-party advertising sales force for advertising sold on eBay's Web site.
(Emphasis added .)
268. On April 28, 1999, a Dow Jones News Service article reported that analysts were
extremely impressed by AOL's staggering reported growth in advertising revenue :
Coming off a "high quality" third quarter, America Online, Inc . (AOL) appears to have a bright future, said Donaldson Lufkin & Jenrette Securities Cori Internet analyst Jamie Kiggen .
40699.1 110 "They were ahead of our model on every key metric ," Kiggen said during a CNBC interview Wednesday, referring to the Internet giant's fiscal third-quarter earnings results, posted late Tuesday .
America Online posted "tremendous" growth in advertising revenue, which Kiggen said is the driving force behind the company's earnings model . America Online said its advertising and commerce backlog grew to about $1 .3 billion at the end of the latest third quarter from $804 million at the end of the second quarter.
(Emphasis added.)
269. On or about May 7, 1999, the AOL Individual Defendants caused AOL to file its
SEC Form 10-Q for the fiscal quarter ended March 31, 1999 . The SEC Form 10-Q contained
substantially the same financial information as the April 24, 1999 press release, including
advertising and commerce revenue of $210 million, an increase of 119% from the year ago
quarter, and $1 .3 billion in advertising and commerce backlog . The Form 10-Q also reported
advertising and commerce revenue for the nine months ended March 31, 1999 as $530 million,
an increase of 127% from the nine months ended March 31, 1998 . In addition, the Form 10-Q
assured investors that the Company's financials were prepared in accordance with GAAP :
The accompanying unaudited condensed consolidated financial statements, which include the accounts of America Online, Inc . (the "Company") and its wholly and majority owned subsidiaries, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X .
270. In fact, AOL's reported advertising and commerce revenue for the qua rter and the
nine-months ended March 31, 1999 was overstated by at least $12 .6 million and $16 .8 million,
respectively, as a result of AOL's improper accounting for the Sun deal , as discussed above.
Further, AOL's representation to the public in its press release and related SEC Form 10-Q
filing that its adve rtising revenue backlog as of March 31, 1999 was $1 .3 billion was false
40699 .1 111 because, due to AOL's improper accounting for the Sun deal, the actual backlog was overstated by at least $134 .4 million, or at least 12% .
c. The Fiscal Quarter and Year Ended June 30, 1999
271 . On July 20, 1999, a Dow Jones News Service article, titled "Ame rica Online Seen
Beating 4Q Views By 10-20 a Share," reported that analysts had high expectations for th e
Company's performance in the quarter, reflected in a "whisper number" two cents above the
consensus earnings estimate, and that the Company was under pressure to make the whispe r
number to keep share prices high :
America Online, Inc. (AOL) is expected to repo rt earnings above the analysts' consensus earnings estimate of 11 cents a share when it releases fou rth-quarter results after the markets close Wednesday .
Some analysts, while officially maintaining previous estimates, have suggested the top Internet service provider will exceed the consensus estimate . The so- called whisper number, or unofficial earnings estimate, is 13 cents a share for the quarter ended June 30. . . .
The whisper numbers are significant because AOL has a history of beating analysts' estimates . Many investors expect the Dulles, Va ., company to do the same this quarter, and they could be disappointed if AOL falls short of the whisper number, even if it beats the official consensus .
America Online exceeded Wall Street earnings expectations by 2 cents a share in the third quarter and by 3 cents a share in the second quarter, according to First Call Corp., which tracks earnings estimates.
272. On July 21, 1999, the AOL Individual Defendants caused AOL to issue a press
release announcing "record" financial results for its fiscal quarter and year ended June 30, 1999 .
AOL's reported earnings of 13 cents for the quarter was equal to the "whisper" number, tw o
cents higher than the analysts ' consensus estimate. AOL also reported $233 million o f
advertising and commerce revenue for the quarter, $1 billion of advertising and commerce
40699 .1 112 revenue for the fiscal year, and $1 .5 billion in advertising and commerce backlog . As Business
Wire reported :
America Online, Inc. (NYSE :AOL) today announced results for its fiscal fourth quarter and full fiscal year ended June 30, 1999 - setting new records across the board for consolidated revenues, advertising and commerce revenues , operating income, and AOL membership growth.
Fourth quarter revenues rose to $1 .4 billion, or 46% over last year's corresponding period. Advertising, commerce and other revenues reached $306 million, up 87% over fiscal 1998's fourth quarter.
Steve Case, Chairman and Chief Executive Officer, said : "This has been a year of tremendous growth and achievement . We added more than five million new members to our flagship AOL service, generated $1 billion in advertising and commerce revenues, and achieved record operating profits .
Key operating metrics from the quarter included : -- Advertising and Commerce Revenues: Revenues from advertising and commerce climbed to $233 million, increasing 86% over last year's corresponding quarter.
(Emphasis added.)
273. On July 21, 1999 a Dow Jones News Service article titled, "AOL's Stron g
Advertising/E-Commerce Revs Boosts Results," reported that AOL's advertising and commerc e
revenue was its fastest growing revenue source and helped offset slowing subscriber revenue :
A sharp increase in advertising and electronic-commerce revenues helped America Online, Inc . (AOL) beat analysts' earnings expectations for its fourt h uq arter, even as its European subscriber growth slumped .
The Dulles, Va., company reported fourth-quarter revenues of $1 .38 billion, up 46% from $943 million a year ago . The latest results included $233 million in advertising and e-commerce revenue, up 86% from a year ago, a sharper rate of increase than the other categories of revenue, subscriptions and enterprise solutions.
(Emphasis added.)
40699 .1 113 274. On or about August 13, 1999, the AOL Individual Defendants caused AOL to file its SEC Form 10-K for the Company's fiscal quarter and year ended June 30, 1999 . The Form
10-K was signed by Defendants Case and Kelly . It contained substantially the same financial information as the July 21, 1999 press release, including $1 billion in advertising, commerce and other revenue in the fiscal year, an 84% increase over the $543 million in such revenue in fiscal 1998, and $1 .5 billion in advertising, commerce and other backlog . The Form 10-K also reported $765 million in advertising and commerce revenue in fiscal 1999, an increase of 114% over fiscal 1998 . The Form 10-K highlighted AOL's increasing dependence on advertising revenue and the reported astronomical growth in advertising and commerce backlog :
. . . An important component of the Company's business strategy in its Interactive Online Services business is an increasing reliance on advertising, commerce and other revenues. These revenues include advertising and electronic commerce fees, the sale of merchandise, as well as other revenues . . . . The growth of advertising, commerce and other revenues is important to the Company's business objectives, as these revenues provide an important contribution to the Company's operating results . Advertising revenues are expected to grow in importance as the Company continues to leverage its large, active and growing user base. . . . Affecting the growth in advertising, commerce and other revenues is the backlog balance as of June 30, 1999, 1998 and 1997 of $1,519 million, $511 million and $180 million, respectively. During fiscal 2000, approximately $680 million of revenue will be generated from the June 30, 1999 backlog .
(Emphasis added.)
275 . In addition, the Form 10-K assured investors that the Company's financials wer e prepared in accordance with GAAP :
The management of America Online, Inc . is responsible for the integrity and objectivity of the financial and operating information contained in this Annual Report on Form 10-K, including the consolidated financial statements covered by the Report of Independent Auditors . These statements were prepared in conformity with generally accepted accounting principles and include amounts that are based on the best estimates and judgments of management, which it believes, are reasonable under the circumstances .
40699 .1 114 276. The Form 10-K also incorporated, with Defendant Ernst & Young's consent, the
July 21, 1999 report of Ernst & Young which assured investors that the financial statements
were audited in accordance with GAAS and were in compliance with GAAP :
We conducted our audits in accordance with generally accepted auditing standards . . . . We believe that our audits provide a reasonable basis for our opinion .
In our [Ernst & Young] opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of America Online, Inc . at June 30, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 1999, in conformity with generally accepted accounting principles.
277. In fact, AOL's reported advertising and commerce revenue for the qua rter and
year ended June 30, 1999 was overstated by at least $28 .6 million and $45.4 million,
respectively. The overstatement of $28 .6 million for the quarter was due to AOL's improper
accounting for the Sun ($12.6 million) and Hughes ($ 16 million) deals, respectively, as
discussed above . The overstatement of at least $45 .4 million for the year ended June 30, 1999
was also due to AOL's accounting improp rieties in connection with the Sun ($29 .4 million) and
Hughes ($16 million) deals, respectively, as discussed previously. Further, AOL' s
representation in its July 21, 1999 press release and the related SEC Form 10-K that its
advertising revenue backlog as of June 30, 1999 was $1 .5 billion was false because the actual
backlog was overstated by at least $686 .8 million, or 84%, due to the improper accounting of
the Sun ($121 .8 million) and Hughes ($565 million) deals .
d. The Fiscal Ouarter Ended September 30, 1999
278. On August 11, 1999, Dow Jones Business News reported that market analyst
Youssef Squali of Ladenburg Thalman & Co ., "expects [AOL] to post $ 329 million in ad and e-
commerce revenue, up from $306 million in the fourth quarter ended June 30 ."
40699 .1 115 279. On October 19, 1999, Dow Jones News Service reported :
Strong subsc riber growth and an increase in advertising and electronic- commerce revenue should help America Online, Inc. (AOL) beat analysts' expectations for its first fiscal quarter.
The Dulles, Va ., Internet service provider is expected to report earnings of 13 cents a share for the quarter ended Sept . 30, up from 5 cents a share a year ago, according to a First Call/Thomson Financial survey of analysts . . . . The unofficial estimate, or whisper number, puts America Online's first-quarter earnings at 15 cents a share . . . .
The report also said that securities analyst, Arthur Newman, "expects the company's revenue from advertising and e-commerce to rise to $325 million from $175 million a ,ergo . . . ."
(Emphasis added. )
280. On October 20, 1999, the AOL Individual Defendants caused AOL to issue a
press release announcing financial results for the quarter ended September 30, 1999, which met
the "whisper" number for earnings and beat analysts' expectations for advertising an d
commerce revenue. Business Wire reported :
America Online, Inc. (NYSE: AOL) today announced results for the first quarter of fiscal 2000 ended September 30, 1999 -- setting new records for consolidated revenues, advertising and commerce revenues, operating income, and membership growth in the first quarter.
The Company's fully taxed net income totaled $184 million, or $0 .15 per diluted share, up from $50 million, or $0 .04 per diluted share, on the same basis in fiscal 1999's first quarter . Operating income for the quarter climbed 244% over the year ago quarter to $265 million .
First quarter revenues rose to $1 .5 billion, or 47% over last year's first quarter, and advertising, commerce, and other revenues reached $350 million, doubling over the fiscal 1999's September quarter.
Steve Case, Chairman and Chief Executive Officer of America Online, said : "This quarter's results clearly demonstrate America Online's leadership and growing earnings power ."
40699.1 116 -- Advertising, Commerce and Other Revenues : Revenues from advertising, commerce and other revenues climbed to $350 million, doubling from $175 million during the year ago quarter .
-- Backlog: The Company brought its consolidated backlog of advertising and commerce revenue to over $2 .0 billion at the end of the quarter, adding a net of more than $500 million since June 30, 1999 .
(Emphasis added.)
281 . Analysts commented very favorably on the company's financial results. For
example, on October 21, 1999, PR Newswire reported :
"Yesterday, AOL reported Q1 :00 results ahead of consensus expectations," reported E*Offering analyst Andrea Williams . "In our opinion, America Online continues to be the dominant force in interactive media today, with a compelling product offering a large and loyal customer base, robust advertising, and sponsorship demand . We believe that AOL remains the company best-positioned for the long term on the Internet ."
(Emphasis added.)
282. On October 28, 1999, Business Wire reported that AOL had again declared a two-
for-one split of its common stock and Defendant Stephen Case , AOL's Chairman and Chief
Executive Officer, said :
"We are delighted that we are able to split our common stock for the second time this year. We are committed to making ownership of our Company accessible to the average investor, and we are very encouraged by the phenomenal growth in individual shareholder accounts in the past year. We hope that this latest split will make it possible for even more people to share in the promising growth of our Company and our industry as we enter the 21st Century ."
(Emphasis added.)
283 . On November 2, 1999, the AOL Individual Defendants caused AOL to file its
SEC Form 10-Q for the fiscal quarter ended September 30, 1999 . The Form 10-Q was signed
by Defendants Case and Kelly . It contained substantially the same financial information as th e
October 20, 1999 press release, including advertising, commerce, and other revenue of $35 0
40699.1 117 million, an increase of 100% from the year ago quarter, and advertising and commerce backlo g
of $2 billion. It also reported advertising and commerce revenue of $272 million for the quarter.
In addition, the Form 10-Q assured investors that AOL' s financials were prepared in accordance
with GAAP:
The accompanying unaudited condensed consolidated financial statements, which include the accounts of America Online, Inc . (the "Company") and its wholly and majority owned subsidiaries, have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X .
284. In fact, AOL's reported advertising and commerce revenue for the quarter ende d
September 30, 1999 of $272 million was overstated by at least $77.4 million, an overstatement
of the actual advertising and commerce revenue by at least 40 %, as a result of AOL's imprope r
accounting for the Sun ($12 .6 million), Hughes ($48 million) and eBay ($16 .8 million) deals, a s
discussed previously. Further, AOL's representation to the public in its October 20, 1999 pres s
release and the related SEC Form 10-Q that its advertising revenue backlog as of September 30 ,
1999 was $2 billion was false because the actual backlog was overstated by at least $72 6
million, or 57%, due to the improper accounting of the Sun ($109 .2 million), Hughes ($51 7
million), and Monster .com ($100 million) deals .
e. The Fiscal Ouarter Ended December 31, 199 9
285 . Analysts continued to be impressed with AOL's financial results and projecte d
exceptional growth in AOL advertising revenue, based on AOL's reported results. For example,
on December 8, 1999, Business Wire reported :
Wit Capital Research Analyst Jordan Rohan today increased estimates for America Online (NYSE: AOL). Rohan also reiterated a Buy rating on the shares of America Online, and increased his 12-18 month target price to $105 per share . In addition, Rohan indicated : "Applying the findings of the updated model, we arrived at a considerably higher (and, we think, still conservative) projection for the company's advertising and e-commerce revenues . We have increased our
40699 .1 118 fiscal 2000 advertising and e-commerce revenue estimate to $1 .7 billion from $1 .6 billion . Accordingly, our total revenue estimate has increased to $6 .5 billion from $6.4 billion in 2000 . Similarly, we have raised our 2001 revenue estimate to $8.2 billion from $7 .8 billion based on more accelerated growth in e-commerce and advertising revenues than previously anticipated . "
The analyst increased his fiscal 2000 and 2001 EPS estimates to $0 .35 and $0.53 per share, from $0.34 and $0 .47, respectively .
(Emphasis added. )
286. On December 17, 1999 Merrill Lynch analyst Henry Blodget similarl y
commented favorably on AOL and, in particular, its growth in revenue from advertising :
He stated that "investors should focus on AOL's profit growth, not subscriber growth or access pricing . They should focus on how much advertising and e- commerce revenue AOL will ultimately be able to receive each month from its customers ." Blodgett said that if advertising/e-commerce increases to $20 of monthly revenues per subscriber, than AOL Stock is "under-valued ." Blodget concluded that "it's reasonable to project that AOL's revenue from advertising/e- commerce will rise to $20 per customer each month in five years .
(Emphasis added.)
287. On January 10, 2000, the Individual Defendants caused AOL and Time Warner to
issue a joint press release announcing that the board of directors of both companies had
unanimously approved a merger agreement to create a new company called AOL Time Warner.
288. On January 19, 2000, the AOL Individual Defendants caused AOL to issue a
press release announcing "record" financial results for the quarter ended December 31, 1999 ,
including record revenue of $1 .6 billion, 27% of which was advertising, commerce and other
revenue. Business Wire reported :
America Online, Inc. (NYSE: AOL) today announced results for the second quarter of fiscal 2000 ended December 31, 1999 -- setting new records for consolidated revenues, advertising and commerce revenues, operating income , and quarterly membership growth .
** *
40699.1 119 Second quarter revenues rose to $1 .6 billion, or 41 % over last year's second quarter, and advertising, commerce and other revenues reached $437 million . 79% over fiscal 1999's December quart er.
Steve Case, Chairman and Chief Executive Officer said : "This is a momentous time for America Online, as we're announcing the strongest results in our Company's history . During the quarter, we achieved record growth in revenues, advertising and commerce, operating income and subscriber growth -- attracting more than 2.1 million new AOL and CompuServe members and millions more Web users to our family of brands."
Mr. Case added: "With Time Warner, we are taking a bold step to extend our leadership as the Internet moves into its next wave of explosive growth. Our combined company will be uniquely equipped to take full advantage of the Internet's growth to create value for our shareholders, and we are committed to making the most of this opportunity."
Bob Pittman , President and Chief Operating Officer said: "Our operating performance this quarter demonstrates that we continue to build enormous value through the creation and development of powerful interactive brands that deliver unmatched benefits to consumers . While our flagship AOL service continues to set subscriber growth and advertising/commerce records in the premium mass market segment , we're also leading the value segment with CompuServe."
*** -- Advertising, Commerce and Other Revenues : Revenues from advertising, commerce and other revenues climbed to $437 million, an increase of 79% from $244 million during the year-ago quarter . -- Backlog: The Company brought its consolidated backlog of advertising and commerce revenue to more than $2.4 billion at the end of the quarter .
*** The Company also completed agreements with : Gateway, to accelerate distribution of each company's products and services including DSL access . . ..
*** The Company extended its advertising and e-commerce leadership through a series of agreements during the quarter. In a four-year, $100-million partnership, Monster.com became the exclusive career-search resource across a range of America Online brands.
(Emphasis added.)
289. On January 20, 2000, the AOL Individual Defendants caused AOL to file with the
SEC its Current Report on Form 8-K dated January 19, 2000 which was signed by Defendan t
40699.1 120 Kelly and incorporated AOL's press release of January 19, 2000 announcing AOL's financial
results for the quarter ended December 31, 1999.
290. On January 20, 2000, The Wall Street Journal praised AOL's reported growth in
advertising revenue and stated that AOL executives had announced high earnings expectations
for the Company following the planned Merger with Time Warner:
Analysts were impressed with AOL' s performance in one closely watched area: advertising and commerce revenue . The company said that figure almost doubled to $437 million from $244 million a year earlier. Advertising and commerce fees tend to carry a higher profit margin than other areas of AOL's business . "We knew it was going to be strong, but it was really, really strong ," James Preissler, an analyst at PaineWebber Inc ., said of AOL's revenue in that category.
*** AOL offered bullish growth predictions for the new AOL Time Warner, saying the Companies ' combined earnings before interest, taxes, depreciation and amortization could grow at a 30% annual rate.
(Emphasis added .)
291 . On or about February 11, 2000, the AOL Individual Defendants caused AOL t o
file with the SEC its Current Report on Form 8-K dated January 10, 2000 which was signed b y
Defendant Kelly and incorporated AOL Time Warner 's pro forma consolidated condensed
financial statements for the three months ended September 30, 1999, the year ended June 30 ,
1999, the nine months ended September 30, 1999 and year ended December 31, 1998. The pro
forma consolidated condensed financial statements were materially false and misleading ,
because they included AOL's fraudulently inflated advertising revenue reported for th e
respective fiscal periods as discussed herein at IT 265, 277 and 283 .
292. On or about February 14, 2000, the AOL Individual Defendants caused AOL t o
file its SEC Form 10-Q for the fiscal quarter ended December 31, 1999 . The Form 10-Q was
signed by Defendants Case and Kelly . It contained substantially the same financial informatio n
40699.1 121 as the January 19, 2000 press release, including advertising, commerce, and other revenue o f
$437 million, an increase of 79% from the year ago quarter, and an advertising and commerc e
backlog of $2.4 billion . The Form 10 -Q also stated that AOL had $ 352 million in advertising
and commerce revenue for the quarter ended December 31, 1999, an 87% increase over the yea r
ago quarter, and commerce and advertising for the six month period ended December 31, 1999
of $624 million, an increase of 94% over the six months ended December 31, 1998. In addition,
the Form 10-Q assured investors that America Online's financials were prepared in accordanc e
with GAAP:
The accompanying unaudited condensed consolidated financial statements, which include the accounts of America Online, Inc . (the "Company") and its wholly and majority owned subsidiaries, have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X .
293. In fact, AOL's reported advertising and commerce revenue of $352 million fo r
the quarter and $624 million for the six-months ended December 31, 1999 was overstated by at
least $79 .5 million, and $156.9 million, respectively, or in percentage terms, an overstatement of
the actual advertising and commerce revenue by at least 29% and 34%, respectively . AOL's
reported advertising, commerce and other revenue was similarly overstated by $79 .5 million and
$156.9 million for the three and six-month periods, respectively. The overstatement of $79 .5
million during the quarter was due to AOL's improper accounting of the Sun ($12.6 million),
Hughes ($48 million), Monster .com ($2.1 million) and eBay ($16.8 million) deals, as discussed
above. In addition, the overstatement of at least $156.9 million during the six-months ended
December 31, 1999 is attributable to AOL's improper accounting for the Sun ($25 .2 million),
Hughes ($96 million), Monster.com ($2.1 million) and eBay ($33 .6 million) deals, as discussed
above.
40699 .1 122 294. Further, AOL's representation to the public in its press release of January 19 ,
2000 and the related SEC Form 10-Q filing that its advertising revenue backlog as of Decembe r
31, 1999 was $2.4 billion was false because the actual backlog was overstated by at least $1 .2 billion, or at least an outrageous 101 %, due to the improper accounting of the Sun ($96 .6
million), Hughes ($469 million), Monster.com ($97 .8 million), and Gateway ($541 .5 million)
deals.
f. The Fiscal Quarter Ended March 31, 200 0
295. On April 3, 2000, Dow Jones News Service again reported that MG Barings LLC
market analyst Youssef Squali, based on AOL's prior financial results, predicted strong revenu e
growth at AOL, driven by growth in the Company's advertising and commerce revenue :
America Online's subscription growth is remarkable . . . . But the growth story at America Online is the way it takes advantage of its large customer : by charging other companies to advertise and conduct electronic-commerce on its proprietary network. Squali estimated that revenue from advertising/e-commerce rose 71 % to $470 million from $275 million a year earlier .
Including sales of business software, overall revenue at Ame rica Online should rise 38% to $1 .72 billion in the third quarter from $1 .25 billion a year earlier, Squali said. America Online's earnings were expected to ri se to 9 cents a share from 4 cents a share a year ago, excluding one-time items .
(Emphasis added.)
296. On April 3, 2000, the AOL Individual Defendants caused AOL to file with th e
SEC its Current Report on Form 8-K dated April 3, 2000, that incorporated AOL Time Warne r
pro forma consolidated condensed financial statements for the six months ended December 31 ,
1999, the year ended June 30, 1999, and the year ended December 31, 1999. The pro forma
consolidated condensed financial statements were materially false and misleading, because they
included AOL' s fraudulently inflated advertising revenue reported for the respective fiscal
periods, as discussed herein at 11277, 293 and 294 .
40699.1 123 297. On April 18, 2000, the AOL Individual Defendants caused AOL to issue a press
release, again announcing "record" financial results for the quarter ended March 31, 2000, an d
soundly beating analyst predictions of advertising, commerce and other revenue by over $10 0
million. As reported by Business Wire:
America Online, Inc . (NYSE : AOL) today announced record results for the third quarter of fiscal 2000, ended March 31, 2000 -- reaching new hi s for consolidated revenues, advertising and commerce revenues, operating income , and EBITDA .
The quarter's net income, fully taxed and excluding one-time items, totaled $271 million, or $0.11 per diluted share, up from $104 million, or $0 .04 per diluted share, on the same basis last year . The Company reported net income of $438 million, or $0.17 per diluted share, up from $411 million, or $0 .16 per diluted share, in fiscal 1999s third quarter. Reported net income included one-time gains from the sale of investments totaling $275 million this quarter and $567 million in last year's third quarter . The year-ago quarter also includes one-time charges of $103 million. Excluding these items, operating income for the quarter climbed more than 155% over the year-ago quarter to $383 million .
Third quarter revenues rose to $1 .8 billion, or 47% over last year's March quarter . Advertising, commerce and other revenues climbed 103% over fiscal 1999's third quarter to $557 million - marking a record $120 million increase, or 27%, over this year's second quarter.
Steve Case, Chairman and Chief Executive Officer, said : "This quarter's results underscore the tremendous strength of America Online's operations, and demonstrate that we are on a clear path to continued strong growth and increased profitability. Since we announced our landmark merger with Time Warner, we haven't missed a beat ."
*** Bob Pittman, President and Chief Operating Officer, said : "This quarter is an excellent example of how America Online is uniquely positioned in the Internet industry. We have built an unmatched collection of interactive brands, which will be further enhanced by the Time Warner merger, and we have an unparalleled connection to consumers. We're taking online advertising and commerce to new heights, yet we've barely scratched the surface in terms of the impact our medium can have."
Key operating metrics from the quarter included :
40699 .1 124 *** --Backlog: The Company brought its consolidated backlog of advertising and commerce revenue to more than $2 .7 billion at the end of the quarter, up from $2.4 billion on December 31, 1999 .
*** Working closely together in anticipation of their merger, America Online and Time Warner this quarter launched a number of cross-promotional agreements involving their world-class brands.
*** Extending its advertising and commerce leadership , the Company announced a series of significant advertising/commerce alliances this quarter with such market leaders as General Motors , American Airlines, Sears, Kinko's, Footlocker .com, Oxygen Media, and PurchasePro.com.
(Emphasis added.)
298. The press release was included in AOL's Current Report on Form 8-K dated Ap ril
18, 2000 and signed by Defendant Kelly that was filed with the SEC on April 21, 2000 .
299. On April 18, 2000 , in commenting upon AOL's just released financial results ,
Dow Jones News Service stated:
Advertising and electronic -commerce activity soared in Ame rica Online, Inc.'s (AOL) third quarter, helping the company soundly beat analysts ' earnings expectations.
*** We saw across the board, and across all brands, strong growth in advertising and e-commerce , revenue, said [Defendant] Michael Kelly, AOL's Chief Financial Officer.
300. On April 21, 2000, a Dow Jones News Service article, titled "Tech Week i n
Review", likewise reported AOL's very strong advertising and commerce revenue growth . It
also noted that a J.P. Morgan analyst warned investors to stay away from most internet stocks,
but continued to rate AOL a top recommendation .
40699 .1 125 Earnings reports were strong throughout the week . . . . America Online, Inc.'s net income advanced 7% on growth in advertising and its electronic-commerce business, underlining its emergence as a media force .
J.P. Morgan Securities Inc. analyst Susan Walker White warned investors to stay away from consumer-oriented Internet stocks this summer . In a 50-page report released Friday, White lowered price targets for most of the stocks in he r coverage area.
White's top recommendations include America Online, Inc. . . . White maintained her 12-month price target of $90 million for America Online ... .
(Emphasis added.)
301 . On or about May 15, 2000, the AOL Individual Defendants caused AOL to file its
SEC Form 10-Q for the fiscal quarter ended March 31, 2000. On May 17, 2000, the AOL
Individual Defendants caused AOL to file a SEC Form 10-Q/A for the period ended March 31 ,
2000. Both the Form 10-Q and 10-Q/A were signed by Defendants Case and Kelly . Both the
Form 10-Q and Form 10-Q/A contained substantially the same financial information as the
April 18, 2000 press release, including advertising, commerce and other revenue of $557
million, a 103% increase from the year ago quarter, and $2 .7 billion in advertising and
commerce backlog . The Form 10-Q and Form I0-Q/A also stated that AOL had $463 million in
advertising and commerce revenue, a 119% increase over the year ago quarter, and $1,08 7
million in advertising and commerce revenue for the nine months ended March 31, 1999, a
104% increase over the nine months ended March 31, 1998 . In addition, both the Form 10-Q
and the Form 10-Q/A assured investors that America Online's financials were prepared i n
accordance with GAAP :
The accompanying unaudited condensed consolidated financial statements, which include the accounts of America Online, Inc . (the "Company" or "America Online") and its wholly and majority owned subsidiaries, have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X .
40699.1 126 3.02 . In fact, AOL's reported advertising and commerce revenue of $463 million fo r
the quarter and $1 .1 billion for the nine-months ended March 31, 2000 was overstated by a t
least $168.6 million, and $325 .5 million, respectively, or on a percentage basis, a n
overstatement of the actual advertising and commerce revenue by at least 57% and 43%,
respectively, as a result of AOL' s improper accounting. The overstatement of $168.6 million
during the quarter was due to AOL' s improper accounting for the Sun ($12.6 million), Hughes
($48 million), Monster .com ($6 .2 million), Gateway ($85 million) and eBay ($ 16.8 million)
deals, as discussed above . The overstatement of at least $325.5 million during the nine months
ended March 31, 2000 was due to AOL's improper accounting for the Sun ($37.8 million),
Hughes ($144 million), Monster .com ($8 .3 million), Gateway ($85 million) and eBay ($50 .4
million) deals, as discussed above.
303 . Further, AOL's representation to the public in its press release dated April 18,
2000 and the related SEC Forms 10-Q and 10-Q/A filings that its advertising revenue backlog as
of March 31, 2000 was $2.7 billion was false. The actual backlog was overstated by at least
$1 .1 billion, or at least 73%, due to the improper accounting of the Sun ($84 million), Hughes
($421 million), Monster.com ($91 .5 million), Gateway ($456 .6 million), DrKoop .com ($9.6
million) and Homestore .com ($79.4 million) deals .
304 . The SEC Form I0-Q/A for the quarter ended March 31, 2000 also reiterated th e
advertising and commerce revenue and advertising backlog previously reported for the yea r
ended June 30, 1999, again overstating AOL's financial results for the period, as previousl y
discussed herein in ¶ 277 .
305. On February 11, 2000 the Company filed the Merger Registration Statement a s
amended on March 24, 2000, April 25, 2000, May 18, 2000 and May 19, 2000, which containe d
40699.1 127 or incorporated by reference all items referenced in IT 634, 639-640, 640-642, 644 and 645-647
and 638-640, including the Merger Agreement, historical AOL financial data, pro form a
consolidated financial data of AOL Time Warner, including AOL Time Warner's consolidated
balance sheet as of March 31, 2000, the Fairness Opinion of Morgan Stanley and Ernst &
Young's unqualified audit reports as referenced in ¶ 644, all of which were materially false an d
misleading for the reasons set forth in ¶¶ 648-655 .
306. Unaware of the concealed adverse information discussed herein, the shareholder s
of AOL and AOL Time Warner voted to approve the Merger of the two companies on June 23 ,
2000.
g. The Fiscal Quarter and Year Ended June 30, 2000
307. On July 6, 2000, Dow Jones News Service reported that , despite the collapsing
internet advertising market, AOL was expected to report another record-breaking quarter:
Many smaller Internet companies ran into cash problems during the quarter ended June 30, causing them to cut back on advertising spending . In turn, this had a domino effect on other Internet companies, in particular those that collect the bulk of their revenue by selling advertising on their Web sites .
But don't expect the cutbacks to have much of an effect on the leaders in the online advertising market, America Online, Inc. (AOL) and Yahoo! Inc . (YHOO). These companies have large and diversified po rtfolios of ad customers, which absorbed the lost business from struggling "dot-com" firms, analysts say.
*** America Online, Dulles, Va ., should report revenue from advertising and electronic-commerce of $557 million for its fourth quarter ended June 30, Newman estimated. That represents an 82% surge from the $306 million reported a year earlier .
(Emphasis added .)
40699.1 128 308. Two weeks later, on July 19, 2000, Dow Jones News Service reported that, based
on AOL 's prior financial results, expectations for AOL 's advertising and commerce revenue and
earnings were very high, notwithstanding the weakness in the internet advertising market :
Buoyed by strong advertising and electronic-commerce revenue , Ameri ca Online, Inc. (AOL) is expected to post fourth-quarter earnings ahead of the analysts' consensus estimate.
A First Call/Thomson Financial survey of 30 analysts predicted that the Dulles, Va., Internet service provider would post earnings of 11 cents a share for the quarter ended June 30, up from 6 cents a share year ago . America Online, the world's largest ISP, is scheduled to report results after the market closes Thursday.
But analysts pect the company to continue its lengthy streak of beating analysts' expectations. Merrill Lynch analyst Henry Blodget, for example, says it's possible the company will post ea rnings of 12 cents a share . Some so-called "whisper number " estimates, which purport to be more accurate than formal estimates, put fourth-quarter net as high as 13 cents a share . In recent quarters, AOL has beaten estimates by at least a penny per share .
America Online, which plans to close its acquisition of media giant Time Warner Inc. (TWX) in the fall, had a strong quarter despite reports of softness in the online advertising market , analysts say. The demise or near-demise of smaller Internet companies prompted many of them to slash their online advertising budgets. But top Web site operators like America Online were mostly immune to the crunch . . . . Squali estimated America Online's fourth-quarter revenue from advertising and e-commerce operations rose 96% from last year to $599 million . Overall revenue, which includes Internet-access subscriptions and business software sales, should come in at $1 .95 billion, up 42% from a year earlier.
(Emphasis added .)
309. On July 19, 2000, Associated Press Newswires reported that Ken Kiarash, an
analyst with Buckingham Research Group, said: "I don't think [AOL's] advertising revenue has
peaked yet. The issue is how fast they will be able to grow that line, which I think is crucial to
this company's success ." (Emphasis added .)
310. On July 20, 2000, the AOL Individual Defendants caused AOL to announce
record financial results for the quarter ended June 30, 2000, again surpassing analysts '
40699.1 129 expectations for advertising, commerce and other revenue and meeting the "whisper" numbe r
for earnings per share. The Dow Jones News Service reported:
America Online, Inc.'s (AOL) fourth-quarter results beat analysts' expectations, helped by strong adve rtising revenue and lower network operation costs .
The Dulles, Va., Internet service provider reported earnings excluding charges of 13 cents a share for the quarter ended June 30, up from 6 cents a share a year earlier and ahead of the analysts' consensus estimate of 1 I cents a share. Revenue rose to $1 .93 billion from $1 .38 billion a year ago.
The company's fourth-quarter revenue from advertising and electronic commerce jumped 95% from a year ago to $609 million, ahead of most analysts' estimates .
The numbers showed that AOL weathered what some analysts expected would be a slump in online advertising during the quart er .
America Online President and Chief Operating Officer Bob Pittman said the company's outlook for advertising revenue was strong. He pointed to AOL's recent deals with top advertisers like Target Corp. (TGT), Coca-Cola Co . (KO) and Citigroup Inc. (C).
In addition, America Online's backlog of advertising/e-commerce revenue rose to $3 billion at June 30 from $2.7 billion at March 31 . The backlog represents the amount of revenue the company expects to receive in future quarters under the terms of contracts that have already been signed .
"We're getting more advertising dollars than anyone except the top four television networks," Pittman said during Thursday's conference call .
Kelly said AOL and Time Warner were on pace to meet financial targets for the combined company. He said AOL Time Warner expects to post revenue of more than $40 billion in 2001 , representing an annual growth rate of 12% to 15% .
"Clearly, we are on our way to making our financial objectives a reality," he said.
Pittman said AOL Time Warner would be an advertising behemoth . He said that only four advertisers are on both companies' respective lists of top 100 advertisers.
(Emphasis added.)
40699.1 130 311 . On July 20, 2000, Dow Jones News Service reported that in an interview with
Defendant Case after AOL reported its fourth quarter earnings, Case emphasized that investor s
need not be concerned that the online advertising slump would lower AOL advertising revenue:
. . . Case said "all our numbers were at or above consensus estimates ." AOL's earnings of 13 cents a share, excluding items, beat the consensus by 2 cents a share. Case said AOL's fourth-quarter results were helped by strong advertising and electronic-commerce revenue, a development that should reassure investors who had feared that a "dot-com" shakeout would hu rt the online advertising market.
(Emphasis added.)
312. On or about September 22, 2000, the AOL Individual Defendants caused the
Company to file its SEC Form 10-K for the Company's fiscal quarter and year ended June 30 ,
2000. On October 30, 2000, the AOL Individual Defendants caused AOL to file a SEC Form
10-K/A for the fiscal quarter ended June 30, 2000 . Both the Form 10-K and Form 10-K/A were
signed by, inter alia. Defendants Case, Pittman and Kelly. Both the Forms 10-K and I 0-K/A
contained substantially the same financial information as the July 20, 2000 press release,
including advertising, commerce, and other revenue of $609 million for the quarter, and
advertising and commerce backlog of $3 billion. Both the Forms 10-K and 10-K/A also stated
that AOL had $1 .6 billion in advertising and commerce revenue in fiscal 2000, an increase o f
107% over fiscal 1999, as well as $1,986 million of advertising, commerce, and other revenue i n
fiscal 2000.
313 . Both the Forms 10-K and 10-K/A also incorporated, with Defendant Ernst &
Young's consent, the July 20, 2000 report of Defendant Ernst & Young which assured investor s
that the Company's financials were audited in accordance with GAAS and in compliance with
GAAP :
40699 .1 131 We conducted our audit in accordance with auditing standards generally accepted in the United States . . .. We believe that our audits provide a reasonable basis for our opinion.
In our [Ernst & Young] opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of America Online, Inc . at June 30, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended June 30, 2000, in conformity with accounting principles generally accepted in the United States .
314. In fact, AOL's reported advertising and commerce revenue of $513 million for
the quarter and $1 .6 billion for the year ended June 30, 2000 was overstated by at least $166 .7
million, and $492 .2 million, respectively, or in percentage terms, an overstatement of the actual
advertising and commerce revenue by at least 48% and 44%, respectively, as a result of AOL's
improper accounting . Likewise, AOL's advertising, commerce, and other revenue for th e
quarter and year ended June 30, 2000 of $609 million and $1 .986 billion, respectively, was
overstated by at least 38% and 33%, respectively. The overstatement of at least $166 .7 million
for the quarter was due to AOL's improper accounting of the Sun ($12 .6 million), Hughes ($32
million), Gateway ($85 million), Homestore ($4 .4 million), DrKoop .com ($9.6 million),
Monster.com ($6.2 million) and eBay ($16 .8 million) deals, as discussed above . The
overstatement of at least $492.2 million for the year ended June 30, 2000 was similarly due to
AOL's improper accounting of the Sun ($50 .4 million), Hughes ($176 million), Gateway ($170
million), Homestore ($4.4 million), DrKoop .com ($9.6 million) Monster.com ($14.6 million)
and eBay ($67 .2 million) deals, as discussed above .
315. Further, AOL's representation in its July 20, 2000 press release and its related
SEC Form 10-K and Form 10-K/A filings that its advertising revenue backlog as of June 30 ,
2000 was $3 billion was false because the actual backlog was overstated by at least $1 billion ,
or 52%, due to the improper accounting of the Sun ($71 .4 million), Hughes ($389 million),
40699 .1 132 Monster.com ($85.3 million), Homestore.com ($75 million), Gateway ($371 .7 million) ,
Ticketmaster ($13 million) and 24dogs .com ($23 .7 million) deals, as discussed previously .
316. Both the Form 10-K and 10-K/A incorporated by reference the Merge r
Agreement between AOL and Time Warner, which contains false representation and warranties
by AOL, as discussed herein at ¶ 655 .
317. Both the Form 10-K and 10-K/A for the fiscal quarter and year ended June 30,
2000 also stated that the advertising, commerce and other revenue for the quarter ended March
31, 2000 was $11 million more than originally reported due to a merger, again overstatin g
AOL's advertising, commerce and other revenue for the quarter ended March 31, 2000, a s
discussed previously in IT 302-303 .
h. The Fiscal Quarter Ended September 30, 200 0
318. The Washington Post reported in an article of July 18, 2002, title d
"Unconventional Transactions boosted Sales," that by at least August 2000, AOL executives ,
including Defendants Colburn and Berlow, knew that various advertising customers of th e
Company were experiencing financial problems that jeopardized existing AOL advertisin g
agreements . Sometime in September 2000, internal AOL documents showed that AOL was "at
risk" to lose more than $108 million in advertising revenue for the 2001 fiscal year (July 2000-
2001) due to the many failing dot-com companies . This estimate quickly increased within the
Company. Indeed, at the beginning of October 2000, Bob O'Connor, then AOL's Vic e
President of Finance for its advertising division, warned Defendant Pittman and several othe r
Company executives that AOL was at risk of losing $140 million in advertising revenue in th e
2001 calendar year because many internet companies which had advertising contracts with AOL
were failing . The Washington Post article also reported that AOL considered suing the failing
40699 .1 133 dot-com companies, but chose not to do so "because the public filings would show som e
weakness in its business."
319. On October 18, 2000, the Dow Jones News Service reported that analysts were
concerned about the potential impact of the internet advertising slump on AOL's advertising
revenue, the Company's fastest growing and most profitable revenue source :
America Online, Inc. (AOL) is expected to meet, and possibly beat, analysts' earnings estimates when it reports first-quarter results Wednesday .
The Dulles, Va., Internet service provider, should post earnings of 13 cents a share, excluding special items, for the quarter ended Sept. 30, according to a First Call/Thomson Financial survey of 28 analysts . . . .
AOL usually beats the analysts' consensus estimate by a penny or two a share . Some analysts, however, appear a little less ce rtain that the results in the latest first quarter will beat estimates as soundly as in previous qua rters.
Merrill Lynch analyst Henry Blodget said in a research note Tuesday that it's possible AOL would beat the consensus by a penny, but "it's not expected ." ING Barings analyst Youssef Squali said "there's a good chance" AOL will beat the mean estimate. J.P. Morgan analyst Susan Walker White sees "slight upside . "
Advertising/e-commerce is the segment that has generated nervousness among investors. While it represents a mino rity of AOL's overall revenue, it is the company's fastest-growing, and most profitable, segment. In recent weeks, concerns about a slowdown in online advertising spending have hit Web po rtals such as Yahoo! Inc. (YHOO). The concerns finally caught up to AOL Tuesday, with its shares falling 17% .
(Emphasis added .)
320. However, once again, AOL's reported numbers beat analysts' estimates by a
penny a share . On October 18, 2000, the AOL Individual Defendants caused AOL to issue a
press release announcing "Record-Breaking Results for FY2001 First Quarter . . . Advertising,
Commerce and Other Revenues Jump 80% to $649 Million ." These financial results were for
the last publicly reported fiscal period prior to the consummation of the Merger . As the press
release reported :
40699.1 134 America Online, Inc . (NYSE: AOL) today reported results for its fiscal first quarter ended September 30, 2000 - reaching new highs for consolidated revenues, advertising, commerce and other revenues, operating income, EBITDA and first-quarter AOL membership growth .
The quarter's net income, fully taxed and excluding one-time items, totaled $350 million, or $0.14 per diluted share, up from $182 million, or $0 .07 per diluted share, on the same basis last year the Company reported net income of $345 million, or $0.13 per diluted share, up from $181 million, or $0 .07 per diluted share, in fiscal 2000's first quarter . Reported net income included onetime merger-related charges of $6 million . Excluding these items, operating income for the quarter climbed more than 86% over the year-ago quarter to $484 million .
The quarter's consolidated revenues climbed 34% to $2 .0 billion from $1 .5 billion in last year's first quarter. Advertising, commerce and other revenues reached a record $649 million, climbing 80% over fiscal 2000's corresponding quarter.
Mr. Pittman added: "Our distinctive strategy of focusing on large strategic marketing agreements with major mainstream companies is paying off in the continuing strength of our advertising nd commerce revenues, which will substantially benefit from the merger. Our advertising and commerce growth prospects are underscored when you look at the top 100 adve rtisers each for Time Inc., Turner Networks and AOL, and find that only four out of the 300 are duplicated on all three lists.
Other operating highlights from the quarter include: Revenues from subscriptions increased to $1 .2 billion, a 21 % rise over the fiscal 2000 first quarter ; advertising, commerce and other revenues climbed to $649 million, increasing more than 80% over last year's corresponding quarter, • and the consolidated backlog o f advertising and commerce revenues grew to more than $3.0 billion at September 30, 2000, from $2.0 billion a year earlier.
(Emphasis added .)
321 . Ina conference call with analysts on October 18, 2000 following the release o f
the quarterly results, then AOL President, Defendant Pittman, responded to a question regarding
whether AOL was feeling the effects of an industry-wide slowdown in advertising as follows :
"I don't see it and I don't buy it ." (Emphasis added.) In the same telephone conference,
Defendant Stephen Case, AOL's Chairman and Chief Executive Officer at the time, sai d
40699 .1 135 "AOL's advertising growth is right on target . . . . The current advertising environment benefit s
us because it will drive a flight to quality." (Emphasis added .) Defendant Michael Kelly, then
AOL's Chief Financial Officer, similarly characterized AOL's advertising and commerce
revenue growth as "very healthy" and emphasized, "I can't say that strongly enough ." Kelly
reiterated his prior predictions that AOL Time Warner's revenue will rise 12% to 15% annually
and the merged company's EBITDA would rise 30% in the Company's first year . (Emphasis
added.)
322 . The market responded very favorably to the midday financial statements release d
by AOL on October 18, 2000, and the stock rose over 7% to $46 .91 per share at the close of the
market on October 18, 2000, up from a price of $43 .60 per share at the close of the market on
October 17, 2000 .
323 . In an October 19, 2000 research note, Mary Meeker, an analyst at Morga n
Stanley, commented on AOL 's advertising revenue : "This has developed quickly into AOL' s
fastest growing revenue stream and a key element of growth going forward ." At about the sam e
time, Christopher Dixon, a PaineWebber Inc . analyst, wrote that AOL's strong advertising and
commerce revenue "should alleviate some concerns about the health of the Internet advertisin g
environment. "
324. On October 19, 2000 , ING Barings LLC analyst, Youssef H . Squall, reiterated his
"strong buy" rating noting the Company' s "[s]olid advertising revenues . . . ."
325. On October 23, 2000, The Wall Street Journal reported that "[i]nitially, AO L
shareholders wondered if the link [with Time Warner] would weigh down the company's rising
stock . Now, a solid affiliation with a traditional company seems a good bet for the future . Of
40699 .1 136 course, AOL is also greatly helped by its reliable earnings and its sustained domination o f
online access ." (Emphasis added .)
326. On or about November 2, 2000, the AOL Individual Defendants caused AOL t o
issue its 1999 Annual Report for the fiscal year ended June 30, 1999, in which Defendants Cas e
and Pittman touted AOL' s remarkable advertising revenue growth:
In short, we are pleased to say that America Online has never been stronger. Our fiscal 1999 highlights include . . ..Advertising, commerce and other revenues climbed 84% to $1 billion, with a backlog of committed revenue of $1 .5 billion.
*** During fiscal 1999, we signed 58 multi-year advertising and commerce agreements, each worth in excess of $1 million .
The 1999 Annual Report also appended AOL's SEC Form 10-K for the fiscal quarter and year ended June 30, 1999 filed August 13, 1999 . For the reasons discussed previously in
¶ 277, the Form 10-K and related statements regarding AOL's advertising revenue for the quarter and year ended June 30, 1999 were mate rially false and misleading .
327. On November 9, 2000, the AOL Individual Defendants caused AOL to file its
SEC Form 10-Q for the fiscal quarter ended September 30, 2000 . The Form 10-Q was signed
by Defendants Case and Kelly. It contained substantially the same financial information as the
October 18, 2000 press release, including $649 million in advertising, commerce and other
revenue, an 80% increase over the year ago quarter, and a $3 billion advertising and commerce
backlog. The Form 10-Q also stated that AOL had $534 million in advertising and commerce
revenue, a 95% increase over the year ago quarter . In addition, the Form 10-Q assured investors
that AOL's financials were prepared in accordance with GAAP :
The accompanying unaudited condensed consolidated financial statements, which include the accounts of America Online, Inc . (the "Company") and its wholly owned subsidiaries, have been prepared in accordance with generall y
40699 .1 137 accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X .
328. In fact, AOL's reported advertising and commerce revenue for the quarter ended
September 30, 2000 of $534 million was overstated by $156 million, an overstatement of the
actual adve rtising and commerce revenue by at least 41 %, as a result of AOL's improper
accounting for the Sun ($12.6 million), Gateway ($85 million), 24dogs .com ($ 16.2 million),
Homestore ($6.6 million), Monster .com ($6.2 million), Ticketmaster ($13 million) and eBay
($16 .8 million ) deals, as discussed above. For the same reasons, AOL's reporting of
advertising, commerce and other revenue was likewise overstated by $156 million for the
quarter. The Company has already admitted overstatement of $66 million of AOL advertising
and commerce revenue for the quarter ended September 30, 2000, based on its restatement of
the quarter' s result in the SEC Form 8-K filed October 23, 2002 .
329. Further, AOL's October 18, 2000 press release and related SEC Form 10-Q filin g
stating that its advertising revenue backlog as of September 30, 2000 was $3 billion was false
because the actual backlog was overstated by at least $1 billion, or by at least 51 %, due to the
improper accounting of the Sun ($58 .8 million), Hughes ($389 million), Homestore .com ($68.4
million), Monster .com ($79 million), Gateway ($286 .8 million), 24dogs .com ($7.5 million),
Veritas ($20 million), Telefonica SA ($15 million), PurchasePro ($41 .4 million) and WorldCom
($48.9 million) deals .
330. The statements made by Defendants Case, Pittman and Kelly to market analyst s
on the conference call of October 18, 2000, as reproduced above, are also false and misleading
for the same reasons, and were particularly egregious in light of the internal AOL informatio n
showing that $140 million of AOL advertising revenue was "at risk" for the following calenda r
year.
40699.1 138 331 . On October 30, 2000 the AOL Individual Defendants caused the Company to file
a SEC Form 10-K/A for the quarter and fiscal year ended June 30, 2000 in which the Compan y
reiterated the advertising and commerce revenue and advertising and commerce backlo g
previously reported for the quarter and year ended June 30, 2000, again overstating AOL' s
financial results for the period, as previously discussed in ¶¶ 313-314, herein .
i. The Fiscal Ouarter and Year Ended December 31, 200 0
332 . On January 11, 2001 , the Individual Defendants caused the Company to issue a
press release announcing that the Merger between AOL and Time Warner had been completed
that day, creating AOL Time Warner.
333 . One day after the Merger was consummated, on January 12, 2001, The Wall
Street Journal reported that despite the weakening advertising market, AOL Time Warner was
standing by its revenue targets for the merged company and that advertising and e-commerc e
would remain the fastest growing revenue source for the Company :
Mike Kelly, AOL's chief financial officer and holder of the same title at the new company, said yesterday that executives are sticking by their targets, which call for revenue to grow by 12% to 15% to total more that $40 billion in 2001, and for earnings before interest, taxes, depreciation and amortization to rise about 30% to $11 billion. He added that the new AOL Time Warner had always planned to aggressively look for cost savings and ways to generate extra revenue .
Analysts' concerns intensified last month after Time Warner warned that its fourth-quarter earnings would be hurt by weaker ad revenue . . . .At the time, AOL said its fourth-quarter advertising and online commerce revenues were "on track" to meet Wall Street expectations .
Mr. Kelly said yesterday he still expected advertising and e-commerce "would be our fastest-growing revenue component ."
(Emphasis added.)
334. On January 12, 2001, the Individual Defendants caused the Company to file an
SEC Form 8-K dated January 11, 2001 and signed by Defendant Cappuccio that incorporate d
40699 .1 139 the Merger Agreement between AOL and Time Warner, which contains false representation s
and warranties by AOL as discussed herein at ¶ 655 .
335. On January 13, 2001, The Los Angeles Times reported that AOL Co-Chie f
Operating Officer, Defendant Pittman, indicated that softness in the advertising market would
not hurt AOL' s advertising revenue . As The Los Angeles Times quoted Defendant Pittman :
"In the advertising world, you hear people say there's a slowdown . But it's not across the board . When [buyers] cut back, they don't cut back on their primary ad buys, which provide a big reach . Turner Networks, WB and the Time magazine group all fit into that category . . . . Also, if you do have a slowdown in traditional media and there's open inventory on our existing media properties, we're a major advertiser ourselves . We're No. 7 in the country in advertising sales. We have the ability to take our own ads and put them on our ow n properties, so we can fill up the slack there ."
(Emphasis added.)
336. On January 26, 2001 , the Individual Defendants caused the Company to file a n
SEC Form 8-K/A dated January 11, 2001 . The Form 8-K/A was signed by Defendant Kelly and
Barge and incorporated the AOL Time Warner consolidated balance sheet as of September 30,
2000 and AOL Time Warner's pro forma consolidated condensed financial statements for the
three months ended September 30, 2000, year ended June 30, 2000 and year ended December 31,
1999, which were materially misleading because they incorporated the fraudulently inflated AOL
advertising revenue for the respective fiscal periods, as discussed herein at ¶¶ 293-294, 314-315
and 328-329.
337. Similarly, on January 26, 2001, the Individual Defendants caused the Company to
file its SEC Form 8-K/A amending its SEC Form 8-K dated January 18, 2001 that updated the
financial results for the quarter ended September 30, 2000 and reiterated the advertising and
commerce revenue and advertising and commerce backlog previously reported for the quarter,
again overstating AOL's financial results for the period, as discussed herein in ¶¶ 328-329 .
40699 .1 140 338. On January 31, 2001, the Individual Defendants caused the Company to
report the first financial results since the Merger was consummated , including "all-time
records" in AOL advertising revenue. The press release stated:
AOL Time Warner Inc . (NYSE: AOL) today reported record December quarter results for America Online, Inc. and pro forma results for the combined Company's December quarter and full year . In addition, the Company released the results for Time Warner Inc.'s December qua rter and full year.
As a result of the AOL Time Warner merger, the Company is reporting the results of America Online, Inc .'s December quarter and AOL Time Warner's pro forma quarter and full year ended December 31, 2000 .
In the December quarter, America Online reported all-time records in revenues, advertising, commerce and other revenues, operating income , EBITDA and AOL membership growth.
The Company's net income, fully taxed and excluding one-time events, climbed 67% to a record $365 million, or $0 .15 per diluted share, up from $219 million, or $0.09 per diluted share, on the same basis last year . Including non-cash charges of $535 million related to write-downs of various investments, the Company's reported net income was $37 million, or $0.01 per diluted share . On the same basis in the year-ago quarter, reported net income was $280 million, or $0.11 per diluted share.
America Online's December quarter revenues climbed 27% to nearly $2 .1 billion from $1 .6 billion in the year-ago quarter. Advertising, commerce and other revenues reached a record $741 million, climbing 65% over last year's corresponding quarter.
Further, AOL operating highlights from the quarter include :
Advertising & Commerce Revenues: Revenues from advertising and commerce climbed to $686 million, increasing 71% over last year's corresponding quarter . . . .
AOL Time Warner Pro Forma Results :
Driven by strong performances at America Online , Cable, Publishing and Networks, AOL Time Warner's pro forma 2000 revenues rose 11% to $36 .2 billion, and adjusted EBITDA increased 19% to $8 .4 billion. That compares to 1999's $32.5 billion in revenues and $7 .0 billion in adjusted EBITDA. AOL Time Warner's 2000 adjusted diluted cash earnings per common share climbed 32% to $0.94, compared to $0.71 in 1999 . The Company's subscription revenues increased
40699.1 141 13% to $14.7 billion, and the Company finished the year with 130 million subscriptions, an increase of 16% over the prior year . Full-year advertising and commerce revenues increased 24% to more than $8 .7 billion .
For the December quarter, AOL Time Warner's revenues rose 8% to $10 .2 billion, and adjusted EBITDA increased 14% to $2 .4 billion . That compares to $9.5 billion in revenues and $2 .1 billion in adjusted EBITDA in last year's corresponding quarter. Subscription revenues increased 11% to $3 .8 billion, compared to $3.5 billion in 1999's December quarter, and advertising and commerce revenues increased 14% to $2 .6 billion, compared to the year-ago quarter's $2.3 billion. AOL Time Warner's December quarter adjusted diluted cash earnings per common share climbed 17% to $0.28, compared to $0.24 in 1999.
(Emphasis added.)
339. On January 31, 2001, Dow Jones News Service reported that AOL Time Warner's
first reported financial results included strong AOL advertising and commerce revenue, despit e
the depressed online advertising market :
AOL's revenue from advertising and electronic-commerce was strong, rising 65% to $741 million, exceeding the expectations of many analysts . The performance showed that AOL was more than able to weather an overall soft market for online advertising .
"AOL's online advertising and commerce platform is alive and well ," said Wit Soundview analyst Jordan Rohan. "The unit's $741 million in revenue implies that despite being more than twice the size of Yahoo, AOL is growing more quickly, and gaining market share ."
. . .AOL Time Warner Co-Chief Operating Officer Bob Pittman said the company can prosper even in a soft ad market and a broader economic slowdown .
(Emphasis added.)
340. On January 31, 2001, Dow Jones Business News reported that the strong revenue
growth for the merged Company's first quarter was boosted by a remarkable increase in
advertising, commerce and other revenue :
Pro-forma revenue rose 8 .1 % to $10.23 billion. AOL Time Warner attributed the increase to strong performances from its America Online , cable, publishing and networks businesses .
40699.1 142 "We are seeing exciting momentum in our subsc ription and advertising/commerce businesses across the company," Bob Pittman, co-chief operating officer, said in a prepared statement.
AOL's revenue rose 27% to $2.06 billion, boosted in part by a 65% jump in revenue from advertising, commerce and related activities .
(Emphasis added.)
341 . On January 31, 2001, Dow Jones News Service reported :
AOL Time Warner Inc . (AOL) Chief Financial Officer J . Michael Kelly reiterated the Company's ambitious 2001 growth targets Wednesday.
In a meeting with analysts here after reporting fourth-quarter results, Kelly said the newly merged Internet and media company expects 2001 revenue of $40 billion, compared with pro forma revenue of $36.2 billion in 2000. It also expects earnings before interest, taxes, depreciation and amortization, or EBITDA, to rise about 30% to $11 billion from $8.4 billion in 2000. "The guidance that we gave over a year ago remains unchanged," Kelly said.
Some analysts have questioned whether AOL Time Warner can meet such ambitious targets, particularly in light of Time Warner's weaker-than-expected fourth quarter . Indeed, AOL Time Warner's fourth-quarter pro forma EBITDA rose just 14% from a year earlier, less than half the targeted 2001 growth rate .
*** Kelly reiterated the company's overall revenue growth target of 12% to 15% .
"Look at the results that are out there ," said AOL Time Warner Chief Executive Jerry Levin. "Look at the financial discipline in this company."
*** In another sign of the company's optimism, Chairman Steve Case said he's focused on two numbers the company hopes to achieve someday: a market capitalization of $1 trillion and $100 billion in annual revenue .
(Emphasis added .)
342. On January 31, 2001, Business Wire reported that Defendant Kelly, AOL Time
Warner's Chief Financial Officer, said:
40699 .1 143 "Strong growth in subscription and advertising revenues will drive the Company's performance , with the benefit of multiple revenue streams from a diverse array of world class brands and customer relationships . AOL Time Warner has all the financial strength necessary to back our vision for the future ."
343 . On February 1, 2001, The Los Angeles Times reported that AOL Time Warner
again told investors they shouldn't worry about the newly merged company meeting its financia l
targets because advertising revenue growth at AOL would continue to boost the Company' s
total revenues, despite the slowing advertising market :
AOL Time Warner tried to reassure Wall Street on Wednesday that the newly merged company-fueled largel y by its fast-growing America Online unit- remains on track to meet its financial targets, despite a slowing economy and softening adve rtising market.
The article continued:
They are in good control of the underlying operations and seem to have the integration process in hand,' said CIBC World Markets analyst John Corcoran. "I have more confidence in their ability to make their numbers.' Corcoran said he was particularly impressed by AOL' s subscription base, which gained another 2.1 million members in the fourth quarter to reach 26.7 million worldwide, and by the online company 's strong advertising and e-commerce revenue, which surged 65% over last year's fourth quarter. `Even though the outside environment is slowing down, AOL continues to do well ,' Corcoran said. `It's the engine that drives all the other parts of this business .'
According to Gerald Levin, chief executive at AOL Time Warner, `We are paying a lot of attention to top-line revenue growth . '
To help calm investor worries about the advertising slowdown, the company noted that it was already reaping the benefits of its larger size . It announced marketing deals with Nortel Network Corp ., Cendant Corp ., Compaq Computer Corp. and Purchase Pro, a business-to-business e-commerce company .
(Emphasis added.)
344. On February 13, 2001, Dow Jones News Service reported that AOL Time Warner
again emphasized the AOL unit's advertising and commerce revenue to assure investors that the
merged Company's revenue growth would remain strong:
40699 .1 144 Michael Kelly said the AOL side of the business would be the "catalyst for change across the whole company."
AOL Time Warner expects the fastest-growing segment of its business to be advertising and commerce revenue . Revenue in this area rose 29% last year, on a pro forma basis, with the AOL side posting the sharpest growth . For 2001, AOL Time Warner expects advertising/commerce revenue to rise 18% to 22%.
(Emphasis added.)
345. On March 8, 2001, Dow Jones News Service reported that Individual Defendants
boasted that the increasing weakness in the advertising market would not affect AOL Time
Warner's advertising business :
Despite increasing signs of a weak advertising market, AOL Time Warner Inc . (AOL) Chief Operating Officer Bob Pittman reaffirmed the company's ambitious financial targets for 2001 .
Speaking at the Merrill Lynch Internet Conference in New York today, Pittman put it bluntly : "our businesses are doing great ."
While acknowledging that the overall advertising market has weakened, he said AOL Time Warner remains strong because its numerous properties make it a must-buy for advertisers .
"I want to assure you we gave The Street our guidance in January and we are sticking to it. Period," he said .
Pittman said, "[I]n addition, the soft economy has sparked a "flight to quality" among advertisers, who are shifting their spending to AOL Time Warner from its competitors."
(Emphasis added.)
346. On March 8, 2001, Lehman Brothers, Inc ., issued an analyst report on AOL Time
Warner in which it rated the Company's common stock a "Buy ." In making the
recommendation, the analyst report relied heavily on the reported strength of the "AOL
division's advertising business ."
40699.1 145 347. On March 14, 2001, Merrill Lynch analyst Henry Blodget similarly issued a
favorable repo rt on AOL's advertising business :
For Ql, we did not change any estimates, and in fact believe AOL will have a solid quarter, possibly even ahead of our estimates (which would be remarkable in this environment) . We note that despite the disastrous state of the online ad market with blowups from Yahoo!, CNET, and other ad supported companies, we still expect AOL to increase adcom revenue slightly sequentially. AOL is the least exposed to the weakness in advertising demand, and continues to sign large cross platform advertising deals with traditional advertisers.
(Emphasis added.)
348 . On March 27, 2001, the Individual Defendants caused AOL Time Warner to issue
its 2000 Annual Report in which Defendant Case and Levin touted AOL's phenomena l
advertising revenue growth:
The ability to monetize the fundamental building blocks of value that we possess is rooted in multiple revenue streams from subscriptions, advertising and commerce, and content .-Continuing to capitalize on its status as the premier Internet brand, America Online extended its industry-leading position in advertising and commerce, growing its base by a remarkable 91 % last year .
(Emphasis added .)
The Annual Report continued :
Advertising and commerce revenues increased by 91 % from $1 .240 million during the year ended December 31, 1999 to $2,369 million during the year ended December 31, 2000. This increase was primarily attributable to additional advertising and electronic commerce on America Online's AOL service , as well as its other branded services and portals .
(Emphasis added.)
349. On March 27, 2001, the Individual Defendants caused AOL Time Warner to fil e
its SEC Form 10-K for the transition period from July 1, 2000 to December 31, 2000. The Form
10-K was signed by Defendants Case, Levin, Kelly, Pittman and Parsons . It contained
substantially the same financial information as the January 31, 2000 press release, includin g
40699.1 146 $686 million in adve rtising and commerce revenue at the AOL unit for the quarter ended
December 31, 2000. The Form 10-K also stated that AOL advertising and commerce revenu e
was $1 .3 billion for the six months and $2 .4 billion for the year ended December 31, 2000, a
91% increase over the year ended December 31, 1999. Starting with this financial report, the
Company discontinued the reporting of advertising and commerce backlog .
350. In addition, the Form 10-K incorporated, with its consent, the January 31, 200 1
report of Defendant Ernst & Young, which assured investors that AOL's financials were audite d
in accordance with GAAS and found to be compliant with GAAP :
We conducted our audit in accordance with auditing standards generally accepted in the United States . . . . We believe that our audits provide a reasonable basis for our opinion .
In our [Ernst & Young LLP] opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of America Online, Inc . at December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States .
351 . The Form 10-K further stated that "An important component of America
Online's strategy is to continue increasing revenues from advertising . . . ."
352. In fact, AOL's advertising and commerce revenue reported in its financial
statements of $686 million for the quarter, $1 .3 billion for the six months and $2 .4 billion for
the year ended December 31, 2000, was overstated by at least $ 186.8 million, $343 million and
$678.1 million , respectively, an overstatement of the actual adve rtising and commerce revenue
by at least 37%, 37%, and 40%, respectively, as a result of AOL' s improper accounting. The
overstatement of at least $186.8 million for the quarter was due to AOL's improper accounting
of the Sun ($12.6 million), eBay ($ 16.8 million), Gateway ($85 million), 24dogs .com ($7.5
million), Homestore .com ($6 .6 million), Veritas ($ 4 million ), Telefonica SA ($10 million) ,
40699.1 147 WorldCom ($12.7 million), Monster .com ($6.2 million) and PurchasePro ($25 .4 million) deals,
as discussed above. The overstatement of at least $343 million for the six months ende d
December 31, 2000 was due to AOL's improper accounting for the Sun ($25 .2 million),
Gateway ($170 million), eBay ($33 .6 million), 24dogs .com ($23.7 million), Veritas ($4
million), Telefonica SA ($10 million), WorldCom ($12 .7 million), Homestore.com ($13.2
million), Monster.com ($12.5 million), PurchasePro ($25 .4 million) and Ticketmaster ($13
million) deals, as discussed above. The overstatement of at least $678 .1 million for the calendar
year ended December 31, 2000 was due to AOL's improper accounting for the Sun ($50.4
million), eBay ($67 .2 million), Homestore ($17 .6 million), Hughes ($180 million), Gateway
($340 million), 24dogs .com ($23.7 million), Veritas ($4 million), Telefonica SA ($10 million),
WorldCom ($12.7 million), Monster.com ($25 million), PurchasePro ($25 .4 million),
Ticketmaster ($13 million) and Dr.Koop.com ($9.6 million) deals, as previously discussed .
353 . The Company has already admitted overstatements of $22 million, $88 million
and $88 million, of AOL advertising and commerce revenue for the quarter, six months and year
ended December 31, 2000, respectively, in the SEC Form 8-K filed October 23, 2002 .
354. The oral statements made by Defendant Kelly as reported by The Wall Street
Journal on January 12, 2001, Defendant Pittman's statements as reported by The Los Angeles
Times on January 13, 2001, Defendant Kelly's comments to market analysts on January 31,
2001 and Defendant Pittman's comments at the Merrill Lynch Internet Conference on March 8,
2001, as reproduced above, are also egregiously false and misleading . Indeed, these
representations that the advertising market slowdown would not adversely affect the advertising
revenue growth at AOL were patently misleading and false for the reasons discussed above an d
40699.1 148 in light of internal information within AOL which showed that AOL was at risk to lose
substantial advertising revenue .
j . The Fiscal Quarter Ended March 31, 200 1
355 . On April 2, 2001, The Wall Street Journal reported that AOL Time Warner was
one of a few large companies continuing to see sharp gains in stock price despite a softenin g
economy and weak stock market :
In a rocky stock market, [AOL Time Warner] is one of few big companies whose stock has shown a sharp gain so far this year, partly because it has stuck by aggressive revenue and earnings targets . The newly merged company, facing a weakening economy, is pulling out all the stops to meet its original forecasts for 2001 : 12% to 15% growth in revenue, to $40 billion, and a 30% increase in earnings before interest, taxes, depreciation and amortization, to $11 billion . The company says not to worry, and many analysts and investors are confident it will deliver."
(Emphasis added .)
356. On April 3, 2001, AFXNews reported that Individual Defendants continued t o
state that the Company could meet its financial goals notwithstanding declines in the economy :
AOL Time Warner Inc chief executive Gerald Levin said the company is "on track" to meet its 2001 sales and profit targets despite a less favorable economic environment.
Speaking at the Salomon Smith Barney/Broadcasting and Cable Magazine Big Picture Conference, Levin said business is very strong.
357. On April 12, 2001 , AFX News reported:
Analysts are confident that AOL Time Warner's first -quarter numbers will not disappoint.
"AOL Time Warner is best positioned . . . [to weather] the on-going weakness in ad land and concerns about upcoming talent strikes," said UBS Warburg's Christopher Dixon.
"America Online continues to attract additional marketing dollar from big traditional advertisers, add new subscribers worldwide and produce metrics that blow the competition away," argued Lehman Brothers' Holly Becker . Becker . . .
40699 .1 149 rates AOL Time Warner a `buy.' Dixon has a "strong buy" recommendation on the stock .
(Emphasis added .)
358. On April 16, 2001, Barron's reported that Individual Defendants predicted stron g
advertising revenue for the Company's fiscal quarter driven by the Company's AOL division :
Indeed, the folks at AOL Time Warner expect advertising and e-commerce revenues to grow nicely this year, despite the punk economy.
But the real growth engine for AOL Time Warner's ad revenue will incontestably be AOL, which has seen its annual advertising and e-commerce revenues soar from zero to $2 billion in the last six years . Indeed, AOL may be immune to the down cycle in the media because what it sells to advertisers is somewhat different from traditional image or product advertising .
"We're renting out the eyeballs and increasingly the fingers of our subscribers, who are primed to buy products as a result of the adjacency, context and product- information surfing the AOL service lends itself to," says Barry Schuler, chairman and CEO of America Online .
(Emphasis added .)
359. On April 18, 2001, the Individual Defendants caused the Company to issue a
press release announcing its financial results for the quarter ended March 31, 2001, includin g
strong revenue gains for the Company, driven by large gains in advertising and commerce
revenue at the AOL unit. As stated in the'press release :
[AJOL Advertising and Commerce Revenues Climb 37% to $721 Million
AOL Time Warner Inc. (NYSE: AOL) today reported results for its first qua rter ended March 31, 2001, posting strong gains in total revenues, EBITDA, cash earnings per share, and Free Cash Flow over pro forma results from last year's comparable quarter.
Total revenues rose 9% to $9 .1 billion, compared to $8 .3 billion in the 2000 first quarter. Excluding one-time events, EBITDA increased 20% to $2 .1 billion, from $1 .8 billion in the corresponding 2000 quarter; cash earnings per common share were $0 .23, versus $0 .19 in last year's first quarter; and Free Cash Flow climbed to $651 million, up 409% from the year-ago quarter's $128 million .
40699.1 150 [AOL Time Warner] Revenue growth was driven by a 9% increase in subscription revenues to $3.9 billion, a 10% increase in advertising and commerce revenues to $2.1 billion , and an 8% increase in content and other revenues to $3 .2 billion. This compares to $3 .5 billion, $1 .9 billion and $2 .9 billion respectively in last year's March qua rter.
In addition, the Company's press release stated that: "strong growth in advertising and commerce revenues were led by year-over-year increases of 37% at America Online ."
(Emphasis added.)
360. On April 18, 2001 , AFX News reported that the strong revenue growth repo rted by
AOL Time Warner in its first quarter as a merged entity helped the Company significantl y
exceed forecasts of earnings per share:
AOL reported a rise in first quarter cash earnings per share to 23 cents from a pro- forma 19 cents a year ago, beating Wall Street consensus forecasts by 3 cents .
Speaking after the release of the figures , AOL Time Warner chief executive officer Gerald Levin said the company is "on track" to meet its full-year revenue and EBITDA targets.
"I think we have made an excellent start," Levin said during a conference call .
Analysts, who had feared the slowdown in online advertising may have hit the group's performance, were buoyed by the figures.
In a note to clients, Merrill Lynch described the company's results as "impressive ."
Salomon Smith Barney was equally upbeat .
(Emphasis added.)
361 . On April 18, 2001, Dow Jones News Service reported that Individual Defendant s
told the investing public that strong advertising and commerce revenue at the AOL division
would be instrumental in achieving the Company's fiscal year goals :
AOL Time Warner Inc. expects the advertising market to improve in the second half of the year, Chief Financial Officer Michael Kelly said Wednesday .
40699 .1 151 "I'd say we are assuming the second half of the year will see some strengthening of the ad markets ," Kelly said during a conference call Wednesday after AOL Time Warner reported better-than-expected first-quarter results.
An improving advertising market could be key to helping AOL Time Warner meet its ambitious financial targets for 2001 . Chief executive Jerry Levin said first-quarter results put the company "on track" to meet those targets .
*** Levin called AOL service the "jewel in the crown of the company."
(Emphasis added.)
362. On April 19, 2001, Lehman Brothers, Inc ., issued an analyst report on AOL Tim e
Warner in which it rated the Company's common stock a "Buy." In making the
recommendation, the Lehman analysts noted that advertising revenue was "robust" and that
online advertising had grown 37% making AOL's "first quarter online advertising revenues of
$721 million . . . equal to our full year revenue forecast of $725 million for Yahoo! " (Emphasis
added.)
363 . On April 19, 2001, Merrill Lynch issued an analyst report on AOL Time Warner
in which it stated that "[aidvertising/commerce segment results were surprisingly strong,
considering the widespread weakness across the industry . Results were boosted by
advertising growth at AOL, which represents nearly 34% of total advertising revenue ."
(Emphasis added.) The report concluded that "[w]ith an estimated 25% of revenue coming from
advertising related business , AOL Time Warner is in an advantageous position relative to its
peers in the current weak advertising environment ." (Emphasis added.)
364 . On April 19, 2001, The Los Angeles Times reported in an article titled, "Company
Town AOL Time Warner Restores Confidence with Strong First-Quarter Earnings," that the
40699 .1 152 surprisingly strong revenue growth in advertising and commerce had a significant positiv e
impact on the market's confidence in the Company:
AOL Time Warner Inc. delivered surprisingly solid earnings Wednesday to a wary Wall Street, putting to rest-for now-doubts about the media and entertainment giant's ability to hit its financial targets amid the advertising slowdown. Fueled by double-digit growth at its Internet and cable businesses, the New York-based company said first-quarter revenue rose 9% to $9 .1 billion. Quarterly earnings, before certain costs, soared 20% to $2 .1 billion. The strong showing was in sharp contrast to those of other Internet and media companies which have disappointed investors in recent weeks with rising losses and falling sales. Last week, Yahoo Inc. said it would fire 12% of its work force and report an $11 .5-million first-quarter loss.
Even with a solid first-quarter performance, the company will have to work overtime to meet its year-end goal of generating $40 billion in revenue and $11 billion in earnings . . .AOL Time Warner's chief executive, Gerald Levin, reiterated those targets Wednesday and said his company is not as vulnerable as others to the ad slowdown. `Our company rides above the normal market dynamics. ' Levin said . . . Advertising and e-commerce revenue-a trouble spot at many Internet companies-rose 10% during the quarter, thanks largely to increase at the flagship AOL Internet service and the Time Warner cable business .
(Emphasis added.)
365. On April 19, 2001, The Wall Street Journal reported that AOL Time Warner' s
growth in online advertising and its confidence in its previously stated goals for fiscal 2001 se t
the Company apart from other companies in the online advertising business :
In its first quarter as a merged company, AOL Time Warner Inc. met most of its financial targets, driven by strong growth at America Online and Time Warner Cable, and renewed its pledge to meet its aggressive full-year goals . The media conglomerate's projections assume a pickup in advertising in the second half of the year in areas that have endured an ad slowdown in recent months .
For the full year, AOL predicts EBITDA of about $11 billion, up about 30%. Wall Street applauded the results. `This sets the tone for a big year for the company,' said Frederick W. Moran, an analyst at Jeffries & Co . ` It shows their resilience in the face of a difficult advertising market .'
AOL overcame softness in the advertising market to post a 10% higher qua rterly advertising revenue, $2.05 billion, in line with projections released in January. Mr. Kelly said AOL's online unit in particular had seen 'very strong performanc e
40699.1 153 in the advertising marketplace.' Advertising and commerce revenue at the unit rose 37% to $721 million from $528 million a year earlier . That helped drive America Online's Ebitda up 35% to $684 million .
Analysts said America Online's success was noteworthy considering the striking Internet advertising slowdown at rival Yahoo! Inc . ` They're clearly tag massive market share in online advertising,' said Jamie Kiggen, analyst at Credit Suisse First Boston.
(Emphasis added .)
366. On April 27, 2001, Salomon Smith Barney issued an analyst report by Jill S.
Krutick on AOL Time Warner which rated the Company 's common stock a "Buy," and
highlighted the unusual strength in the Company's online advertising revenues compared to it s
competitors. In making the recommendation, the Salomon analyst noted that during AOL's first
quarter earnings conference "management expressed confidence in a strengthening Lof th e
advertising market] in the second half of 2001 ." (Emphasis added .) The Salomon analyst also
stated : "Despite the current challenges in the overall advertising market and the onlin e
advertising market in particular, we believe AOL has strong prospects in its advertising an d
commerce line in the next few years [and described AOL as] the most desirable advertising and
marketing venue on the Internet at present ." (Emphasis added .)
367. Salomon analyst Krutnick concluded that "AOL's stock should rise as earnings
targets are met. AOL Time Warner's first quarter 2001 results were ahead of our
expectations. . ." The report went on to do a detailed comparison of AOL and its peers, and
noted that "AOL's adle-commerce revenues were $721 million , representing 5% sequential
growth, and 37% year-over-year growth. In comparison, Yahoo! 's ad/e-commerce revenues
were down 28% year-to-year in the same qua rters." (Emphasis added.) The Salomon report
stated that these "[h]ealthy gains in ad/e-commerce revenues at AOL also contributed to margin
improvement. . ." (Emphasis added.) For instance, AOL's ad/e-commerce revenues rose from
40699.1 154 29% of AOL's total revenues in first quarter 2000, to 34% in first quarter 2001, with the total
ad/c-commerce dollars rising 37% year to year . "To put that number in some context," the
Salomon analysts wrote, ". . .both Yahoo! and DoubleClick recently reported steeper-than-20%
year-to-year declines in their first quarter online ad revenues . AOL is the online advertising
market's growth driver." (Emphasis added.)
368. Comparing AOL's performance with Excite ,Home, Krutnick's repo rt stated that
"[t]he difference between +37% year-to-year growth at AOL and a -41 % decline in
ad/commerce revenue at Excite@Home in first quarter 2001 is a wider performance gap than we
have ever seen between these two companies." The Salomon report went on to compare AOL
with EarthLink and concluded that with respect to advertising revenue, "the race is not even
close: AOL produced healthy year-over-year advertising revenue growth while EarthLink
experienced a steep year-over-year ad revenue decline." The report noted the difference
between AOL's +37% year-to-year growth and EarthLink's -57% decline, and observed that
while "others put erasing losses ahead of growth, AOL accelerates ." In sum, the Salomo n
report concluded that "f i]n the sea of uncertainty that is 2001, we believe AOL Time Warner
has . . .the market share growth of its advertising franchises . . ." (Emphasis added .)
369. On May 2, 2001, Salomon Smith Barney issued another analyst report on AOL
Time Warner which again rated the Company's common stock a "Buy ." In making the
recommendation, the Salomon report stated :
An area of obvious interest is the advertising market where AOL Time Warner made the point that tough economic times breed defensive spending and reversion to "core" ad vehicles like those Time Warner provides . In our judgment, solid first quarter results did much to chase away skepticism and we expect this to lift even further as the year unfolds and the company delivers.
(Emphasis added .)
40699 .1 155 370. On May 4, 2001, the San Jose Mercury News reported that Defendant Cas e
boasted of the unusually strong advertising and commerce revenue at the AOL unit:
As Internet stocks flounder around him, AOL Time Warner Chairman Steve Case on Thursday boasted that his company is hitting Wall Street targets . . .The merged company announced financial results last month that were in line wit h expectations of most analysts. He pointed out that even as Internet advertising has declined for others, AOL operations reported advertising and e-commerce had increased 37 percent.
(Emphasis added .)
371 . On or about May 15, 2001, the AOL Individual Defendants caused the Compan y
to file its SEC Form 10-Q for the Company's first fiscal quarter as a merged entity ended March
31, 2001 and subsequently caused the Company to file a SEC Form 10-Q/A for the same period
on May 16, 2001 . The Form 10-Q and Form I0-Q/A was signed by Defendant Kelly an d
contained substantially the same financial information as the April 18, 2001 press release,
including the 37% increase in advertising and commerce revenue for AOL, which means that
although it was not broken out as such, the Form 10-Q financial results of $2 .1 billion revenue
for the AOL business segment included $721 million in AOL advertising and commerce
revenue. In addition, the Form 10-Q and Form 10-Q/A assured investors that the Company's
financials were prepared in accordance with GAAP :
The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles applicable to interim periods.
372. In fact, AOL Time Warner's reported AOL segment advertising and commerc e
revenue for the quarter ended March 31, 2001 of $721 million was overstated by at least $214 .3
million, an overstatement of the actual advertising and commerce revenue by at least 42%, as a
40699 .1 156 result of AOL' s improper accounting. The $214 .3 million overstatement was a result of AO L
Time Warner's improper accounting for the Sun ($12 .6 million), eBay ($16 .8 million),
Homestore .com ($11 .1 million), Gateway ($130 million), Veritas ($4 million), Telefonica SA
($5 million), WorldCom ($5 .3 million), Monster .com ($6.2), PurchasePro .com ($7 million), and
Bertelsmann ($16.3 million) deals, as discussed above . Based on the restatement of the
Company's financial results in its SEC Form 8-K filed on October 23, 2002, the Company ha s
already admitted overstating at least $ 13 million of AOL advertising and commerce revenue for
the quarter ended March 31, 2001 .
373. Defendant Barry Schuler' s public statements that AOL's internet advertising wa s
so different from traditional media that it was immune to the advertising slump, as reported by
Barron's on April 16, 2001, and Defendant Levin's statements to market analysts on April 18,
2001 that the AOL unit was the crown jewel of the merged entity, as reproduced above, are also
egregiously false and misleading . Again, not only was the Company improperly recording AOL
advertising revenue, but internal AOL information revealed that AOL was suffering from the
same weak advertising market as the rest of the industry.
374. In addition, the Form 10 -Q and Form 10-Q/A for the quarter ended March 31 ,
2001 contained a footnote reclassifying certain revenue amounts a year after they were first
reported, resulting in a decrease in "advertising, commerce and other" revenue for the quarter
ended March 31, 2000. The SEC Form 10-Q and Form 10-Q/A failed to specify the origin of
the reclassified revenue, continued to inflate AOL's advertising, commerce, and other revenue,
and the reclassified revenue amount was substantially less than the amount of the alleged
overstatement . Thus, the reclassified advertising revenue remained materially overstated, as set
forth herein at 11302-303 .
40699 .1 157 k. The Fiscal Quarter Ended June 30, 200 1
375. On June 7, 2001, Merrill Lynch Capital Markets issued an analyst report on AO L
Time Warner in which it rated the Company's common stock a "Buy ." In making the recommendation , the Merrill Lynch analyst stated: "We believe AOL continues to be the
`crown jewel ' within the group, with the COO [Defendant Parsons] giving many examples o f how the traditional business had been able to plug into the AOL growth engine (and vice- versa) ."
376. On June 20, 2001, The Wall Street Journal reported that concerns about online advertising deals made with PurchasePro led AOL Time Warner to investigate, but the
Company stated that it had accounted properly for all revenue related to PurchasePro :
America Online suspended top deal maker Eric Keller as part of an investigation into the company's involvement with PurchasePro.com Inc . Mr. Keller is a senior vice president for business affairs at America Online, a unit of New York's AOL Time Warner Inc. He runs a team of negotiators who hammer out deals such as the one with PurchasePro, a start-up business-to-business software firm that this past year agreed to pay America Online $50 million for a marketing agreement and $20 million for a software agreement . America Online owns 5 .7% of PurchasPro, Las Vegas, and is entitled to a cut of PurchasePro's software revenue . . . . An America Online spokesman said, `All revenues related to PurchasePro have been accounted for appropriately and accurately by AOL . '
(Emphasis added.)
377. On June 21, 2001, Dow Jones News Service reported that AOL Time Warner continued to advise the market that its advertising revenue was a reliable revenue source despit e the continuing decline in the advertising market:
Offering a glimmer of good news for the struggling media industry, AOL Time Warner (AOL) Chief Executive Jerry Levin said advertising revenue at the company has started to stabilize.
Earlier this week, a number of top newspaper publishers said that the state of the advertising market remains gloomy. Dow Jones & Co. (DJ), publisher of The
40699 .1 158 Wall Street Journal and this and other newswires, said the company hasn't seen any improvement in the advertising climate this month .
Knight Ridder Inc . (KRI), the U .S.'s second-largest newspaper publisher, expects advertising revenue to fall between 8% and 9% for the second quarter. Washington Post Co . (WPO) estimates its ad revenue dropped 8 .4% in the first five months of the year.
However, AOL has boasted that its diverse media properties have allowed it to sell lucrative ad packages, helping to cushion the blow of the weakened economy .
AOL closed its acquisition of Time Warner Inc. on Jan. 11 and reported its first quarter as a combined company in Ap ril. At the time, the company said it overcame softness in the advertising market to post a 10% higher quarterly advertising revenue, $2 .05 billion, in line with projections released in January .
(Emphasis added.)
378. On June 25, 2001, Lehman Brothers, Inc. issued an analyst report on AOL Time
Warner in which it rated the Company's common stock a "Buy ." In making the recommendation, the Lehman analysts noted : "While the ad market in general still remains i n flux . . . AOL continues to do deals and remains committed to strong ad/commerce revenue growth this year. We are currently forecasting $3 .4 billion in ad/commerce revenues for
America Online, up 45% over last year." (Emphasis added .)
379. In a Salomon Smith Barney report, dated June 27, 2001, the analyst stated :
Based upon our expectation that industry-wide Online advertising revenue will be down 30% in 2001 vs . 2000, AOL continues to dramatically outperform its competitors and grab market share in the near term. In particular, we note that AOL captured a 45%+ market share of online ad dollars in 1 Q01, up from 25-30% in 1 Q00, and we believe AOL will control more than half of the online advertising market in 2Q01 .
(Emphasis added.)
380. On July 18, 2001, the Individual Defendants (except for Keller who was dismissed in June 2001) caused the Company to issue a press release stating its record financia l results for the fiscal quarter ended June 30, 2001, led by 26% growth in advertising an d
40699 .1 159 commerce revenues in the AOL business segment as compared to the year ago quarter . The
press release stated :
AOL Time Warner Inc . (NYSE: AOL) today reported results for its second quarter ended June 30, 2001, posting records in total revenues, EBITDA and cash earnings per common share.
Total revenues rose 3% to $9 .2 billion, up from $8 .9 billion, on a pro forma basis, in last year's corresponding quarter, led by a 10% increase in subscription revenues to $4.1 billion . . . . Advertising and commerce revenues grew 1 % to $2 .3 billion, with America Online and Time Warner Cable posting strong increases of 26% and 19% respectively . . . .EBITDA increased 20% to $2.5 billion ; cash EPS climbed 28% to $0 .32; and Free Cash Flow climbed 55% to $519 million, excluding merger-related costs . These compare to pro forma EBITDA of $2 .1 billion, cash EPS of $0.25 and Free Cash Flow of $334 million in last year's corresponding quarter . . . .
AOL Advertising and commerce revenues reached $706 million , climbing 26% over last year's June quarter . . .
(Emphasis added .)
381 . On July 18, 2001, Dow Jones News Service reported that AOL Time Warner' s
financial results increased dramatically, due to strong growth in AOL's advertising and
commerce revenue:
In a prepared statement, chief executive Jerry Levin said, "We couldn't be more proud of what we accomplished this quarter. We achieved outstanding bottom- line results, dramatic improvement in profit margins and a huge increase in Free Cash Flow. Our record results are further proof that we are delivering on the promise of the AOL Time Warner merger."
*** America Online's revenue increased 13% to a record $2.14 billion. AOL's EBITDA improved 37% to a record $801 million on higher advertising and commerce revenue, increased operating efficiencies, and reduced network costs per hour and selling, general and administrative expenses .
Levin added, "In just six months, we've made great progress integrating the Company."
(Emphasis added .)
40699-1 160 382 . On July 18, 2001, a Dow Jones News Service article entitled, "AOL CEO: Co.
Was 2nd Largest U .S Advertiser In 2Q," reported that AOL Time Warner was increasing its
forecast of 2001 cash earnings growth by ten percent, asserting that the company could continu e
to grow advertising revenue :
"We are assuming only a slight upturn in the (advertising) market in the second half of the year " in the company's networks and publishing units, Kelly said .
Kelly said AOL was lifting its forecast of 2001 cash earnings growth to a range of 35% to 40%, compared with 2000 levels, from a range of 25% to 30%. Kelly's remarks came as the New York media and entertainment company reported second-quarter cash earnings that beat analysts' expectations, but with revenue that fell short of estimates .
One way AOL has responded to the advertising market downturn is to step up its own advertising, filling up unused ad inventory . Levin said AOL was the second- largest U .S. advertiser in the second quarter ; normally, the company is somewhere in the top 10, he said .
383. On or about August 14, 2001, the Individual Defendants (except Keller) cause d
the Company to file its SEC Form 10-Q for the Company's second quarter ended June 30, 2001 .
The Form 10-Q was signed by Defendant Kelly and contained substantially the same financial
information as the July 18, 2001 press release, including a reported 26% increase in advertising
and commerce revenue for the AOL business segment over the year ago quarter, which means
that although it was not broken out as such, the reported financial results of $2 .1 billion AOL
business segment revenue for the quarter included $706 million in AOL business segment
advertising and commerce revenue. The Form 10-Q also asserted that the "growth in [AOL]
advertising and commerce revenues was due to an overall increase in advertising . . . ." The
Form 10-Q also reported a 31 % increase in AOL business segment advertising and commerce
revenue for the year ended June 30, 2001 over the year ended June 30, 2000 . In addition, th e
40699 .1 161 Form 10-Q assured investors that the Company's financials were prepared in accordance wit h
GAAP :
The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles applicable to interim periods.
384. In fact, AOL Time Warner's reported AOL segment advertising and commerc e
revenue for the quarter ended June 30, 2001 of $706 million was overstated by at least $150 .3
million, or an overstatement of the actual advertising and commerce revenue by at least 27% .
The overstatement of at least $150 .3 million for the quarter was due to AOL Time Warner's
improper accounting for the Sun ($12 .6 million), eBay ($16 .8 million), Homestore.com ($11 .1
million), Veritas ($4 million), WorldCom ($5 .3 million), Monster.com ($6.2 million), Oxygen
Media ($19.8), PurchasePro ($9 million) and Bertelsmann ($65 .5) deals, as discussed above.
The Company has already admitted that at least $28 million for the quarter and $41 million for
the six months ended June 30, 2001, respectively, of AOL advertising and commerce revenue
was overstated based on its restatement of the quarter's results in the SEC form 8-K filed
October 23, 2002.
385 . In addition, the Form 10-Q for the quarter ended June 30, 2001 contained a
footnote reclassifying certain revenue amounts, a year after they were first reported, resulting in
a decrease in "advertising, commerce and other" revenue for the quarter ended June 30, 2000 .
The SEC Form 10-Q failed to specify the origin of the reclassified revenue, continued to inflate
AOL's advertising, commerce and other revenue, and the reclassified revenue amount was
substantially less than the amount of the alleged overstatement . Thus, the reclassified
advertising revenue remained materially overstated, as set forth herein at ¶¶ 314-315 .
40699 .1 162 1. The Fiscal Quarter Ended September 30, 200 1
386. On September 24, 2001, a Dow Jones News Service article titled, "AO L
Abandons Longstanding Financial Targets For Year" reported that AOL Time Warner, for th e
first time, acknowledged that the slowdown in the advertising market would affect its future
performance:
For more than 18 months, executives from AOL and its predecessor companies, America Online, Inc . and Time Warner Inc., had insisted the merged entity would post cash flow growth of 30% and revenue growth of more than 10% . The projections were among the proposed merger's selling points to Wall Street .
But AOL said late Monday its cash flow growth in 2001 will be in the 20% range and revenue growth between 5% and 7% . AOL cited the [September 11 terrorist] attacks and the advertising market slowdown, becoming the latest company to sound a note of caution in the wake of the attacks.
While many analysts had lowered their AOL estimates in recent weeks, some were surprised by the magnitude of the expected shortfall . . . . "These numbers are lower than what we had been projecting," said CIBC World Markets analyst John Corcoran. "The magnitude of the shortfall might surprise the Street ."
"The bottom line is - despite this tragedy and the resulting economic effects - our unique mix of assets give us confidence that we can generate strong earnings growth next year and into the future," Chairman Steve Case said in the press release.
Still, there was no disclosure of the fact that advertising revenue had already decline d
significantly at AOL, and the illegal steps AOL had taken to artificially inflate its advertising
revenue in order to mask that fact .
387.On October 17, 2001, the Individual Defendants (except Keller) caused the Compan y
to issue a press release repo rting its financial results for the qua rter ended September 30, 2001 ,
including $624 million in AOL advertising and commerce revenue, a 5% increase over the year
ago quarter.
40699.1 163 388. On November 14, 2001, the Individual Defendants (except Keller) caused the
Company to file its SEC Form 10-Q for the Company's fiscal quarter ended September 30 ,
2001 . The Form 10-Q contained substantially the same financial information as the October 17 ,
2001 press release , including advertising and commerce revenue of $624 million at the AOL unit
for the quarter, a 5% increase over the year ago quarter . The Form 10-Q also reported
advertising and commerce revenue for the AOL business segment for the nine months ended
September 30, 2001 of $2 .051 billion, a 22% increase over the nine months ended September
30, 2000.
389. In addition, the Form 10-Q assured investors that the Company financials were
prepared in accordance with GAAP:
The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles applicable to interim periods.
390. In fact, AOL Time Warner's reported AOL segment advertising and commerc e
revenue of $624 million for the quarter and $2 .1 billion for the nine months ended September
30, 2001, was overstated by at least $122 .1 million, and $486.7 million, respectively, or an
overstatement of the actual advertising and commerce revenue by at least 24% and 31 %,
respectively, as a result of AOL Time Warner's improper accounting . The overstatement of at
least $122.1 million for the quarter was due to AOL Time Warner's improper accounting for the
Sun ($12.6 million), eBay ($12 .8 million), Oxygen Media ($19 .8 million), Veritas ($4 million),
WorldCom ($5 .3 million), Homestore ($6 .6 million), Monster .com ($6.2 million), Golf Channel
($15 million) and Bertelsmann ($39 .8 million) deals, as discussed above . The overstatement of
at least $486.7 million for the nine months ended September 30, 2001 was due to AOL Tim e
40699 .1 164 Warner's improper accounting for the Sun ($37 .8 million), eBay ($46.4 million) ,
Homestore.com ($28.8 million), Oxygen Media ($39 .6 million), Veritas ($12 million) ,
Telefonica SA ($5 million), WorldCom ($15 .9 million), Gateway ($130 million), Monster.com
($18.6 million), PurchasePro ($16 million), Golf Channel ($15 million) and Bertelsman n
($121 .6 million) deals, as discussed previously.
391 . The Company has already admitted overstating $ 16 million, and $57 million o f
AOL advertising and commerce revenue for the fiscal quarter and nine months ended Septembe r
30, 2001, respectively, based on its restatement of financial results in the SEC form 8-K filed
October 23, 2002.
392. In addition, the Form 10-Q for the quarter ended September 30, 2001 contained a
footnote reclassifying certain revenue amounts, a year after they were first reported, resulting i n
a decrease in "advertising, commerce and other" revenue for the quarter ended September 30 ,
2000. The SEC Form 10-Q failed to specify the origin of the reclassified revenue and continued
to inflate AOL's advertising, commerce and other revenue, and the reclassified revenue amoun t
was substantially less than the amount of the alleged overstatement . Thus, the reclassified
advertising revenue remained mate rially overstated, as set forth herein at ¶¶ 328-329 .
M. The Fiscal Quarter and Year Ended December 31, 200 1
393 . On November 27, 2001, a Dow Jones News Service article titled, "AOL Co-COO
Backs '02 Double-Digit Cash Flow Growth View" reported that despite the economic downturn ,
AOL Time Warner was holding to its ambitious targets for the year ended December 31, 2002 :
AOL Time Warner Inc. (AOL) Co-Chief Operating Officer Bob Pittman said he's comfortable with the company's previous estimate of posting a "double-digit" cash flow growth rate in 2002 .
The media and Internet company said in late September it expected earnings before interest, taxes, depreciation and amortization, or EBITDA, to rise by a
40699 .1 165 double-digit percentage in 2002. At the same time, AOL lowered its forecasts for this year, citing the weak economy and advertising market . It expects EBITDA to rise 20% in 2001 .
"We're comfortable with the double-digit EBITDA growth" in 2002, Pittman told investors at the Credit Suisse First Boston technology conference in Scottsdale, Ariz . "We have enough control of our destiny to be comfortable ."
(Emphasis added.)
394. On January 30, 2002, the Individual Defendants (except Keller) caused the
Company to issue a press release with financial results for the fiscal quarter and year ended
December 31, 2001, which included a year-over-year increase in AOL advertising and
commerce revenue for the year of 13% to $2 .7 billion, and AOL advertising and commerce
revenue of $637 million for the quarter.
395. On or about March 25, 2002, the Individual Defendants (except Keller) caused th e
Company to file its Form 10-K for the fiscal quarter and year ended December 31, 2001 . The
Individual Defendants (except Keller) subsequently caused the Company to file a Form I0-K/A
on March 26, 2002 for the fiscal quarter and year ended December 31, 2001 . The Form 10-K
and Form 10-K/A contained substantially the same financial information as the January 30,
2002 press release, including $637 million and $2 .7 billion in AOL advertising and commerce
revenue, and $2 .2 billion and $8 .5 billion in AOL Time Warner advertising and commerce
revenue, respectively, for the fiscal quarter and year ended December 31, 2001 . The Form 10-K
and Form 10-K/A was signed by, among others, Defendants Case, Levin, Pace, Parsons and
Pittman.
396. The Form 10-K and Form 10-K/A further stated:
While advertising revenues declined overall, certain segments and businesses of AOL Time Warner experienced an increase in advertising revenues . Specifically, and as discussed in more detail below under Business Segment Results ,
40699 .1 166 advertising revenues increased at the AOL and Cable segments, and at The WB Network.
397. The Form 10-K and Form 10-K/A also incorporated, with the consent o f
Defendant Ernst & Young, the January 28, 2002 report of Ernst & Young which assure d
investors that the Company' s financials were audited in accordance with GAAS and were
prepared in compliance with GAAP :
We conducted our audit in accordance with auditing standards generally accepted in the United States . . . . We believe that our audits provide a reasonable basis for our opinion.
In our [Ernst & Young] opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of AOL Time Warner at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule and supplementary information, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein .
398. On March 27, 2002, AOL Time Warner issued its 2001 Annual Report in which
Defendants Case, Parsons and Pittman emphasized the growth in advertising revenue compared
to the previous year, noting there was "a 13% increase in AOL advertising and commerce
revenues from $2.369 billion to $2.688 billion."
399. In fact, AOL Time Warner's reported AOL segment advertising and commerc e
revenue of $637 million for the quarter and $2 .7 billion for the year ended December 31, 200 1
was overstated by at least $60 .3 million, and $547.2 million, respectively, or an overstatement
of the actual advertising and commerce revenue by at least 10% and 26%, respectively, as a
result of AOL's improper accounting . AOL Time Warner's reported advertising and commerce
revenue for the quarter and year ended December 31, 2001 was similarly overstated by at least
$60.3 million and $547.2 million, respectively, as a result of AOL Time Warner's imprope r
40699 .1 167 accounting. The overstatement of at least $60.3 million for the quarter was due to AOL Time
Warner's improper accounting for the Sun ($8.4 million), Oxygen Media ($19 .8 million),
Gateway ($3 million), Veritas ($4 million ), WorldCom ($ 11 .8 million), Homestore ($6 .6
million), Monster.com ($6.2 million) and Bertelsmann ($0.5) deals, as discussed above. The
overstatement of at least $547 .2 million for the year ended December 31, 2001 was due to AO L
Time Warner's improper accounting for the Sun ($46 .2 million), eBay ($46 .4 million),
Homestore .com ($35.4 million), Oxygen Media ($59 .4 million), PurchasePro ($16 million) ,
Gateway ($ 133 million), Veritas ($ 16 million), Telefonica SA ($5 million ), WorldCom ($27 .7
million), Monster.com ($25 million ), Golf Channel ($ 15 million) and Bertelsmann ($122 . 1
million) deals, as discussed above .
400. The Company has already admitted overstating AOL advertising and commerce
revenue for the quarter and year ended December 31, 2001 by $17 million, and $74 million,
respectively, based on its restatement of financial results in the SEC form 8-K filed October 23 ,
2002.
n. The Fiscal Ouarter Ended March 31, 200 2
401 . By March 2002, the advertising market had become so bleak, that the Compan y
was forced to acknowledge a significant impact on its AOL advertising business . Nevertheless ,
AOL secretly continued to artificially inflate its advertising revenue .
402. Indeed, on or about May 6, 2002, the Individual Defendants (except Keller )
caused the Company to file its SEC Form 10-Q for the Company's fiscal quarter ended March
31, 2002. The Form 10-Q reported $501 million in AOL advertising and commerce revenue for
the quarter ended March 31, 2002 . In addition, the Form 10-Q assured investors that the
Company's financials were prepared in accordance with GAAP :
40699.1 168 The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles applicable to interim periods.
403. In fact, AOL Time Warner's reported AOL segment advertising and commerce
revenue for the quarter ended March 31, 2002, of $501 million was overstated by $130.4
million, or an overstatement of the actual advertising and commerce revenue by at least a
stunning 35%, as a result of AOL's improper accounting, as discussed above. The $130.4
million overstatement is due to AOL Time Warner' s improper accounting for the Oxygen Medi a
($19 .8 million), Gateway ($9 million), Monster.com ($6 .2 million), Homestore ($6 .6 million),
WorldCom ($8.5 million) and Bertelsmann ($80.3 million) deals, as discussed above. The
Company has already admitted an overstatement of at least $6 million in advertising an d
commerce revenue for the quarter in the SEC Form 8-K filed October 23, 2002 .
404. The Form 10-Q for the quarter ended March 31, 2002 also stated that th e
advertising and commerce revenue for AOL Time Warner the quarter ended March 31, 200 1
was $17 million less than originally reported a year previously, but failed to identify the origi n
of the reduced revenue and whether the decrease related to AOL . The Form 10-Q again
overstated the Company's advertising and commerce revenue for the quarter ended March 31 ,
2001, as previously discussed in ¶ 372 .
o. The Fiscal Quarter Ended June 30, 200 2
405. On July 24, 2002, one day prior to the end of the Class Period, Individual
Defendants, including Defendants Pace and Parsons, held a conference call with market analyst s
after the Company issued a press release announcing the Company's financial results for the
quarter ended June 30, 2002 . The press release was issued and the conference call took place
40699.1 169 after the stock market had closed on July 24, 2002 . During the conference call, Defendant Pac e
stated that the AOL division had $412 million in advertising and commerce revenue in the
quarter ended June 30, 2002, $342 million of which was advertising revenue. Pace also stated
that the advertising and commerce backlog as of June 30, 2002 was $860 million . Also durin g
the call, Defendant Parsons stated that the SEC was conducting an investigation into th e
Company's accounting practices with respect to AOL advertising revenue in reaction to
allegations raised in articles published by The Washington Post on July 18 and 19, 2002 .
406. In fact, AOL Time Warner's reported AOL segment advertising and commerc e
revenue of $412 million and advertising revenue of $342 million for the quarter ended June 30 ,
2002, were both overstated by at least $126 million, or in comparison with actual advertisin g
and commerce revenue, by at least 44% and 58%, as a result of AOL's improper accounting.
407 . The overstatement of at least $126 million for the quarter was due to AOL Time
Warner's improper accounting for the Oxygen Media ($ 19.8 million), Homestore ($ 6.6 million),
Monster.com ($6.2 million), Bertelsmann ($84 .4 million) and Gateway ($9 million) deals, as
discussed above. Further, Pace's statement in the July 24, 2002 press release that AOL Time
Warner's AOL segment advertising revenue backlog as of June 30, 2002 was $860 million was
false because the actual backlog was overstated by at least $212.8 million, or at least 33%, due
to the improper accounting of the Homestore .com ($13 .2 million), Monster.com ($35.4 million),
Gateway ($51 million), and Bertelsmann ($113 .2 million) deals. Accordingly, notwithstanding
the extremely weak advertising market that left the Company no choice but to report decreased
advertising revenue, and acknowledgement by the Company of the SEC investigation, the
Company still artificially inflated its reported advertising revenue and backlog .
40699 .1 170 408. On July 24, 2002, AOL Time Warner stock closed at $11 .40 per share. Following
the Company's disclosure of the SEC investigation after the market closed on July 24, 2002, th e
stock fell 15.4% to close at $9 .64 per share at the end of trading on July 25, 2002.
409. Based on the foregoing, during the Class Period the Company, AOL, the
Individual Defendants and Defendant Ernst & Young, have made material misrepresentation s
and omitted material facts, in SEC filings, press releases, financial statements, and AOL Tim e
Warner's consolidated pro forma financial statements referred to above, including the Merger
Registration Statement, the Joint Proxy Statement-Prospectus, and the financial statements an d
pro forma financial statements incorporated by reference in the Merger Registration Statemen t
and Joint Proxy Statement-Prospectus as follows :
a. Materially overstated AOL and Company advertising and commerc e
revenue, AOL advertising and commerce backlog, and percentage increases of such amounts in
year over year comparisons in statements referenced above;
b. Materially overstated AOL advertising revenue in the consolidated pro
forma financial statements in the documents referenced above ;
c. Failed to disclose that AOL and AOL Time Warner had engaged in sham
transactions and improper accounting, resulting in the overstated advertising revenue an d
backlog, and percentage comparisons referenced above ;
d. Failed to disclose in the documents referenced above the true current an d
anticipated condition of AOL's advertising revenue and advertising business, both before an d
after the Merger;
e. Falsely represented in the documents referenced above that the subject
financial statements were prepared in accordance with GAAP and Article 10 of Regulation S-X ;
40699.1 171 f. Falsely represented in the documents referenced above that the audite d financial statements were audited in conformance with GAAS;
g. Falsely represented in the documents referenced above that the subjec t financial reports fairly presented the results of the companies' operations, particularly wit h respect to the advertising and commerce revenue of AOL, including the advertising and commerce revenue of the Company's AOL business segment; and
h. Falsely represented in the documents referenced above that results of th e companies' operations, particularly with respect to the advertising and commerce revenue o f
AOL, including the advertising and commerce revenue of the Company's AOL busines s segment.
410. AOL, the Company and Individual Defendant made numerous statement s described above in the companies' press releases, and otherwise to market analysts and th e media, that materially overstated AOL and Company advertising revenue and falsely represented or failed to disclose the effect on AOL and the Company of an industry-wid e deterioration of the Internet advertising market . Such statements include those of Defendant s
Case, Pittman and Kelly on October 18, 2000, to market analysts as detailed in ¶¶ 320-32 1 above. Other such false and misleading statements include, as discussed above, the following :
Kelly's statements reported by The Wall Street Journal on January 12, 2001, as set forth in ¶ 333 above ;
2. Pittman's statements as reported by The Los Angeles Times on January 13, 2001, as set forth in ¶ 335 above ;
3 . Kelly's comments to market analysts on January 31, 2001, as set forth in ¶¶ 341-342 above ;
4. Pittman's comments at the Merrill Lynch Internet Conference on March 8, 2001, as set forth in ¶ 345 above ;
40699.1 172 5 . Schuler' s comments as repo rted by Barron 's on April 16, 2001, as set forth in ¶ 358 above ;
6. Levin's statements to analysts on April 18, 2001, as set forth in ¶¶ 360-361 above;
7 . Pace' s statements to analysts on July 24, 2002, as set forth in ¶ 405 above ; and
8 . The statements of Case, Pittman, Kelly and others in the AOL and Company press releases announcing financial results throughout the Class Period, as set forth above.
411 . The longstanding and pervasive artificial inflating of AOL's advertising revenue,
including various sham deals, constituted devices, schemes or artifices to defraud investors and
the marketplace. Indeed, the systematic practices of AOL and the Company to mate rially
overstate advertising revenue operated as a fraud on the market and investors resulting in th e
purchase or acquisition of AOL and AOL Time Warner securities at artificially inflated prices.
412 . In addition, AOL's artificially inflated advertising revenue caused the value of the
Company's goodwill, created as part of the Merger, to be vastly inflated. As discussed in the
following section, the Company materially overstated the value of goodwill prior to and in
conjunction with the Merger and improperly accounted for the goodwill after the Merger,
causing it to continue to be greatly overstated .
H. The Materially False and Misleading Statements, Omissions of Material Fact and Devices, Schemes or Artifices to Defraud Regarding AOL Time Warner's Goodwill
413. AOL and AOL Time Warner created a grossly overstated goodwill value of $12 7
billion, comprised of $94 .705 billion of new goodwill and approximately $33 billion of existin g
goodwill, in connection with the Merger. The Company, AOL and Time Warner before and in
conjunction with the Merger, falsely reported the Company's goodwill created by the Merger.
After the Merger, the Company continued to falsely report its goodwill . The representations i n
40699.1 173 the Company's Merger Registration Statement, AOL's & Time Warner' s Joint Proxy
Statement-Prospectus in connection with the Merger , AOL's SEC Form 10-K filings for the
year ended June 30, 2000 and the six-month pe riod ended December 31, 2000, AOL's SEC
Form 8-K filings on February 11, 2000, April 3, 2000 and May 23, 2000 and AOL Time
Warner's SEC Form 8-K/A filings on January 26, 2001 and March 30, 2001 vastly overstated
the value of the pro forma goodwill . The post-Merger representations in Company financia l
statements continued to report a greatly inflated goodwill valuation and failed to tak e
appropriate write-downs of the goodwill as required by GAAP.
414. Goodwill is defined by APB 16 as the premium paid by one company to acquire
another when the purchase price exceeds the fair market value of the acquired company's
underlying identifiable tangible and intangible assets . Goodwill is intended to be th e
quantification of the real and actual value of the unidentifiable intangible assets of a company .
Such assets include primarily the value of a business' reputation and customer patronage an d
loyalty to be derived therefrom.
415. With respect to the pre-Merger misrepresentations, AOL incorporated by
reference in its SEC Form 10-K filed on September 22, 2000 for its fiscal year ended June 30 ,
2000, certain pro forma financial statements "which were presented to illustrate the effects o f
the Merger." Those pro forma statements reported that, as a result of the Merger, an estimate d
amount of $94 .705 billion would be allocated to goodwill due to the excess purchase price ove r
identifiable tangible and other intangible assets . The pro forma statements also estimated a
"useful life" for the goodwill of 25 years .
416. AOL's SEC Form 10-K filed on March 27, 2001 for the period July 1, 200 0
through December 31, 2000, incorporated by reference the same pro forma financial statement s
40699.1 174 which again estimated new goodwill attributable to the Merger of $94 .705 billion with a useful
life of 25 years.
417. AOL' s SEC Form 8-K filed on February 11, 2000 contained a pro form a
consolidated condensed balance sheet of AOL Time Warner at September 30, 1999 to illustrat e
the effects of the Merger as if it occurred as of that date . That balance sheet estimated new
goodwill attributable to the Merger to be $95 .842 billion, with an estimated useful life of 2 5
years.
418. AOL' s SEC Form 8-K filed on April 3, 2000 contained a pro forma consolidated
condensed balance sheet of AOL Time Warner at December 31, 1999 to illustrate the effects o f
the Merger as if it occurred as of that date . That balance sheet estimated new goodwill
attributable to the Merger to be $94 .736 million, with an estimated useful life of 25 years .
419. AOL's SEC Form 8-K filed on May 23, 2000 contained a pro forma consolidated
condensed balance sheet of AOL Time Warner at March 31, 2000 to illustrate the effects of th e
Merger as if it occurred as of that date. That balance sheet estimated new goodwill attributabl e
to the Merger to be $94.705 billion, with an estimated useful life of 25 years .
420. AOL's 8-Ks filed on April 3 , 2000 and May 23, 2000 represented that :
AOL Time Warner will periodically review the carrying value of the acquired goodwill . . . for acquired businesses to determine whether an impairment may exist. AOL Time Warner will consider relevant cash flow information, including estimated future operating results, trends and other available information, in assessing whether the carrying value of goodwill . . . can be recovered. If it is determined that the carrying value of goodwill . . . will not be recovered from the undiscounted future cash flows of acquired businesses, the carrying value of such goodwill . . . would be considered impaired and reduced by a charge to operations in the amount of the impairment.
40699 .1 175 (Emphasis added.) In addition, the Form 8-Ks represented that an "impairment charge i s measured as any deficiency in the amount of estimated undiscounted cash flows of acquired businesses available to recover the carrying value related to goodwill . . .."
421 . The Company's Merger Registration Statement which incorporated by referenc e
AOL's and Time Warner's Joint Proxy Statement-Prospectus was filed with the SEC o n
February 11, 2000, as amended on March 24, 2000, April 25, 2000, May 18, 2000 and May 19,
2000. The Merger Registration Statement and Joint Proxy Statement-Prospectus incorporate d
by reference the same pro forma financial statements "presented to illustrate the effects of th e
merger" and previously referenced in ¶ 415 .
422. On or about May 23, 2000, the Joint Proxy Statement-Prospectus was mailed b y
AOL and Time Warner, respectively, to their stockholders . The Merger Registration Statement
and Joint Proxy Statement-Prospectus represented that :
AOL Time Warner will periodically review the carrying value of the acquired goodwill for acquired businesses to determine whether an impairment may exist. AOL Time Warner will consider relevant cash flow information, including estimated future operating results, trends and other available information, in assessing whether the carrying value of goodwill can be recovered . If it is determined that the carrying value of goodwill will not be recovered from the undiscounted future cash flows of acquired businesses, the carrying value of such goodwill would be considered impaired and reduced by a charge to operations in the amount of the impairment .
(Emphasis added.) In addition, the Merger Registration Statement and Joint Proxy Statement-
Prospectus represented that an "impairment charge is measured as any deficiency in the amoun t
of estimated undiscounted cash flows of acquired businesses available to recover the carryin g
value related to goodwill."
423 . Following the Merger, on January 26, 2001, the Individual Defendants caused th e
Company to file its SEC Form 8-K/A amending its SEC Form 8-K filed January 12, 2001 . Form
40699.1 176 8-K/A included as an exhibit the consolidated balance sheet of AOL Time Warner as of
December 31, 2000, which was subsequently updated as a pro forma consolidated condensed
balance sheet in AOL Time Warner's SEC Form 8-K/A filed on March 30, 2001 and set forth the
amount allocated to goodwill as a result of the Merger .
424. The newly created $94.705 billion in goodwill was predicated upon AOL's
overstated advertising revenue, and therefore a valuation of AOL that exceeded its true fai r
market value. Indeed, as discussed in this Complaint in great detail , AOL's advertising revenue
was artificially inflated to bolster the price of AOL' s stock and to make ce rtain the Merger that
Individual Defendants desperately wanted, was consummated. Accordingly , AOL's inflated
advertising revenue essentially created "counterfeit money" with regard to the inflated value o f
AOL stock, which in turn vastly overstated the value of goodwill . Therefore, the pro forma
financial statements incorporated by reference in AOL's Form 10-Ks for the year ended June
30, 2000, and the six-month period ended December 31, 2000, AOL's SEC Form 8-K filings on
February 11, 2000, April 3, 2000 and May 23, 2000, the Company's Merger Registration
Statement, the Company's SEC Form 8-K/A filings on January 26, 2001 and March 30, 2001
and AOL's and Time Warner's Joint Proxy Statement-Prospectus, falsely represented the true
value of goodwill . The Form 10-Ks, the Form 8-K, the Form 8-K/As, the Merger Registration
Statement and the Joint Proxy Statement-Prospectus also falsely represented the useful life of
the goodwill to be an estimated 25 years . As discussed below, the real useful life for the
goodwill was, in fact at best, two years.
425 . In addition, the grossly overstated goodwill was not properly accounted for by the
Company in its financial statements for each of the fiscal 2001 quarters and the year ended
December 31, 2001, as well as the first two quarters of fiscal 2002. For the quarter ended March
40699.1 177 31, 2001 and until the quarter ended September 30, 2002, goodwill was the largest asset on AO L
Time Warner's balance sheet. Because goodwill was such a significant part of AOL Time
Warner's financial statements, comprising more than half of total reported assets, its accounting
treatment was crucial to the proper and accurate determination of AOL Time Warner's earnings
and shareholders' equity. By failing to write-down this inflated asset and thereby properly value
goodwill, Defendants materially overstated the Company's goodwill, shareholders' equity (the
Company's net worth) and net income in its financial statements for each of the fiscal quarters in
2001, the year ended December 31, 2001, and the first two quarters of 2002 .
426 . Goodwill and other intangible assets were recorded in AOL Time Warner's SE C
Form l0-Q for the quarter ended March 31, 2001 (filed with the SEC on May 15, 2001) as
$127.907 billion, which included the goodwill created by the Merger and other goodwill and
intangible assets acquired by the Company after the Merger. The Company's reported goodwill
reflected a reduction since the Merger for pro rata amortization of the goodwill over what the
Company represented to be the goodwill's useful life of 25 years. However, the Company failed
to take any write-downs of this vastly inflated asset . As a result of the inflated goodwill, the
Form 10-Q also contained a greatly overstated value of shareholders' equity in the amount of
$156.525 billion.
427. Goodwill and other intangible assets were recorded in AOL Time Warner's SE C
Form 10-Q for the quarter ended June 30, 2001 (filed with the SEC on August 14, 2001) as
$126.6 billion, reflecting a reduction since the Merger for pro rata amortization of the goodwill
over what the Company represented to be the goodwill's useful life of 25 years . However, the
Company failed to take any write-downs of this vastly inflated asset. The Company also
continued to report overstated shareholders' equity of $156 .1 billion.
40699.1 178 428. Goodwill and other intangible assets were recorded in AOL Time Warner's SEC
Form 10-Q for the quarter ended September 30, 2001 (filed with the SEC on November 14 ,
2001) as $126 .9 billion, including a reduction of the goodwill created by the Merger for pro rat a amortization of the goodwill over what the Company represented to be the goodwill's useful life of 25 years. However, the Company failed to take any write-downs of this vastly inflated asset , and accordingly also reported inflated shareholders' equity of $154 billion .
429. The Company's SEC Form 10-Q for each of the above-referenced financia l periods also stated :
The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all of the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles applicable to interim periods.
430. The Company's SEC Form 10-K for the year ended December 31, 2001, (file d with the SEC on March 25, 2002) reported goodwill and intangible assets of $128 billion, which again reflects pro rata amortization of the original $94.705 billion of goodwill over its supposed useful life of 25 years. However, no write-downs of the overvalued asset were taken and th e
Company again reported overstated shareholders' equity of $152 billion .
431 . In addition, the Form 10-K represented that the Company "periodically reviews the carrying value of acquired intangible assets, including goodwill, to determine whether an impairment may exist." The Form 10-K also stated, with Ernst & Young's consent, that the financial statements therein were prepared in compliance with GAAP and were audited by and given an unqualified opinion by Ernst & Young, who stated, "We conducted our audits in accordance with auditing standards generally accepted in the United States" (GAAS) . Ernst &
Young further stated as part of the Form 10-K: "In our opinion, [the Company's] financial
40699.1 179 statements ... present fairly, in all material respects, the consolidated financial position of AOL
Time Warner at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States."
432 . By failing to write-down the overstated goodwill in any of the fiscal 200 1 quarters, or the fiscal year ended December 31, 2001, the Company violated GAAP and thereby avoided substantially reducing the carrying value of goodwill and shareholders' equity an d reporting a huge operating loss. GAAP, as set forth in FAS No. 121, which was applicabl e during the Class Period, required that companies review long-lived assets, including goodwill, to determine whether the assets are impaired. FAS No. 121, ¶¶ 5-6 :
5 . The following are examples of events or changes in circumstances that indicate that the recoverability of the carrying amount of an asset should be assessed:
a. A significant decrease in the market value of an asset ;
b. A significant change in the extent or manner in which an asset is used or a significant physical change in an asset;
c. A significant adverse change in legal factors or in the business climate that could affect the value of an asset or an adverse action or assessment by a regulator;
d. An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset; and/or
e. A current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with an asset used for the purpose of producing revenue .
6. If the examples of events or changes in circumstances set forth in paragraph 5 are present or if other events or changes in circumstances indicate that the carrying amount of an asset that an entity expects to hold and use may not be recoverable, the entity shall estimate the future cash flows expected to result from the use of the asset and its eventua l
40699.1 180 disposition . Future cash flows are the future cash inflows expected to be generated by an asset less the future cash outflows expected to be necessary to obtain those inflows. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the asset, the entity shall recognize an impairment loss in accordance with this Statement . Otherwise, an impairment loss shall not be recognized; however, a review of depreciation policies may be appropriate.
(Footnote omitted. )
433 . Individual Defendants were aware of several factors at the time of the Merger and thereafter which established that the goodwill was materially overstated as recorded by AOL
Time Warner in the financial statements referred to above . Individual Defendants knew of the previously overstated AOL advertising revenue, which resulted in the inflated value of AOL stock and therefore a huge overstatement of goodwill when the Merger was consummated .
Individual Defendants were also aware of a material decline in the advertising market and th e increasingly dramatic decline in demand for AOL advertising, which had typically represente d
20% of the Company's revenue. The fact that large amounts of existing AOL advertisin g revenue were at significant risk was known by AOL executives at least as early as August 2000 .
Indeed, in the months preceding the consummation of the Merger, AOL's senior managemen t was advised that the company faced the risk of losing more than $140 million in advertising revenue the following calendar year .
434. Notwithstanding the material decline in the value of the previously inflate d
goodwill, AOL Time Warner and the Individual Defendants failed to take required w rite-downs
so that the Company would not report a huge loss for the fiscal periods referenced above o r
admit that the value of AOL stock was greatly overvalued as part of the Merger. Moreover, the
Company repeatedly reported to the public that the estimated useful life of the goodwill was 2 5
years, when in fact, as discussed below, it was less than two years
40699.1 181 435 . Due to the accounting improprieties related to goodwill, the Company presented its financial results and statements in a manner which violated GAAP, including the following fundamental accounting principles :
a. Interim financial reporting should be based upon the same accounting
principles and practices used to prepare annual financial statements (APB No . 28, ¶ 10);
b. Financial reporting should provide information that is useful to presen t
and potential investors and creditors and other users in making rational investment, credi t
and similar decisions (CON 1 ¶ 34);
c. Financial reporting should provide information about the economi c
resources of an enterprise, the claims to those resources, and effects of transactions ,
events and circumstances that change resources and claims to those resource s
(CON I ¶ 40) ;
d. Financial reporting should provide information about how management o f
an enterprise has discharged its stewardship responsibility to owners (stockholders) fo r
the use of enterp ri se resources entrusted to it . To the extent that management offers
securities of the enterprise to the public, it voluntarily accepts wider responsibilities fo r
accountability to prospective investors and to the public in general (CON 1 ¶ 50);
e. Financial reporting should provide information about an enterprise' s
financial performance during a period . Investors and creditors often use information
about the past to help in assessing the prospects of an enterprise . Thus, although
investment and credit decisions reflect investors' expectations about future enterprise
performance, those expectations are commonly based at least partly on evaluations of
past enterprise performance (CON 11 42);
40699.1 182 f. Financial reporting should be reliable in that it represents what it purport s
to represent. That information should be reliable as well as relevant is a notion that i s
central to accounting (CON 2 ¶¶ 58-59);
g. Completeness, which means that nothing is left out of the information that
may be necessary to insure that it validly represents underlying events and condition s
(CON 2 ¶ 79); and
h. Conservatism be used as a prudent reaction to uncertainty to try to ensur e
that uncertainties and risks inherent in business situations are adequately considered . The
best way to avoid injury to investors is to try to ensure that what is reported represent s
what it purpo rts to represent (CON 2 1195, 97) .
436. The SEC' s former Chief Accountant , Lynn Turner, remarked in a May 18, 200 1 speech that " . . . the staff wants to be very clear that if events occurring subsequent to the acquisition result in impairment . . . an impairment charge should be recorded in the appropriate period." (Emphasis added.) Clearly, the Company's knowledge of the gross overstatement of value both prior and subsequent to consummation of the Merger, as well as deteriorating market conditions and Company performance, should have caused it to evaluate and write down the goodwill in the quarter ended March 31, 2001, and continue to do so in subsequent quarters to reflect the real value of goodwill .
437. Further, the undisclosed adverse information concealed by Defendants during th e
Class Period is the type of information which, because of SEC regulations, regulations of the national stock exchanges and customary business practice, is expected by investors and securities analysts to be disclosed and is known by corporate officials and their legal and financial advisors to be the type of information which is expected to be and must be disclosed .
40699.1 183 438 . On August 14, 2001, the Company's SEC Form 10-Q for the quarter ended Jun e
30, 2001 described changes in accounting standards for goodwill :
[t]hese standards change the accounting for business combinations by . . . prohibiting the prospective use of pooling-of-interests accounting and requiring companies to stop amortizing goodwill and certain intangible assets with an indefinite useful life created by business combinations accounted for using the purchase method of accounting. Instead, goodwill and intangible assets deemed to have an indefinite useful life will be subject to an annual review for impairment. The new standards generally will be effective for AOL Time Warner in the first quarter of 2002 and for purchase business combinations consummated after June 30, 2001 . AOL Time Warner is in the process of quantifying the anticipated impact of adopting the provisions of FAS 142, which is deemed to be significant.
Upon adoption, AOL Time Warner will stop amortizing goodwill, including goodwill in the carrying value of certain investments accounted for under the equity method of accounting . Based on the current levels of goodwill, this would reduce amortization expense and, with respect to equity investees, it would reduce other expense, net, by approximately $5 .3 billion and $600 million, respectively. Because goodwill amortization is nondeductible for tax purposes, the impact of stopping goodwill amortization included in the carrying value of equity investees would be to increase AOL Time Warner's annual net income b y approximately $5.9 billion. In addition, AOL Time Warner is in the process of evaluating certain intangible assets to determine whether they are deemed to have an indefinite useful life. As a result of this process, AOL Time Warner may stop amortizing an additional $25 billion to $40 billion of intangible assets . This could result in an additional reduction of pretax amortization of approximately $1 .0 billion to $1 .5 billion, which will have a corresponding after-tax increase in AOL Time Warner's net income of $600 to $900 million .
(Emphasis added .)
439. AOL Time Warner's representation that earnings would increase under the "new" accounting requirements for goodwill, FAS 142, by the amount of $5.9 billion was materially misleading and omitted mate rial facts because AOL Time Warner was well aware that the goodwill figure was grossly overstated. The goodwill should have been adjusted due to its impairment before 2002, thereby greatly reducing the "plug figure" of goodwill that was far i n excess of the goodwill's true value . The required "impairment" test would have instantl y
40699 .1 184 revealed that an impairment loss had occurred which required reporting in the first quarter o f
2001 and in the succeeding quarters to reflect the overvaluation of goodwill .
440. On January 7, 2002, Business Wire reported:
Effective January 1, 2002, all calendar year companies will be required to adopt the new accounting standard "Goodwill and Other Intangible Assets" ("FAS 142"). FAS 142 eliminates amortization of goodwill and other intangible assets with indefinite lives, which is expected to reduce AOL Time Warner's annual amortization by over $7 billion.
FAS 142 provides new measurement techniques for goodwill and other intangible assets resulting from business combinations . While its revaluation has not been completed, the Company said it expects to record a one-time, non-cash charge in its income statement for the first quarter of 2002 in the $40-$60 billion range to reflect overall market declines since the AOL Time Warner merger was announced in January of 2000. This charge will reflect the cumulative effect of adopting the accounting change and does not affect the Company's operations .
(Emphasis added.)
441 . In the Company's 2001 SEC Form 10-K, for the year ended December 31, 2001 ,
the Company stated that it would be implementing FAS 142, which superseded FAS 121, in th e
first quarter of 2002 . FAS 142 requires an annual test for impairment in addition to inte rim tests
similar to FAS 121 . AOL Time Warner stated :
As a result of this initial review for impairment, AOL Time Warner expects to record a one-time, noncash charge of approximately $54 billion upon adoption of the new accounting standard in the first quarter of 2002 . Such charge is non- operational in nature and will be reflected as a cumulative effect of an accounting change.
(Emphasis added.)
442. Under GAAP, AOL Time Warner could not wait until the first quarter of 2002 to
record any impairment of goodwill. In so doing, it improperly took advantage of a prospective
change in accounting principles under FAS 142 to avoid a charge against operating income .
Under the prior accounting directive (FAS 121) that, as discussed above, should have been
40699.1 185 applied to the Company's financial statements for the fiscal quarters and the year ende d
December 31, 2001, the impairment would have been charged to operating income .
443 . The first impairment was ultimately reported in the Company's March 31, 200 2
SEC Form 10-Q (filed on May 6, 2002) when AOL Time Warner announced, as reported by th e media, "the largest write-down in histo ry." This write-down reduced the Company ' s value by
$54 billion in a massive charge against assets in its 2002 first quarter financial report, and left a substantial remaining goodwill amount repo rted by the Company in the Form 10-Q. The
Company represented in the Form 10-Q that the write-down of goodwill "is reflected as a cumulative effect of an accounting change. . . ."
444. The impairment, however, was neither caused by nor the result of ne w accounting regulations because the "old" accounting standard clearly required the same action , but at an earlier date. By ignoring the application of FAS 121 (the "old" accounting directive) ,
AOL Time Warner did not acknowledge the immediate issue that the deal was improperl y valued at the Merger date due to the artificially inflated advertising revenue, and thus th e purchase price was improperly calculated and recorded .
445 . The Company's write-down of goodwill in the first quarter of 2002 wa s insufficient, resulting in a continued overstatement of goodwill value . Indeed, the Company' s
SEC Form 10-Q for the quarter ended March 31, 2002 wrote down goodwill in the amount o f
$54 billion, reducing outstanding goodwill to a reported $80 .178 billion. The Form 10-Q als o stated:
The accompanying consolidated financial statements are unaudited but, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the financial position and the results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles applicable to interim periods.
40699.1 186 446 . On July 24, 2002, the Individual Defendants (except Keller and Pittman) cause d the Company to issue a press release announcing its financial results for the quarter ended Jun e
30, 2002, which did not include a write-down of goodwill.
447. As discussed above, the pro forma financial statements included as part of AOL' s
SEC Form 10-Ks for the year ended June 30, 2000, and the six month period ended Decembe r
31, 2000, AOL Time Warner's SEC Form 8-KIA filings on January 26, 2001 and March 30 ,
2001, the Company's Merger Registration Statement and AOL's and Time Warner's Join t
Proxy Statement-Prospectus were materially false and misleading and omitted material facts
because:
a. The pro forma financial statements materially overstated the real fair market value of goodwill ;
b. The pro forma financial statements failed to disclose that the goodwill was overvalued; and
c. The useful life of the goodwill created by the Merger was far less than the 25 years represented in the pro forma financial statements.
448. Similarly, the Company's financial statements for the quarters ended March 31 ,
2001, June 30, 2001 and September 30, 2001, and the year ended December 31, 2001, and fo r the first fiscal quarter of 2002, as well as the Company's July 24, 2002 press release announcing the Company's 2002 second quarter financial results, were materially false and misleadin g and/or omitted material facts because :
a. The failure to write-down or sufficiently write-down the goodwill, as discussed above, materially overstated the goodwill of the Company and its shareholders' equity ;
b. The financial statements and July 24, 2002 press release failed to disclose that the goodwill was materially overstated;
40699 .1 187 c. The financial statements did not comply with GAAP or fairly present the goodwill of the Company;
d. The Company's Form 10-K for the year ended December 31, 2001 was not audited in conformity with GAAS;
e. If the Company had properly written down the goodwill, it would have reported a huge operating loss, rather than the much smaller reported losses, for at least one of the fiscal 2001 quarters as well as for the entire 2001 fiscal year ;
f. If the Company had properly written down goodwill in 2002, it would have reported a bigger net loss for the quarter ended March 30, 2002, and when it failed to do so, it would have reported a huge loss for the second quarter of 2002 ;
g. The useful life of the goodwill created by the Merger was far less than 25 years;
h. The Company's announcement that earnings would increase by $5 .9 billion in 2002 following the effective date of SFAS 142 was misleading because the goodwill should have been written down in 2001 based on SFAS 121 ; and
i. The Company's representation that SFAS 142 caused the impairment in the value of outstanding goodwill was false because the prior accounting standard, FAS 121, required the same action, but at an earlier time .
449. The gross overstatement of the true value of goodwill created by the Merger an d
failure to properly account for the goodwill also constitutes a device, scheme or artifice t o
defraud the public. Indeed, the overstated goodwill masked the real value of AOL stock and the
Company.
I. Defendants' Course of Conduct Is Revealed
450. The conduct described above, which caused the true value of the Company' s
goodwill and its useful life to be vastly overstated and also includes a devices, schemes o r
artifices to defraud. Indeed, the grossly inflated goodwill and its useful life masked AOL' s
inflated advertising revenue and the real value of AOL stock .
40699.1 188 451 . On July 18, 2002, The Washington Post published the first of two articles, based
on statements of former Company employees and confidential documents, which reporte d
allegations that the Company and AOL artificially inflated AOL' s advertising revenue, enabling
Defendants to report to the public materially false advertising revenue . The article reported tha t
the Company denied the allegations and quoted from a lawyer retained by the Company :
The accounting for all these transactions is appropriate and in accordance with generally accepted accounting principles. . .. The disclosures in AOL' s financial statements are appropriate and accurate . AOL's statements provide our investors with all appropriate material information about our business .
(Emphasis added.) The article quoted Defendant Ernst & Young as stating that it "stands by it s
original view that the accounting and disclosures were appropriate ."
452. Within hours of the publication of The Washington Post article, Defendant
Pittman abruptly resigned from the Company.
453 . The second of The Washington Post articles regarding the fraud, published the
next day, July 19, 2002, further detailed allegations of prior improper reporting of AO L
advertising revenues .
454. On July 24, 2002, the Company acknowledged that the SEC was investigating it s
accounting practices in connection with AOL' s advertising revenue . As The Washington Post
reported on July 25, 2002:
AOL Time Warner Inc. disclosed yesterday that the Securities and Exchange Commission has launched a probe into its accounting practices after questions were raised about how the company generated revenue through a series of unconventional deals.
The world's largest media company said that its accounting was proper and that all the transactions were approved by its outside auditor . But its chief executive and chief financial officer vowed to give investors a better understanding of the business, beginning yesterday with more detailed disclosures about its online division, including its advertising and commerce revenue, as part of AOL Time Warner's announcement of second-quarter financial results .
40699.1 189 *** Pace said he is comfortable with the company's accounting and disclosure practices, but he said he wants AOL Time Warner to be "on the leading edge" of disclosures .
(Emphasis added. )
455. On July 25, 2002, the San Jose Mercury News also reported on the Company' s
disclosure that the SEC was looking into the Company' s accounting practices. The Company' s
Chief Executive Officer, Defendant Parsons, was quoted in the article as stating "In the current
environment, any such allegations will necessarily and appropriately draw inquiry from th e
appropriate regulatory authorities even where, as here, they are without merit ."
456. On July 25, 2002, after AOL Time Warner disclosed that the SEC had launched a
civil investigation into its accounting practices, several Wall Street analysts immediatel y
downgraded the Company's stock.
457 . Only after the existence of the SEC investigation regarding the imprope r
recognition of AOL advertising revenue was revealed by the Company did Defendants'
improper conduct and its effect become clear to the marketplace. After the Company
acknowledged the SEC investigation, AOL Time Warner shares declined by 15 .4% to close at
$9.64. Thus, AOL Time Warner common stock had plummeted in value by more than 77%
from its trading price of AOL common stock at the beginning of the Class Period ($41 .38) to the
Company's trading price at the end of the Class Period ($9 .64), as adjusted for stock splits and
the Merger. The value of AOL Time Warner stock from when it first started trading until the
end of the Class Period decreased by 79 .9%.
458. On July 31, 2002, the Company confirmed that the DOJ had opened a criminal
investigation into the Company's accounting practices .
40699.1 190 459. On or about August 9, 2002, the Company fired Defendant Colburn, the President
of AOL' s Business Affairs division, who had reported directly to Defendant Pittman .
460. On August 14, 2002, the Individual Defendants (except Keller, Pittman, an d
Colburn) caused the Company to issue a press release announcing the Company's certification
of its Annual Report on Form 10-K for 2001 and all reports on Form 10-Q, all reports on For m
8-K, all proxy materials and all amendments to the foregoing filed with the SEC subsequent to
the filing of its Form 10-K for 2001 . In that release, the Company noted that it had disclosed i n
its SEC Form 10-Q for the second quarter 2002, which was filed with the SEC on August 14,
2002, that based on information it claims to have learned in the previous 10 days:
the Company had identified three transactions involving its AOL unit with respect to which the Company may conclude, after further investigation, that consideration received by AOL from third parties may have been inappropriately recognized as advertising and commerce revenues . The advertising and commerce revenues recognized in connection with these three transactions totaled approximately $49 million occurring over a period of six quarters.
In the 10-Q filing, the Company noted that it may be necessary to restate the results of prio r fiscal periods.
461 . On October 23, 2002, AOL Time Warner publicly stated that its previousl y
announced financial results for each of the quarters ended September 30, 2000 through June 30,
2002 were incorrect and had to be restated . For the AOL division, the impact of the adjustments
reduced advertising and commerce revenue by $168 million dollars over the eight quarterly
periods. The remaining $22 million dollars represented a reduction in revenues related to AO L
in which the advertising was delivered by other AOL Time Warner divisions . The Compan y
also announced that the review of accounting for advertising transactions was continuing.
462. On January 12, 2003, at the AOL Time Warner annual shareholder meeting ,
Chairman Case announced that he would step down in May, 2003 .
40699 .1 191 463 . On January 20, 2003, The Wall Street Journal reported :
Veritas Software Corp., Mountain View, Calif., said it will restate some financial results to reflect changes in the accounting for two AOL Time Warner Inc. transactions, which the Secu rities and Exchange Commission is reviewing . Regulators are looking at whether AOL's America Online Internet business and Veritas had entered into transactions in which they bought products from each other for legitimate business purposes or whether the deals were simply designed to inflate revenue on both sides .
(Emphasis added.)
464. On January 30, 2003, The Wall Street Journal reported:
In an astonishing end to a disastrous year, AOL Time Warner Inc . reported a 2002 net loss of $98.7 billion after taking a fourth-quarter charge of $45 .5 billion, mostly to write down the value of its troubled America Online unit . The write-down, creating the biggest annual corporate loss in history, was more than twice what Wall Street had anticipated . AOL also announced the resignation of Ted Turner as vice chairman .
(Emphasis added.)
465 . On February 5, 2003, The Wall Street Journal reported:
In an indication that federal authorities are expanding their criminal investigation of AOL Time Warner Inc .' s America Online unit, the Federal Bureau of Investigation has sought to question several former PurchasePro .com Inc. officers in the past few weeks.
. . .People familiar with the situation said the Department of Justice and the Securities and Exchange Commission are focusing on America Online and some of its former executives, including Eric Keller and David M . Colburn . These people said the investigation, which was launched last summer, is continuing and prosecutors are expected to decide whether to bring charges later this year . Simultaneously, federal prosecutors in Los Angeles are probing America Online's relationship with Homestore Inc . Several former Homestore officials have pleaded guilty to fraud and are cooperating with prosecutors .
AOL declined to comment .
(Emphasis added. )
466. On March 12, 2003, The Washington Post reported:
40699.1 192 The federal investigation of America Online, Inc . and two of its former key executives has been broadened to include alleged "aiding and abetting" of schemes by other companies to artificially inflate reported revenue , sources familiar with the probe said yesterday.
Federal investigators are scrutinizing the roles that AOL and two dealmakers, David M. Colburn and Eric Keller, may have in enabling certain companies, including Homestore Inc., an online real estate firm to improperly pump up financial results. At the core of the investigation, sources said, Securities and Exchange Commission investigators are examining alleged quid pro quo schemes in which AOL and other companies exchanged cash through sham transactions to falsely boost revenue, both before and after America Online's merger with Time Warner Inc. in January 2001 .
The expansion of the probe increases the potential exposure of AOL Time Warner Inc. and the individuals involved, because they could be found culpable not only for the firm's own accounting irregularities but also for the financial misconduct of others, sources said .
AOL Time Warner has been cooperating extensively with investigators in the hope that the company can avoid criminal charges . Still, insiders expect the media giant to face civil s anctions from the SEC.
***
Investors in Homestore named AOL, Colburn and Keller as defendants in a lawsuit filed last year in California, alleging that the company and its executives made it easier for Homestore to falsify financial results. Last week, a federal judge said she was reluctantly removing the AOL defendants from the case, citing a Supreme Court decision that limits the ability of private parties to seek damages from those who aid wrongdoing rather than perpetrating it themselves .
At the same time, U.S. District Judge Marsha J . Pechman lashed out at AOL. She noted that the SEC has the explicit legal authority to bring charges of "aiding and abetting" wrongdoing. "The acts alleged . . . . which this Court must accept as true for purposes of this motion, describe a massive conspiracy driven by pure avarice," Pechman wrote in her 41-page opinion.
While dropping the AOL defendants from the Homestore suit, Pechman said they remain in the cross hairs of a federal probe .
"This decision does not mean that the wrongs of these aiders and abettors will necessarily go unchecked ; the [law] expressly granted the SEC the authority t o
40699.1 193 bring civil actions against aiders and abettors of securities fraud, and it is this Court's understanding that some investigation is ongoing," she wrote.
(Emphasis added. )
467. On March 28, 2003, the Company reported that it might have to restate a s
much as an additional $400 million in AOL advertising revenue as a result of
transactions with Bertelsmann AG that were part of the SEC's investigation . At the
same time, the Company acknowledged that further restatement may be necessary with
respect to other transactions being investigated by the SEC and DOJ .
468. On April 1, 2003, Reuters reported that Gateway "would delay filing its
2002 annual report by up to 15 days because of plans to restate 2000 and 2001 revenu e
and costs of goods sold as it reviews transactions with AOL."
J. Scienter of The Individual Defendant s
469. The history of AOL is that they have pushed the envelope ever since Steve Case has been running the Company . The first time I wrote about AOL accounting was back in 1996 and then they were fessing up to playing accounting games in the years before that . They were hiding expenses just like WorldCom so that they could look profitable. They came clean, they straightened things out, Steve Case gave a speech back then in which he promised gold standard accounting. Three months later, he had to restate earnings again . There's a long history of this .
Jerry Knight, The Washington Post financial reporter, guest on CNBC television program Kudlow & Cramer, Jan . 21, 2003.
1. The Individual Defendants Knew, or Recklessly Disregarded , that AOL and AOL Time Warner Were Engaged in Fraud and Were Motivated to Use and Cover Up the Use of Improper Accounting and Sham Transactions to Artificially Inflate Advertising Revenue
470. As alleged herein, the Individual Defendants acted with scienter in that the y
knew, or recklessly disregarded, that the public documents and statements issued o r
disseminated in the name of AOL and AOL Time Warner were materially false and misleading
40699.1 194 and omitted material facts ; were aware that such statements or documents would be issued o r
disseminated to the investing public ; and knowingly, or recklessly, participated or acquiesced i n
the sham transactions and improper accounting practices which led to the issuance o r
dissemination of such statements or documents .
471 . The Individual Defendants as a group, and separately, either knew, or recklessl y
disregarded, the false and misleading statements or material omissions referred to above. The
types of accounting fraud engaged in during the Class Period were similar to earlier activity
engaged in by AOL. Notwithstanding prior SEC actions against AOL, AOL and AOL Time
Warner maintained a culture of arrogance and greed geared solely toward maximizing reported
advertising revenue of AOL, inflating the value of AOL and the Company's securities, and
ensuring the consummation of the Merger . In addition, the Individual Defendants had both
motive and opportunity to engage in the fraudulent activities Plaintiff alleges .
a. The Individual Defendants Were Actively Engaged in the Company's Daily Activities Such That They Were Aware Of, Recklessly Disregarded, Controlled and/or Culpably Participated in the Fraudulent Activities of the Business Affairs Division
472. The organizational structures at AOL and AOL Time Warner were such that the
companies' improper dealmaking and accounting practices, as well as the downturn in AOL' s
advertising business, were known, or were recklessly disregarded, at the highest levels o f
AOL-including Stephen Case, its Chairman .
473 . As a founder of AOL, its Chairman and Chief Executive Officer, and Chairman o f
AOL Time Warner, Case had access to all significant corporate information possessed by the
two companies. In addition, all of the key participants in the transactions at issue reported eithe r
directly or indirectly to Case . According to a former Senior Manager in AOL's Interactive
40699.1 195 Marketing division, David M . Colburn, Robert Pittman, and Myer Berlow all reported directl y
to Case at AOL.
474. According to a former AOL Vice President for business development, AOL's
"Operating Committee" or "Op Com", consisting of nine top members of senior managemen t
chaired by Pittman, held weekly meetings to discuss matters of importance to the company . As
a result of these weekly meetings, the Operating Committee knew about the "BA Specials", the
restructuring of advertising deals for failing dot-coms, and the downturn in AOL's advertising
business. Members of the Operating Committee during 2000-2001 included, among others,
Defendants Pittman, Colburn, J . Michael Kelly, Berlow, and Barry Schuler . Case had the
authority to sit in on the Operating Committee's meetings .
475. As President and Chief Operating Officer of AOL and Co-Chief Operatin g
Officer of AOL Time Warner, Robert Pittman was privy to all significant financial an d
operational information at the two companies . According to an Advertising Age article dated
May 7, 2001 entitled, "Crunchtime ; Bob Pittman is Promising the World . AOL Time Warner
Better Deliver," Pittman was deeply involved with AOL's and the Company's advertising
business. He admitted to being the "Account Executive" on the biggest accounts and to fielding
client calls at home after hours . In addition, Pittman was one of Colburn's primary mentors,
promoting Colburn several times . According to The New York Times, Pittman promoted
Colburn to the head of the Business Affairs unit at AOL and at AOL Time Warner an d
personally worked to support Colburn's efforts to push through the combined Company's majo r
advertising deals, including the agreement to sell advertising from both the AOL division an d
Time Warner to WorldCom.
40699 .1 196 476. According to The Washington Post, David M. Colburn, who ran the Business
Affairs division, reported to Pittman, who reported directly to Case . In addition, Colburn i s
reported to have been particularly close to Pittman . Colburn was heavily involved in all of th e
transactions at issue in this Complaint-he reviewed and signed off on all deals . In addition to
his hands-on involvement with the subject deals, according to numerous witnesses and pres s
accounts, Colburn was also a major force in instilling the culture of greed and arrogance tha t
drove others within the companies to make sham deals or to take steps to engage in and cover
up the improper accounting used in connection with the deals .
477. J. Michael Kelly served as Executive Vice President and Chief Financial Officer
for AOL Time Warner and Senior Vice President and Chief Financial Officer for AOL . Kelly
joined AOL in June 1998, and as its Chief Financial Officer, was the executive most directly
responsible for the accuracy of the Company' s accounting. According to AOL Time Warner
executives, as reported in The New York Times article dated September 1, 2002 entitled "Ouste r
at AOL, but Where Does Trail End?," it was Colburn's job to try and do everything possible to
post strong results , and Kelly's job to stop him at the limits of accounting rules . As Chief
Financial Officer, Kelly signed off on all of AOL and AOL Time Warner' s major advertising
deals and its financial reports until December 2001, when he was demoted to Chief Operatin g
Officer of the AOL division.
478. According to press accounts, Myer Berlow was part of Pittman ' s inner circle, the
so-called "Friends of Bob" group . Berlow, as head of Interactive Marketing was responsible fo r
advertising sales and worked in tandem with Colburn and his Business Affairs division. On
October 30, 2000 The Industry Standard in an article entitled , "AOL's Rough Riders," reported
that it is "[t]he salesperson's job is to strap someone down to a chair, while someone in busines s
40699.1 197 affairs [Colburn' s group] beats the hell out of them ." At AOL, Berlow was Vice President for
National Accounts at AOL. Later, he became President of AOL's Worldwide Interactive
Marketing Division in the Business Affairs division . In August 2001, Berlow became Presiden t
of the Global Marketing Solutions Group under the direction of AOL Time Warner's
Advertising Counsel Body.
479. Upon the Merger, Barry Schuler became Chairman and Chief Executive Office r
of the AOL subsidiary of the Company. As the head of the AOL subsidiary, Schuler knew of o r
recklessly disregarded the accounting improprieties at the Company. Prior to the Merger he
served as President of Interactive Services at AOL since 1998 .
480. Every advertising deal was reviewed and signed off by Colburn. A former
account manager in the account services unit of AOL's Interactive Marketing division stated
that for big advertising deals, Berlow, Schuler or Pittman also signed off . According to the
former employee, the bigger the deal the more significant the list of people signing off on th e
deal. In an Advertising Age article dated May 7, 2001, Pittman noted, with regard to cross-
media advertising deals: "We generally do these issues at the COO or CEO level within the
Company."
481 . Eric Keller, a Senior Vice President in the Business Affairs Division an d
purported number two dealmaker to his boss Colburn, was deeply involved in the creation an d
execution of the Company's advertising transactions, including the Homestore and PurchasePr o
stock warrant deals .
482. Joseph Ripp, as Executive Vice President and Chief Financial Officer of AOL
Inc. (the online subsidiary of AOL Time Warner), had access to and was involved with financial
matters relevant to the transactions . In August 2001, Ripp along with Steven Rinder, a Senior
40699 .1 198 Vice President in AOL' s Business Affairs and Development division, took over handling th e
sham transactions with Homestore on behalf of the Company .
483 . Within Business Affairs, Keller and Rinder, as Vice Presidents, reported directly
to Colburn who signed off on all deals emanating from that division .
484. Since November 2001 Wayne Pace has served as Executive Vice President an d
Chief Financial Officer of AOL Time Warner. In this capacity, he played a pivotal role in
driving value creation across AOL Time Warner and has overseen all of the Company's financ e
functions, including tax, financial planning, mergers and acquisitions, treasury, accounting an d
capital allocation. He has made numerous statements regarding the strength of the Company' s
advertising revenue despite knowledge that such revenue was mate rially overstated. As Kelly' s
successor, Pace took on Kelly's responsibilities and involvement in the Company .
485 . Upon the Merger Date, Novack became Vice Chairman of the Company . As a
member of the Office of the Chairman, he provided strategic counsel and handled specia l
assignments for the Chairman, and assumed a leading role in major corporate transactions-
including taking a leading role in AOL's joint venture with Bertelsmann . Formerly the Vice
Chairman of AOL and a Director, Novack played a number of critical roles at that company. In
addition to broad strategic responsibilities, he oversaw AOL's Legal Department, as well as
AOL Investments, and was a key architect of the Merger between AOL and Time Warner. Prior
to joining AOL, Novack was outside counsel to the company.
486. Gerald Levin, as Chairman and Chief Executive Officer of Time Warner an d
Chief Executive Officer of AOL Time Warner, had access to any and all corporate information
possessed by the two companies . Levin was one of the primary driving forces behind th e
Merger. After the Merger, Levin made numerous misrepresentations regarding the Company' s
40699.1 199 financial prospects and overruled internal efforts to disclose the true nature of the Company' s
advertising revenues.
487. Richard Parsons was a Director and President of Time Warner and a Director ,
Chief Executive Officer and Co-Chief Operating Officer of AOL Time Warner . In that role, he
was privy to all information regarding the Company's operations including the Business Affairs
division. Despite having this access to the truth, Parsons made misrepresentations denying th e
accounting improprieties at the Company .
488. As set out in detail below, the Individual Defendants were aware that AOL
advertising revenue was artificially inflated through sham transactions and improper accountin g
and that the advertising market was in a major downturn through regular company report s
tracking such revenue and several whistleblowers communicating such issues to senio r
management .
489 . The Individual Defendants were insiders who were engaged in active daily role s
at the companies and were involved with or were aware of the relevant transactions at issue i n
this Complaint . Through their collective efforts, the companies issued public filings, pres s
releases, and other group-published information containing false and misleading information .
490. Even in cases where Defendants were not personally engaged in suc h
transactions, they knew, individually or as a group, of the existence of improper accounting an d
either approved of it or failed to act to prevent it despite their ability to control the actions of th e
key dealmakers.
491 . As set forth elsewhere herein in detail, the Individual Defendants, by virtue o f
their receipt of information reflecting the true facts regarding AOL and AOL Time Warner, their
control over, and/or receipt and/or modification of AOL's and AOL Time Warner's allegedly
40699.1 200 materially misleading misstatements and/or their associations with the AOL and AOL Tim e
Warner which made them privy to confidential proprietary information concerning AOL and
AOL Time Warner, participated in the fraudulent conduct alleged herein .
b. The Nature of the Accounting Improprieties and Sham Transaction s
492. Many of the subject transactions involved actions that demonstrate intentiona l
misconduct as the actions had no legitimate business purpose in AOL and AOL Time Warner's
business other than to hide the true nature of the transactions so that advertising revenue coul d
be artificially inflated . For example, in the fraudulent Homestore deals, Defendants set up
sixteen separate sham transactions in which the two companies generated bogus advertisin g
revenue through the use of three-legged "round-trip" deals involving third parties . As part o f
the deals Defendants agreed with Homestore executives not to document the secret leg of th e
sham transaction in order to avoid their detection .
493 . As set out more completely above, Keller was the architect of sixteen separat e
sham transactions with Homestore-all approved by Colburn-in which the two companie s
generated bogus advertising revenue through the use of three-legged "round trip" deal s
involving third parties. Once the deals were in effect, Keller worked with Homestore's to p
dealmaker, Peter Tafeen, in May 2001 to avoid detection by Homestore's auditing firm of th e
sham deals that were to take place in the second quarter 2001 . Keller and Colburn also agreed
with Homestore executives not to document the secret leg of the sham transaction in order t o
avoid detection. In addition, Keller was directly involved in the fraudulent Homestore-Hous e
and Home Deal in 2000.
494. With the end of the 2001 second quarter rapidly approaching, Ripp and Rinde r
participated in a conference call with Homestore CEO Stuart Wolff on June 29, 2001 and agree d
40699.1 201 to carry on with the sham transactions despite their knowledge that the deals were corrupt . By
doing so, they were able to allow AOL Time Warner to inflate advertising revenue and avoid
negative publicity for both AOL Time Warner and Homestore, in which AOL Time Warner had
a significant equity interest.
495. Similarly, Defendants' activities with regard to the PurchasePro warrants deal did
not serve any legitimate business purpose and shows intentional misconduct . That deal, which
according to The Washington Post was referred to as "science fiction" by Colburn, involved a
purported revision of the terms of AOL's equity interest in PurchasePro , and AOL and the
Company fraudulently accounted for the transaction by repo rting $27 .5 million in advertising
revenue.
496. Keller was involved with the PurchasePro transaction in which AOL receive d
PurchasePro stock warrants in exchange for distributing PurchasePro software . According to
Charles E . Johnson, Jr ., PurchasePro's CEO as reported by The Washington Post on July 19,
2002, "[t]he warrants had nothing to do with ad revenue. They were directly related to selling
our marketplace software to our customers, suppliers and partners ."
497. Other types of fraudulently accounted for deals involved "round-tripping" ,
"jackpotting", conversion of settlement proceeds into advertising revenue, improperly booking
revenue in cases where AOL acted as an advertising broker, converting contract termination
fees from failing dot-corns into advertising revenue, and double-booking of advertising revenue
obtained in cross-platform deals .
498 . In a classic "round-trip" transaction negotiated in 2000, AOL paid Veritas $5 0 million for $30 million in software . Veritas, in turn, used the excess money paid by AOL to purchase $20 million in AOL advertising . The Gateway deal also involved "round-tripping ."
40699.1 202 Both Gateway and Veritas have since restated their revenues based on the improper accountin g
involved in their transactions with AOL demonstrating the fraudulent nature of the deals .
499. By its "jackpotting" practices, AOL would run inordinate, and wholly ineffective ,
amounts of advertising in the final few days before a quarter ended so that it could meet th e
number of advertising impressions required to realize all of the advertising revenue in tha t
quarter. Such behavior, which made no sense from an advertising or business standpoint, wa s
only done to commit fraud and produce improperly inflated advertising revenue .
c. Whistleblowers Provide Further Evidence of Individual Defendants' Knowledg e
500. Several AOL and AOL Time Warner whistleblowers raised concerns with upper
management, including Pittman, about the propriety of the accounting methods being engage d
in by the Company with regard to advertising revenue only to be dismissed for their efforts .
Some of these concerns were raised and summarily dismissed during the pendency of th e
Merger that the Individual Defendants so badly wanted to be effectuated . The Individual
Defendants, particularly Case, Pittman, Kelly, Pace and Levin, in company press releases ,
continued to misrepresent to investors critical information relating to advertising revenue wit h
full knowledge that investors were relying heavily on such information .
501 . Numerous employees questioned the improper recognition of the advertising
revenue alleged herein, raising the matter with senior management . According to the July 18 ,
2002 Washington Post article entitled "Unconventional Transactions Boosted Sales : Amid Bi g
Merger, Company Resisted Dot-Com Collapse" Robert O'Connor outlined his concerns in a
series of meetings in 2001 and 2002 with Pittman, Colburn, Kelly and other AOL executives .
According to O'Connor, "Clearly, a lot of what they were living on was revenue that was not o f
the highest quality. I don't know if they're still in denial, but there was some pretty big business
40699.1 203 issues they were not willing to face . For nine months I tried to get these guys out of denial. I
tried to take the perfume off the pig ." O'Connor also told Company officials at some point that
he was concerned that AOL's accounting practices might lead to another SEC investigation .
502 . According to the July 18, 2002 Washington Post article, another former
employee, James Patti, a senior manager in AOL's business affairs division told senior
executives he was uncomfo rtable with some of the AOL advertising deals. He was laid off
shortly thereafter in 2001 even though he had recently received a merit promotion . Patti said he
believes that his job termination was directly related to his unwillingness to go along with the
advertising deals . Patti said, "I had been asked to paper many of these questionable deals an d
was unwilling to cooperate, making my concerns known to management," and that "[t]he layoff
came exactly one week later . Ultimately, I was happy to leave the company with my integrit y
and professional ethics intact ."
503 . Recognizing that falling advertising rates would produce an inventory problem-
i.e., AOL would be forced to sell so many additional ads to meet revenue targets that it woul d
run out of space to post additional ads-Robert O'Connor warned Company executives that thi s
would create a fundamental business problem . Told that he was not a team player, O'Connor
left the Company on March 29, 2002 without negotiating a severance package because he wa s
no longer comfortable working in an environment where officials did not want to hear abou t
internal business issues . According to O'Connor, as reported in the July 19, 2002 Washington
Post article entitled "Creative Transactions Earned Team Reward :" "Not only were they not
willing to get out of denial, now they were going to actually punish those who were going to
even raise issues."
40699 .1 204 504. Berlow, President of Interactive Marketing, commented on O'Connor in a March
8, 2002 e-mail obtained by The Washington Post. The e-mail, sent to Schuler, at the time
President of AOL's Interactive Services Group , noted that "[t]he only reason you know that
there is an inventory problem is that Bob [O'Connor] continued up the ladder with the inventor y
problem (Bobby-Ripp-Kelly-Mayo) and shot his career out the window ." Berlow was referring
to Robert Friedman, then head of AOL's interactive marketing division; Defendant Joseph A .
Ripp, Chief Financial Officer of the AOL division of the Company; Defendant J. Michael Kelly,
the Chief Operating Officer for the AOL division; and Mayo Stuntz , Jr., executive vice
president of AOL Time Warner's cross divisional initiatives .
505 . Berlow summed up, stating: "I have no need to be right only a desire to see my
stock go up ."
506. Soon after the Merger, Individual Defendants boldly projected a quick 30 percent
profit increase. Defendants took this position despite fierce internal opposition from Joan
Nicolais, Time Warner's chief contact with Wall Street . According to a December 9, 2002
Newsweek article entitled "How it All Fell Apart," one top executive stated that Nicolais
criticized AOL's approach as "basically an elaborate spin machine. . . . She didn't think the
numbers added up ."
d. The Prior Pattern of Improper Accounting Practices
507. As noted in detail above, AOL has an extensive history ofhaving engaged in, an d
been disciplined for, accounting improprieties by the SEC. Past SEC investigations of and
actions against AOL occurred between 1997 and 2000. On May 15, 2000 , the SEC issued a
Cease and Desist Order against AOL requiring it to comply with accounting rules and the
securities laws . AOL agreed to comply with the Cease and Desist Order . In the same SEC
40699 .1 205 action, the SEC fined AOL $3 .5 million, the largest fine ever assessed at the time, and required
AOL to restate its financial statements for 1995-97.
508. As a result of the multiple SEC actions, the Individual Defendants were wel l
aware of the importance of proper accounting and in fact Case had pledged to adopt "new gold-
standard accounting practices." Despite this knowledge, the Individual Defendants continued t o
intentionally ignore or recklessly disregard applicable accounting regulations and the securities
laws.
e. Defendants' Restatement of AOL's Advertising Revenue and GAAP Violations Provide Evidence of Sciente r
509. Defendants' GAAP violations, as presented in detail above, were not technica l
violations of esoteric accounting rules, but conduct violative of basic GAAP principles that
further demonstrates the Individual Defendants' dishonesty .
510. Since the filing of the initial complaint, the Company has admitted that improper
accounting occurred over at least eight consecutive quarters with respect to almost $200 million
of advertising revenue. The biggest quarterly period of artificially inflated advertising revenue
that the Company has admitted, $66 million, was for the quarter that commenced just one month
after the SEC issued the Cease and Desist Order and imposed a $3 .5 million civil penalt y
against AOL.
511 . By issuing a restatement over eight consecutive quarters of almost $200 million in
advertising revenue, AOL Time Warner has admitted that its publicly-issued financial
statements for each of the restated periods were not prepared in conformity with GAAP, and
that AOL Time Warner materially misstated its financial condition and results of operations .
Under GAAP, the restatement of previously issued financial statements is reserved fo r
circumstances where no lesser remedy is available. Under APB 20, Accounting Changes,
40699.1 206 restatements are only permitted, and are required only to correct material accounting errors o r
irregularities that existed at the time the financial statements were originally prepared an d
issued.
512. The restatement of a company's previously issued financial statements becomes
necessary when it is discovered that previously issued financial statements contained errors or
irregularities in accounting which caused them to be materially misstated . Such misstatements
can be the result of errors or fraud, and once discovered, the company is obligated to notify all
parties who may rely on the previously issued financial statements that they should no longer
place reliance thereon . The restatement of a company's previously issued financial statement is,
in fact, an admission that such financial statements contained material misstatements that caused
them to be misleading to the reader .
f. The Individual Defendants' Awareness of Improper Deals and Continued Denial of Any Wronp-doint! After the Truth is Reveale d
513. After the Company's accounting improprieties were revealed by The Washington
Post, the Individual Defendants admitted knowledge of the suspect deals but arrogantly denie d
any wrongdoing. Only after the allegations persisted and the SEC and DOJ investigation s
became public, did the Defendants acknowledge any wrongdoing.
514. According to The Washington Post July 18, 2002 article, a lawyer hired by th e
Company responded : "The accounting for all of these transactions is appropriate and i n
accordance with generally accepted accounting principles. The disclosures in AOL' s financial
statements are appropriate and accurate . AOL's statements provide our investors with al l
appropriate material information about our business." The attorney added that The Washingto n
Post's investigation was "not only grossly unfair and unwarranted in light of the exhaustive
facts we have presented to you, but is also reckless in the current highly-charged environment ."
40699.1 207 515. Within weeks of making these fervent denials, Pittman resigned, Colburn wa s
fired and locked out of his office, and the Company disclosed that government agencies wer e
conducting civil and criminal investigations into their accounting practices and that the
Company itself was conducting an internal investigation of its accounting practices . As a result
of this internal investigation, the Company has thus far restated its advertising and commerc e
revenue in the amount of $190 million for the eight consecutive quarters ended September 30,
2000 through June 30, 2002 . The government's investigations are ongoing and reportedly were
recently broadened in scope. Most recently, the Company announced that it may further restate
AOL advertising revenue by reducing it in an amount of up to $400 million for 2001 and 2002
as a result of the SEC's investigation into the Bertelsmann AG transactions .
2. Motive and Opportunity of the Individual Defendants to Engage in Improper Accounting, Sham Transactions and Reporting of Inflated Advertising Revenue
a. Salaries, Bonuses, Stock Sales - The Culture of Greed Begin s
516. Throughout the Class Period, the Individual Defendants all shared an overriding
motive to enrich themselves through the considerable wealth that flowed to them from thei r
generous salaries and bonuses and the sale of stock at inflated prices . During the Class Period,
this motive became increasingly focused on the Merger between the two companies, the so-
called "deal of the century ." Prior to the Merger, Individual Defendants engaged in fraud to
inflate AOL's stock price and to initiate the Merger and ensure its ultimate consummation,
along with the corresponding acceleration of vesting of stock options and lifting of restrictions
on restricted stock. After the Merger, the Individual Defendants engaged in fraud to keep the
illusion of growth, profitability and synergy of the merged entity alive-and, correspondingly,
keep the stock price up . After the Merger, the Individual Defendants also recognized that if th e
40699.1 208 Merger turned out to be a failure or was even perceived as such, they would be faced wit h
removal from their positions of power and access to corporate riches . In the end, this becam e
the reality for Individual Defendants Case, Levin, Pittman, Colburn, Keller, and Berlow .
Defendants' collective motivation can be summed up, at least in part, by Berlow who stated, " I
have no need to be right only a desire to see my stock go up ." Such short-sightedness and gree d
helped to produce the facts that are the subject of this Complaint .
517 . Faced with these motivations and the knowledge of a general downturn in the
advertising market and a specific decrease in AOL advertising revenue, especially as a result of
dot-com failures, Defendants, individually and as a group, were highly motivated to engage i n
improper accounting and sham dealmaking to inflate advertising revenue at the companies .
b. The Shift to Flat Rate Pricing and the Increased Importance of Advertising Revenue to AOL's Bottom Line
518 . Partly as a result of increased competition, in December 1996 AOL dropped its
pay-by-the-hour method of charging subscribers and adopted a "flat-rate" pricing plan .
519. Following the introduction of the flat rate plan for the AOL subscriber service i n
December 1996, the company experienced a significant decline in its profit margins for revenu e
flowing from usage of its online service. As AOL began seeing its subsc ription revenue for th e
online service drop, the company looked for ways to increase advertising revenue .
520. The growth of higher margin advertising revenue became increasingly impo rtant
to AOL's business objectives. Advertising revenue grew in importance as the company
continued to leverage its large, active and growing user base . For fiscal years 1997, 1998, and
1999 AOL reported advertising and commerce revenue of $147 million, $358 million, and $765
million, respectively. Advertising was the fastest growing part of AOL's business .
40699 .1 209 521 . AOL's SEC Form 10-K for the fiscal year ended June 30, 1997, described th e
importance of advertising revenue to AOL's success:
An important component of the company's business strategy is to increase non- subscription based revenues, including from advertising sales and transaction fees associated with electronic commerce, and the sale of merchandise, which the company believes are increasingly important to its growth and success . The company continues to establish a wide variety of relationships with advertising and electronic commerce partners in order to grow its non-subscription based revenues and to provide AOL subscribers with access to a broad selection of competitively priced, easy to order products and services .
(Emphasis added .)
522. Beginning at least as early as mid-1998, many of these alliances and partnership s
enabled AOL, and later AOL Time Warner, to artificially inflate revenue through, among other
means, the use of improper accounting practices regarding "round-trip" and barter transactions .
This was accomplished, in large part, through the emergence of AOL "portal" deals described in
detail above.
523. According to a former AOL Chief Technology Officer , Product Manager and
Senior Business Manager, as AOL became a portal with an increasing number of millions of
subscribers, the company had more power to demand what it wanted . It insisted that some of its
advertisers and content providers give AOL performance warrants or shares of their companies
for as little as a penny a share .
524. According to the same source, AOL used creative accounting when the company
began charging other companies for exposure to its subscribers .
c. A Culture of Recklessness and Greed
525. The explosive growth in advertising revenue at AOL, brought about in large part
by the fraudulent accounting and dealmaking of the Business Affairs division, elevated tha t
division's and Colburn's importance at the company. As subscription revenues fell, advertisin g
40699.1 210 growth was the only way the company could sustain its sky-high stock prices and ensure the
company's long-term viability. The inflated stock value allowed AOL employees to become
increasingly wealthy as a result of stock options and large salaries . The Individual Defendants'
desire to maintain such wealth created a culture that expected and rewarded improper deal-
making in AOL's Business Affairs unit through the use of a mix of lavish perks and financial
rewards and the threat of verbal abuse .
526. For example , a September 1, 2002 New York Times article entitled "Ouster at
AOL, but Where Does the Trail End?" reported that Pittman "lavishly rewarded executives who
did meet their quarterly goals." The article proceeds to note that Colburn earned enough from
AOL stock options to hire popular music groups `N Sync and the Dave Matthews Band to play
at parties for his children.
527 . Colburn, as the leader of the Business Affairs division, has been described as a
"larger than life figure." The Washington Post, in a July 19, 2002 article, described Colburn's
tactics as follows:
He burnished his imposing reputation on Sundays at 9 a.m. on the regulation basketball court outside his large, clapboard and stone country-style house in Potomac.
There, he gathered his loyalists-a group of deal makers who wanted to move up the corporate ladder . Attendance was de rigueur . What he taught his disciples was his way of playing sports-and doing business . He played a ferocious game, breaking down his opponents with rough elbows, blatant fouls and name-calling, attendees said .
"It's the way he gets people to love him and fear him," said an AOL official. "You don't go to play, you go there to be abused ."
Colburn could be rougher on his troops at work, said several sources, many of whom declined to speak for attribution for fear it would hurt their career or jeopardize their benefits .
40699 .1 211 Once Colburn beckoned Ted Rogers, then a new member to his team- and a former Washington Redskins player--and gave him a dressing down outside AOL's fifth-floor boardroom during a meeting of "Op Com," the operating committee of senior executives, chaired by Pittman.
Witnesses said Colburn screamed at Rogers for a paperwork mistake- getting the wrong AOL executive's signature on a particular deal . The berating became water-cooler legend : If Colburn could decimate Rogers, a 250 pound, 6- foot-2 1/2 former linebacker, what about the rest of his crew ?
Every couple of weeks, AOL sources said, Colburn would pick other people, poke fun at them, yell at them, break them apart, and build them back up .
"He'd put an arm around you, and say, `Things are going to be all right, I really love you,"' said an AOL source . "He'd say a kind word, and it'd make your day. It's like an abusive father ."
Colburn also bestowed financial rewards on his minions . He would send favored underlings and their spouses on weekend getaways to places like New York, all expenses paid, including limousine service and lavish dinners, AOL sources said.
Colburn helped decide who got stock options, another powerful incentive to keep employees in line, especially when AOL shares were on the rise, sources said. During the height of the Internet boom, employees recalled logging on to their computers in the morning, checking their portfolio and staring in amazement at their growing assets .
"It was like, `Wow, I just made a few thousand dollars just by sleeping,"' said an AOL official .
But in exchange for such largess, Colburn demanded loyalty, AOL sources said, and never was that more clear than when AOL was at the pinnacle of its power.
"He created these foot soldiers who went to war for him," said an AOL source. "These were heady times ."
528. Colburn's efforts to create loyalty in his Business Affairs division wer e
successful. As described in the Industry Standard article "AOL Rough Riders" dated Octobe r
30, 2000:
40699.1 212 [Colburn] has a posse of imitators at AOL who show up at work dressed in Hawaiian shirts and needing a shave . They'll plunk a pair of cowboy boots up on the table during a meeting no matter who's present because that's somethin g Colburn would do . Some even borrow his strange accent . "Every guy working on deals inside AOL wants to be just like Colburn," [ex-AOL dealmaker Phillip] Zakas says . "So you'd have these people walking around trying to sound like Colburn: `If you don't sign this deal, you're f*#king crazy ; this is a great deal .' That kind of stuff happened all the time even though it was frowned upon-unless of course it was Colburn or a vice-president, because they had the charisma to get away with it ."
529. In January 2000, when AOL announced its anticipated merger with Time Warner ,
Colburn's Business Affairs division was at the height of its power, making huge deals wit h
start-up Internet companies desperately seeking the type of business legitimacy that only AO L
could offer them. The Business Affairs division's successes enriched those in the division an d
employees throughout the Company. The Washington Post reported on July 19, 2002 :
The transactions, in turn, helped enrich AOL . Everyone, it seemed, was becoming an instant millionaire at the company's Dulles headquarters . There were a lot of Ferraris . And twenty somethings and secretaries retiring with seven- figure bank accounts after a few years on the job, thanks to the incredible windfall from stock options .
At business affairs, almost anything seemed possible . Hard work begot wealth. Wealth begot parties. And parties, on occasion, became part of that work.
That included a spontaneous excursion from Dulles to San Francisco by a handful of AOL officials on the corporate jet . They called it a "team-building trip."
It took place in the Gold Club topless bar on Howard Street, said sources who were present, and both men and women from AOL attended .
"The lavish parties, the crazy antics--it really socialized you," said another AOL source . "You had to toe the line."
530. The importance of the Company's stock price was instilled in every facet o f
corporate culture at AOL and AOL Time Warner. For example, according to a former
employee, even security issues were presented in terms of stock value . At a security session,
40699.1 213 AOL's head of security, a former FBI agent , began his presentation by saying "Everything w e
do around here is related to one word." Then he stopped and wrote on the blackboard the word
"stock." He then went on to explain that "the main reason to practice good corporate securit y
was that security leaks and problems could affect AOL's stock price."
531 . On a monthly basis, Colburn would present "Sammy Awards" to the to p
performers of the 100 or so employees of AOL' s Business Affairs division . A takeoff on
television's Emmy awards, the Bammys were presented by Colburn to those employees who
had put together deals most favorable to AOL .
532. At one such ceremony in December 2000, just prior to the Merger, Colburn
awarded the Bammy gold star plaque to Kent Wakeford and Jason Witt, who had put togethe r
the sham transaction with PurchasePro .Com described herein. According to The Washington
Post, Colburn praised Wakeford and Witt for what he called a "science fiction" deal to generat e
advertising revenue, a comment some attendees took for the aggressive way the Company ha d
constructed the transaction .
533 . One attendee at the ceremony said, "The sheer arrogance, the feeling of bein g
untouchable, was amazing."
534. In light of the important role played by the Business Affairs division in helpin g
AOL and AOL Time Warner meet its revenue targets and the fact that its work was approved by
executives at the highest level, it is not surprising that Business Affairs employees believed the y
could do no wrong.
d. The Importance of Initiating, Consummating and Successfully Implementing the Merger
535 . Case and Levin may have had different motives in merging their two companies,
but the strength of their desire to merge was the same .
40699.1 214 536. "Case had been searching for a big acquisition for a year. Time Warner was
exactly what he longed for, a traditional company rich in assets and history. Gerry Levin had
been searching for something entirely different. In a career that encompassed the history of the
modem media, Levin held fast to a vision of an interactive world . For him, AOL was the
fulfillment of that vision ." CNBC television program The Big Heist: How AOL Took Time
Warner, CNBC, January 9, 2003, transcript at 3 ("Big Heist Trans . at ").
537. According to John Malone, a longtime business associate of Steve Case an d
Chairman of Liberty Media (one of AOL's largest shareholders) stated : "Case was ready to
marry anybody that would have hard assets and liquidity." Id. at 3. Richard Beattie. AOL's
lead deal attorney, confirmed this observation : "We spent a good amount of time, I believe in
the spring and summer leading up to [the Merger], looking at a lot of different strategi c
choices." Id. at 8.
538. The Newsweek article, dated December 9, 2002 entitled "How it All Fell Apart, "
noted: "Case was also increasingly worried that customers would dump his snail's-pace dial-u p
service for faster connections offered by cable companies . His hot stock was burning a hole in
his pocket. "
539. In addition to a desire to meet the market's continued expectations of increased
advertising revenue to keep the company's stock price artificially inflated, the Individua l
Defendants were under tremendous pressure to keep advertising revenue up so as to no t
jeopardize AOL's pending Merger with Time Warner.
540. After the Merger agreement was announced in January 2000, the pressure to
generate adve rtising revenue became even more intense . According to the July 19, 2002
Washington Post article, in August 2000, employees in the Business Affairs division wer e
40699.1 215 meeting regularly in a conference room between the office of Case and Pittman to discuss what
to do with a growing list of failing dot-com customers which were pleading with AOL to
restructure their advertising deals . Colburn and Berlow conducted the meetings with thei r
employees, oftentimes screaming at them to get AOL's business partners to pay up . According
to AOL sources, Colbu rn was constantly reminding people that pressure was on because of the
Merger and would say "Are you guys crazy? Are you forgetting what we have to accomplish? "
541 . As reported in The Washington Post article on July 18, 2002, according to former
AOL employee, James Patti: "The bubble had clearly burst, but senior management was unde r
enormous pressure to hit the [financial] numbers and close the Time Warner transaction, whic h
would diversify the revenue base and lower the risk profile of the company . "
542. Not surprisingly, the Company' s largest quarterly restatement of advertising
revenue was for the last publicly reported quarter prior to the consummation of the Merger .
543. There was also a strong motive at Time Warner to consummate the Merger,
especially on behalf of Levin . Michael Fuchs, former HBO Chairman and CEO who worke d
with Gerry Levin for nearly 20 years, stated that Levin "has an enormous drive to be seen as a
visionary. It started back in 1975 when HBO went up on the satellite. It became Gerry 's calling
card. And replicating that visionary situation was driving motivation for him throughout hi s
career. Every deal was the transforming deal." Big Heist Trans. at 4.
544. Levin was so intent on consummating the Merger that he reportedly told few
Time Warner colleagues of the deal's existence . According to a reporter who covered the story
for Time, "People who reported directly to Levin, you know, heads of huge divisions who had
no idea, they found out about it, I believe it was the Sunday night before the Monday morning
announcement ." Big Heist Trans . at 9 .
40699.1 216 545. Once implemented, Time Warner individuals such as Levin were motivated to se e
the Merger succeed in order that they not be viewed as failures for having agreed to merge wit h
an Internet company such as AOL.
546. Perhaps recognizing that his vision would not be fulfilled, Levin retired from th e
Company unexpectedly in May 2002 . On January 12, 2003, Levin's partner in the Merger, Case
announced his resignation from the Company effective May 2003, noting that, among othe r
things, the Merger had been a "disappointment."
e. Defendants' Financial Incentives Related to the Merger
547. In addition, certain Individual Defendants had enormous financial incentives to
complete the merger due to the accelerated vesting of their stock options and lifting of
restrictions on stock sales . AOL Time Warner's 2002 Proxy Statement noted : "All options
awarded prior to 2000 held by Messrs . Levin, Turner, and Parsons became immediately
exercisable in full upon the approval of Time Warner's board of directors of the AOL-T W
Merger on January 9, 2000. All options awarded prior to 2000 held by Messrs . Case and
Novack became immediately exercisable in full on the Merger Date and all such options held b y
Mr. Pittman became immediately exercisable on the first anniversary of the Merger Date ."
Restricted shares of stock at both companies similarly became vested and unrestricted .
548. Once the Merger was completed, part of Defendants' motivations for the Merge r
became clear. As set out in detail below, the Individual Defendants engaged in extensive insider
selling in the months immediately following the Merger with numerous sales taking place
between January and May 2001, when the combined company's stock hit its all-time high .
During this period the Individual Defendants (whose information is publicly available) sold over
11 .4 million shares of AOL Time Warner stock for proceeds of nearly $270 million .
40699.1 217 549. This massive insider sell-off occurred while the Company was engaged in a $ 5
billion repurchase of its stock . During the first six months of 2001, the Company repurchased
30 million shares of its stock for $1 .3 billion serving to further inflate the stock price while the
Individual Defendants sold 11 .4 million of their own shares for proceeds of $270 million during
the same period.
f. The Individual Defendants Deny and Cover Up Problems Associated with Shrinking Advertising Revenue
550. Due to the critical importance of advertising revenue to AOL, such revenue wa s
tracked closely by the companies and their top executives . According to one former AOL Vice
President, Robert O'Connor (Vice President of Finance for the Business Affairs unit) prepared
reports that showed "every advertising deal that AOL had and the amount of annual revenue
recognition expected from each deal ." The reports would show the amount of revenue initially
expected from a deal and would show a lower amount than initially expected if that advertiser
were experiencing financial difficulties . According to The Washington Post article dated July
18, 2002, AOL tracked on a weekly basis the health of the dot-corns, how much they owed
AOL, what AOL was doing to get its money, how the dot-corns were responding and how much
money AOL could lose if the dot-corns did not pay their bills .
551 . In addition, according to a former employee AOL used a "pipeline report"
prepared by the Interactive Services unit that showed what advertising deals were in the pipeline
and could be expected to turn into revenue producers .
552. As reported in The Washington Post on July 18, 2002, according to sources at
AOL, the Company considered suing failing dot -corns in order to get them to pay for ads that
they had agreed to buy. But sources said that AOL decided against such a strategy because the
public court filings would publicize the weakness in the business.
40699 .1 218 553. In September 2000, internal company documents indicated that AOL was "at risk" to lose more than $ 108 million in advertising revenue in fiscal 2001 (July 2000 to Jun e
2001) with most of the jeopardized revenue coming from failing dot-coms.
554 . According to the July 18, 2002 The Washington Post article, approximately two weeks before AOL released its first quarter results on October 18, 2000, Pittman and several o f the Individual Defendants were told in a meeting at AOL's Dulles headquarters by Rober t
O'Connor that AOL faced the risk of losing more than $140 million in advertising revenue i n calendar year 2001 . This came at a time when the market was aware of the downward trend facing the industry. For example, just a week before the AOL's October 18, 2000 statements, the common stock of Yahoo Inc., plunged 21 % after the company reported that its advertising revenue growth could no longer be sustained .
555. According to the July 18, 2002 The Washington Post article, AOL's top executives were already holding weekly emergency meetings to discuss the status of advertising agreements with failing dot-corns.
556 . Not only did Pittman, Case and Kelly not communicate the Company' s advertising revenue problem to analysts during an October 18, 2000 conference call, they actually touted the strength of AOL's advertising and commerce revenues.
557 . When asked whether AOL was feeling a slowdown in advertising, Pittma n responded "I don't see it, and I don't buy it."
558 . At the same conference, Case said "AOL's advertising growth is right on target" and noted that "[t]he current advertising environment benefits us because it will drive a flight to quality."
40699.1 219 559 . Similarly, Kelly told analysts that AOL's advertising and commerce revenue
growth was "very healthy" and emphasized, "I can't say that strongly enough ."
560 . Despite his vehement denial of any problems with AOL advertising, J . Michael
Kelly later sought to disclose problems related to the decline in advertising revenue to investors
just months after the Merger, but was overruled by Levin and Pittman . On October 14, 2002 ,
The New York Times reported the following:
Six months after America Online bought Time Warner , the merged company's top executives rejected arguments from its chief financial officer that they should back down from their ambitious promises to Wall Street, three senior executives involved in the company's deliberations now say . . . . Instead, the executives waited two more months, until September 2001, to publicly acknowledge that the company would badly miss their financial projections made at the time of th e merger.
The chief financial officer, J. Michael Kelly, made his case while preparing AOL Time Warner's second-quarter earnings report in July 2001, arguing that a prolonged downturn in the advertising market was jeopardizing the company's promise of an annual operating profit, excluding certain charges, of $11 billion in the merger's first year, the senior executives said .
But Mr. Kelly's boss, Gerald M. Levin, the former chief executive, and Robert W. Pittman, the former co-chief operating officer, overruled him, arguing that the combination of new company-wide advertising deals and deep cost cuts could still make up for any shortfalls, the senior executives said .
Mr. Kelly eventually signed off on the company's public statements . But his caution in July 2001 suggests that AOL Time Warner's top executives may have been more aware of the risks to the company's results than they previously acknowledged.
Mr. Kelly was the executive most directly responsible for the company's financial reports and the chief financial officer of AOL before the merger, giving him a unique familiarity with its books as well as those of the merged company .
The Securities and Exchange Commission and the Justice Department are investigating the possibility that AOL temporarily inflated its advertising revenue around the time it acquired Time Warner, and one question they are asking is how much Mr. Kelly and his colleagues knew about the preca riousness of AOL's finances, people involved in the investigations have said .
40699.1 220 New information emerging in light of the investigations suggests that even by the time the merger was complete, AOL's advertising and marketing revenue the most crucial component of the combined company's profits and growth already depended on a variety of unusual deals creating the temporary but unsustainable appearance of strong demand for its services . More than $500 million of AOL's advertising, marketing and other revenue between June 2000 and July 2001 derived from anomalous soon-to-expire deals.
A company spokesman said that the company consistently gave investors its best information and its executives worked hard to fulfill their promises .
And yet, AOL had always declined to answer questions about who its biggest advertisers were or exactly where its revenue came from, even to other executives at its sister companies like AOL Europe, two executives involved said . After the merger closed in January 2001, AOL Time Warner disclosed even less. The company for the first time stopped revealing AOL's backlog of future advertising revenue under contract . As a result, investors had no way of knowing during the next 18 months that the backlog was declining to $800 million, from $3 billion before the merger .
(Emphasis added.)
561 . Despite his earlier denials of the possibility of a slowdown in advertising at AOL ,
Pittman abruptly resigned from AOL Time Warner following the two Washington Post articles
published on July 18 and 19, 2002 .
562. Soon after publication of the same two articles, Colburn was fired and locked out
of his office.
3 . Individual Defendants' Compensation Incentive s
563 . Although scienter of the Individual Defendants is described in the immediatel y
preceding paragraphs and throughout this Complaint, the following is a summary of publicly
known compensation information regarding the Individual Defendants.
Stephen M . Case
564. According to publicly available data, Case made the most money from his insid e
sales of stock of all the Individual Defendants .
40699 .1 221 565 . All stock options awarded prior to 2000 and held by Case became immediately
exercisable in full on the Merger Date, providing a strong personal motive for him to ensure th e
Merger went through at all costs. During the Class Period Case sold over 6 million shares of
AOL and AOL Time Warner stock for total proceeds of over $555 million. In the four months
immediately following the Merger, Case sold 2 million shares for total proceeds of over $10 0
million.
566. Case's executive compensation during the Class Period provides further evidenc e
of his motive. During 2001 and 2002 he received an annual salary of $1 million . In 2002, Case
also received "other annual compensation" of $277,555 consisting of "financial services" of
$99,213 and transpo rtation-related benefits of $178,342 . For July 1, 2000 through December
31, 2000 (the "Transition Period") Case received a salary of $383 ,333, for AOL fiscal year 2000
(July 1, 1999-June 30, 2000) he received a salary of $725,000 and a bonus of $1 .125 million,
and for AOL fiscal year 1999 he received salary of $575,000 and a bonus of $1 million.
Moreover, Case received option grants of 4 million shares in 2001, 1 .75 million shares during
the Transition Period, 3 million shares for AOL fiscal year 2000, and 1 .8 million shares during
AOL fiscal year 1999.
Robert W . Pittman
567 . All stock options awarded prior to 2000 and held by Pittman became immediatel y
exercisable on the first anniversary of the Merger Date providing a strong personal motive for
him to ensure the Merger went through at all costs. During the Class Period Pittman sold over
3.3 million shares of AOL and AOL Time Warner stock for proceeds of over $262 million . He
sold 1 .5 million shares for over $72 million in the four months immediately following the
Merger. Bloomberg, in a July 30, 2002 article entitled "AOL Time Warner Pay Dilemma Goes
40699.1 222 Beyond Pittman ," suggests that Pittman sold an unusually large percentage of his AOL and
AOL Time Warner stock: "Pittman seems to have been a far more savvy investor than an
executive. He clearly didn't believe in the notion that one ought to hold a lot of shares in one's
company, as he owned just 13,388 shares as of Jan . 31 [2002] ."
568. Pittman's executive compensation during the Class Period provides furthe r
evidence of his motive. Up until his departure in July 2002, Pittman received a salary o f
$769,230. During 2001 he received a salary of $1 million . In 2002, Pittman also received
"other annual compensation" of $288,837 consisting of, inter alia, "financial services" of
$100,000 and $167,192 for reimbursement for the payment of taxes related to life insurance
coverage provided in 2001 . In 2001, Pittman also received "other annual compensation" of
$399,611 consisting of, inter alia, $100,000 for financial services and $286,346 for the payment
of taxes related to life insurance coverage . For July 1, 2000 through December 31, 2000 (the
"Transition Period") Pittman received a salary of $358,333 and a bonus of $550,000, for AOL
fiscal year 2000 (July 1, 1999-June 30, 2000) he received a salary of $683,334 and a bonus of
$1 .05 million, and for AOL fiscal year 1999 he received salary of $591,667 and a bonus of $1
million. In addition, Pittman received option grants of 210,000 shares in 2002, 3.5 million
shares during 2001, 1 .5 million shares during the Transition Period, 2.5 million shares for AOL
fiscal year 2000, and 1 .44 million shares during AOL fiscal year 1999.
J. Michael Kelly
569. During the Class Period Kelly sold over $42 million in AOL and AOL Time
Warner stock . Kelly sold 400,000 shares for proceeds of over $19 million in the three month s
immediately following the Merger. Kelly's executive compensation provides further evidenc e
of his motive . In 1999 Kelly received a base salary of $450,000 and a minimum bonus of 75%
40699 .1 223 of base salary or greater if certain personal and corporate goals were met. In addition, he
received a stock option package consisting of an initial reward of 250,000 shares vesting over 4
years and the option to purchase 225,000 additional options per year during years 4, 5, and 6 .
David M. Colburn
570. During the Class Pe riod Colburn sold at least 150,000 shares of AOL and AOL
Time Warner stock for proceeds of over $7 .5 million-all during the four months following th e
Merger. Colburn's stock sales while an employee at AOL are not publicly available because h e
was not required to notify the SEC of sales due to his level of employment with the company .
However, according to the The Industry Standard article of Oct . 30, 2000 entitled "AOL' s
Rough Riders," it is likely that he had very substantial sales during this period as the articl e
reported that he had an estimated net worth of $250 million.
Joseph A. Ripp
571 . During the Class Pe riod Ripp sold at least 20 ,000 shares of his AOL and AOL
Time Warner stock for proceeds of over $1 .7 million.
Gerald M. Levin
572. All stock options awarded pri or to 2000 and held by Levin became immediatel y
exercisable in full upon the approval by Time Warner's board of directors of the Merger o n
January 9, 2000 providing a strong personal motive for Levin to ensure the Merger wa s
approved at Time Warner .
573 . Levin's executive compensation during the Class Period provides further
evidence of his motive . In 2002, Levin received a salary of $769,230 and other annual
compensation of $285,058 consisting of, inter alia, $100,000 in financial services and $178,342
in transportation-related benefits . During 2001 he received a salary of $1 million and othe r
40699 .1 224 annual compensation of $237,602 consisting of, inter alia, of $97,500 in financial services and
transportation-related benefits of $127,446 . In 2000 Levin received a salary of $1 million, a
bonus of $10 million, and other annual compensation of $226,620 from Time Warner . In
addition, Levin received option grants for 4 million shares during 2001 and 750,000 share s
during 2000.
Richard D. Parsons
574. All stock options awarded p rior to 2000 and held by Parsons became immediately
exercisable in full upon the approval by Time Warner's board of directors of the AOL Tim e
Warner Merger on January 9, 2000 providing a strong personal motive to ensure the Merger wa s
approved at Time Wa rner. During the Class Period Parsons sold 700,000 shares of AOL Time
Warner stock for proceeds of over $35 million-all in the four months immediately following
the Merger.
575 . Parsons' executive compensation during the Class Period provides further
evidence of his scienter . In 2002 and 2001 Parsons received an annual salary of $1 million and
other annual compensation of $178,980 and $166,597, respectively, consisting primarily of
financial services and transportation-related benefits. In 2000 Parsons received a salary of
$750,000, a bonus of $6 million, and other annual compensation of $146,535 from Time
Warner. In addition, Parsons received options grants for 300,000 shares in 2002, 3 .5 million
shares in 2001, and 525,000 shares during 2000 .
Wayne H. Pace
576. During a large portion of the Class Period Pace held positions that did not requir e
him to publicly report his insider transactions.
40699.1 225 Kenneth J. Novack
577. Novack's executive compensation du ring the Class Period provides fu rther
evidence of his motive . During 2002 and 2001 he received an annual salary of $1 million and
"other annual compensation" of $200,257 and $165,790 respectively consisting primarily of
"financial services" and insurance coverage . For July 1, 2000 through December 31, 2000 (the
"Transition Period") Novack received a salary of $258,333 and a bonus of $275,000, for AOL
fiscal year 2000 (July 1, 1999-June 30, 2000) he received a salary of $433,333 and a bonus of
$506,000, and for AOL fiscal year 1999 he received salary of $350,000 and a bonus of
$400,000. In addition, Novack received option grants of 2 million shares in 2001, 1 million
shares during the Transition Period, 1 million shares for AOL fiscal year 2000, and 2 .56 million
shares during AOL fiscal year 1999 .
578. During the Class Period, Novack sold over 1 .2 million shares of AOL and AOL
Time Warner stock for proceeds of over $86 million . He sold nearly 700,000 of those shares i n
the four months following the Merger for proceeds of over $33 million .
Myer Berlow, Eric Keller, Barry Schuler, Steven Rinde r
579. Due to these Defendants' positions with the companies, they were not required to
file forms with the SEC related to insider sales and therefore that information is not publicl y
available.
K. Scienter of Ernst & Young
580. In addition to the facts alleged above, the following facts, among others, sho w
that Ernst & Young acted with scienter.
40699 .1 226 1 . Ernst & Young's Work for AOL, Time Warner and AOL Time Warner
581 . Ernst & Young was retained by and had served as independent auditor to bot h
AOL and Time Warner for many years prior to the Merger, and AOL Time Warner since th e
Merger. Ernst & Young performed annual audits on AOL's and AOL Time Warner 's financial
statements during the Class Pe riod, as well as quarterly review work for AOL since at least the
first quarter 2000, and as to AOL Time Warner, for every quarter since the Merger, to date . As
such, Ernst & Young was heavily involved in the regular accounting practices of the companies .
For each fiscal year 1999, 2000 and 2001 and transition period ended December 31, 2000, Erns t
& Young issued "clean" opinions as set forth in AOL and AOL Time Warner's SEC Form 10-
Ks, opining that AOL and AOL Time Warner' s financial statements were prepared in
conformity with GAAP, that the financial statements "present fairly in all material respects" the
financial condition of the companies and that Ernst & Young had planned and performed it s
audits in accordance with GAAS. Each of these representations was untrue. Ernst & Young
also consented to the incorporation of its reports containing its unqualified opinions, and to th e
reference to itself as "Experts" in the Merger Registration Statement and Bond Registratio n
Statement.
2. Ernst & Young's Close Relationship with AOL Time Warner
582. AOL and AOL Time Warner were huge clients for Ernst & Young . For example,
Ernst & Young billed AOL Time Warner $49.05 million in 2002 and $52.7 million in 2001 . Of
the 2002 amount, $32 .5 million, or 66%, was for services other than AOL Time Warner's U.S.
Audit. Of the 2001 amount, $42.1 million , or 80%, was for services other than AOL Time
Warner's U .S. Audit. The additional fees in 2002 included $ 19.2 million for tax complianc e
and planning, $5 .9 million for internal audit services, and $4 .2 million for subsidiary and
40699.1 227 international audits. The additional fees in 2001 included $25.9 million for tax compliance and
planning, $8.2 million for internal audit services, and $3 .6 million for subsidiary an d
international audits.
583. For 2000 (prior to the Merger), Ernst & Young was paid by the two companies a
combined $59 million (AOL $3 . 5 million and Time Warner $55.4 million ). Of this amount ,
only $8 million was for the U .S. audits of AOL and Time Warner. The rest was for consulting
services provided by the Ernst & Young consulting group (prior to its sale on May 23, 2000 t o
the French company, Cap Gemini).
584. In addition, former Ernst & Young alumni were employed at AOL and AOL Time
Warner during the Class Period . James W. Barge, a Senior Vice President and Controller at
AOL Time Warner, came from Ernst & Young. Barge is responsible for overall internal an d
external financial reporting functions, financial planning and analysis and Board-leve l
communications. Barge came to Time Warner from Ernst & Young in March of 1995 a s
Assistant Controller. At Ernst & Young, he was the Area Industry Leader of the Consumer
Products Group and a Partner in the West Region Accounting Auditing Department . During
that period he had regional responsibility for consultations on a wide variety of accounting an d
auditing issues managing SEC related matters.
585. John Martin, AOL Time Warner's Vice President of Investor Relations and the
Company's principal day-to-day contact with the investment community, is also an Ernst &
Young alumnus . Before joining Time Warner in 1993 as a Manager of SEC financial reporting ,
he was a Senior Accountant in the Business Assurance Group at Ernst & Young in New York .
40699.1 228 3. Ernst & Young's Auditing Expertise and Industry Knowledge
586. Ernst & Young is a sophisticated multinational accounting and tax firm ranking a s the fourth largest such firm in the world with annual revenues of $4 .4 billion according to a
2002 survey .
587 . In addition, Ernst & Young promoted itself as having expertise specifically suited for internet and e-commerce companies through its Technology Communications an d
Entertainment division (TCE) . In their brochure, Ernst & Young boasted "Ernst & Young helps technology, communications, and entertainment companies operate more efficiently, profitably, and successfully."
588. Ernst & Young, along with the Massachusetts Institute of Technology and
Inter@ctive Week, studies the companies involved in the internet economy to produce the
Internet 500 which ranks the top 500 businesses by their revenue generated from onlin e operations.
589 . In addition to AOL Time Warner, Ernst & Young lists numerous technology companies on its roster of clients including several entities with which AOL had agreements a s to which it engaged in improper accounting practices . Such entities include eBay and Sun
Microsystems. Ernst & Young also served as auditor for Veritas before being replace d following that company's year 2000 audit .
4. Ernst & Young's Actual Knowledge of Specific Transactions and Accounting Thereof
590. In the wake of SEC actions against AOL Time Warner and in response to the July
18 and 19, 2002 Washington Post articles, the Company has stated that it had relied on Ernst &
Young's approval of not only the accounting methods used, but many ofthe particular
40699 .1 229 transactions at issue as well . In addition, Ernst & Young has stated that its audits were properly
performed when it knew that they were not.
591 . Prior to the July 18, 2002 Washington Post article, H. Stephen Hurst, Ernst &
Young partner, released a statement at AOL Time Warner' s request saying the firm stood by it s
original view that the accounting and disclosures were appropriate .
592. In July 2002, then AOL Time Warner CEO Richard Parsons said in a conferenc e
call following The Washington Post articles that "They [Ernst & Young] have confirmed in
writing, without qualification, that the accounting for each and every one of the transaction s
mentioned in [The Washington] Post articles and the related financial statement disclosures for
those transactions were appropriate and in accordance with Generally Accepted Accountin g
Principles."
593 . Ina July 29, 2002 article in Advertising Age, Defendant Pace also reassured
investors that AOL Time Warner and its auditor Ernst & Young stood by the accounting.
594. Regarding the Homestore transactions in particular, AOL Time Warne r
spokesman John Buckley stated in an August 6, 2002 Los Angeles Times article that "AOL' s
accounting for all transactions with Homestore.com were appropriate and signed off by our
outside auditors, Ernst & Young ." (Emphasis added.)
595. One of the transactions described in The Washington Post articles involved
AOL's deal with PurchasePro in the fall of 2000, a deal AOL Time Warner said was approved
by Ernst & Young .
596. However, PurchasePro's auditor, Arthur Andersen, disagreed with the wa y
PurchasePro accounted for revenue from reseller agreements . PurchasePro's SEC Form 8- K
dated November 29, 2001 states:
40699.1 230 During Andersen's review of the Company's interim financial statements for the three-month period ended September 30, 2000, Andersen expressed disagreement with prior members of the Company's management regarding propose d recognition of revenue derived from reseller agreements between the Company and its business partners . This issue was the subject of discussion between Andersen and the Company's Audit Committee and was resolved to Andersen's satisfaction .
As a result of this disagreement, Arthur Andersen resigned as PurchasePro's auditor o n
November 21, 2001 .
5. The Restatement of AOL's and AOL Time Warner's Financial Statements
597. Despite Ernst & Young's immediate and unequivocal denial of any improper
accounting when The Washington Post first reported on July 18, 2002 on the accountin g
improprieties, both the Company and Ernst & Young acknowledged only three weeks later tha t
at least $49 million of advertising revenue had been improperly reported when the allegation s
persisted and the SEC and DOJ started their investigations . Two months later, the Company
reported that $190 million in advertising revenue was improperly reported and that th e
Company's internal investigation was continuing . Then, on or about March 28, 2003, the
Company reported that the SEC may require it to restate an additional $400 million in revenue
based on the Company's improper accounting for an advertising deal with Bertelsmann AG .
598. Ernst & Young issued unqualified audit reports, which were published in th e
companies Forms 10-K and Annual Reports to shareholders for, inter alia, the years ended
December 31, 2001 and December 31, 2000.
599. However, by restating its financial results , AOL Time Warner has admitted that
its and AOL's publicly-issued financial statements for each of the restated periods were no t
prepared in conformity with GAAP, and that AOL and AOL Time Warner materi ally misstated
its financial condition and results of operations . Thus, Ernst & Young's opinions that the
40699.1 231 financial statements for the years ended December 31, 2000 and 2001, had been prepared in
conformity with GAAP were false and misleading. Under GAAP, the restatement of previously
issued financial statements is reserved for circumstances where no lesser remedy is available .
Under APB 20, Accounting Changes, restatements are only permitted, and are required to
correct material accounting errors or irregularities that existed at the time the financia l
statements were originally prepared and issued.
600. The restatement of a company's previously issued financial statements become s
necessary when it is discovered that previously issued financial statements contained errors o r
irregularities in accounting which caused them to be materially misstated . Such misstatements
can be the result of errors or fraud, and once discovered, the company is obligated to notify all
parties who may rely on the previously issued financial statements that they should no longer
place reliance thereon . The restatement of a company's previously issued financial statements
is, in fact, an admission that such financial statements contained material misstatements tha t
caused them to be misleading to readers .
6. Ernst & Young's Past Involvement with Previous Accounting Frauds
601 . Ernst & Young has been involved in accounting fraud in the past . Recently, Ernst
& Young paid $335 million to settle claims arising from its auditing role in a securities frau d
case involving Cendant Corp., a record amount paid by an auditing firm in such a case .
602. On November 23, 1992, The Office of Thrift Supervision filed a Notice o f
Charges against Ernst & Young stemming from its improper audit practices with regard to som e
of the most notorious failed financial institutions of the 1980's savings and loan crisis, includin g
Continental Illinois . To resolve these charges and numerous related lawsuits filed by the FDIC ,
40699.1 232 Ernst & Young paid $400 million in settlement, and agreed to a cease and Desist Orde r
restricting its future work for insured depository institutions .
603 . In May 1999, Ernst & Young settled claims that it failed to publicly disclose
accounting irregularities by paying $34 million in a securities case involving Informix .
604. In a complaint filed in 2002 by the Federal Deposit Insurance Corporation
("FDIC"), the FDIC alleged "Ernst & Young has a long history of breaching duties owed to th e
FDIC and other regulatory agencies overseeing financial institutions ."
7. Ernst & Young's Responsibilities as AOL's and AOL Time Warner's Independent Auditor
605. The duty owed by an independent auditor to a company's shareholders is well-
established. As the United States Supreme Court explained in a case involving a predecesso r
firm of Ernst & Young :
By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client . The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public . This "public watchdog" function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust .
United States v. Arthur Young & Co ., 465 U.S. 805, 817-18 (1984) .
606. In addition, the responsibilities and functions of an independent auditor include
the following:
The objective of the ordinary audit of financial statements by the independent auditor is the expression of an opinion on the fairness with which they present, in all material respects, financial position, results of operations and cash flows, in conformity with generally accepted accounting principles . (AU § 110.01).
The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. (AU § 110.02).
40699.1 233 The professional qualifications required of the independent auditor are those of a person with the education and experience to practice as such. (AU § 110.04).
607. The independent auditor must also comply with professional training and
proficiency rules, including the following:
The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor. (AU Section 150.02).
In the performance of the audit which leads to an opinion, the independent auditor holds itself out as one who is proficient in accounting and auditing . (AU § 210.03).
The independent auditor's formal education and professional experience compliment one another; each auditor exercising authority upon an engagement should weigh these attributes in determining the extent of his or her supervision of the subordinates and review of their work . It should be recognized that the training of a professional person includes a continual awareness of developments taking place in business and in his or her profession. (AU § 201 .04) .
In the course of his or her day- to-day practice, the independent auditor encounters a wide range of judgment on the pa rt of management , varying from true objective judgment to the occasional extreme and deliberate misstatement. He or she is retained to audit and repo rt upon financial statements of a business because, through training and experience, he or she has become skilled in accounting and auditing and has acquired the ability to consider objectively and to exercise independent judgment with respect to the information recorded in books of account or otherwise disclosed by his or her audit. (AU § 210.05).
608. Ernst & Young, in contracting to perform its audit of AOL's and AOL Time
Warner's financial statements, assumed all of the responsibilities and obligations set forth in the
preceding paragraphs.
8. Ernst & Young's Violations of Accounting and Auditing Standard s
609. As discussed below, Ernst & Young violated its professional responsibilities and
knowingly or recklessly participated with AOL and AOL Time Warner in improper revenue
recognition practices , policies, and procedures in order to artificially boost AOL's and AOL
Time Warner's reported advertising revenue . Although Ernst & Young was aware that the
40699.1 234 revenue recognition practices of AOL and AOL Time Warner were in violation of GAAP, Erns t
& Young provided unqualified audit opinions in order to continue earning lucrative fees for th e
auditing and other services that it provided for AOL and AOL Time Warner.
610. As part of its planning for and implementation of various audit engagements fo r
AOL and AOL Time Warner, Ernst & Young was required under GAAS to be thoroughl y
familiar with the nature of AOL's and AOL Time Warner 's business, the manner in which
senior management ran the companies, the internal control environment at the companies, and
the areas of audit risks at AOL and AOL Time Warner. As AOL and AOL Time Warner's
auditor, Ernst & Young had unfettered access to the Company's books and records throughou t
the Class Period. Ernst & Young, as a world-renowned "Big 4" public accounting firm, ha d
knowledge of the requirements of GAAS, and, as described below, knew of the audit risks
inherent in AOL, AOL Time Warner and in the industry.
611 . Ernst & Young knew, or except for its reckless disregard of the facts would hav e
known, that (i) it had not performed its audits of AOL's and AOL Time Warner 's financial
statements in compliance with GAAS; (ii) it never should have issued an "unqualified" audit
report on AOL's and AOL Time Warner's financial statements for the fiscal/calendar year s
ended 1999, 2000, 2001 and the transition period for AOL ended December 31, 2000 ; and (iii)
its audit reports on AOL's and AOL Time Warner's financial statements for the years ended
1999, 2000, 2001 and transition period for AOL ended December 31, 2000 were not in
conformity with GAAS when opining that the financial statements were in accordance wit h
GAAP and that the "financial statements . . . present fairly in all material respects," the financial
condition of the companies . This conclusion may be expressed only when the auditor ha s
40699.1 235 formed such an opinion on the basis of an audit performed in accordance with GAAS. (AU
508.07). Ernst & Young failed to do so .
612. As set forth above, AOL and AOL Time Warner repeatedly violated GAAP with
respect to its accounting for the deals at issue . Yet, Ernst & Young failed to identify and correct
those violations despite its admitted awareness of many of the deals. In fact, Ernst & Young's
audits of the financial statements were so woefully inadequate that Ernst & Young repeatedly
violated GAAS. Ernst & Young utterly failed to perform the most fundamental of procedures to
provide a basis for its unqualified reports . As described herein, Ernst & Young repeatedly and
materially violated GAAS in each of its audits of AOL and AOL Time Warner during the Class
Period, failed to plan or to perform its audits to obtain reasonable assurance that AOL and AO L
Time Warner's financial statements were free of material misstatement, and, therefore, had n o
basis on which to state that the financial statements were presented in conformity with GAAP .
GAAS violations include:
a. Ernst & Young Failed to Properly Consider Fraud.
613. Ernst & Young knowingly or recklessly failed to plan its audits to evaluate th e
risk factors relating to management's characteristics, their influence over the contro l
environment and the company's accounting and internal control policies . "The auditor should
specifically assess the risk of material misstatement of the financial statements due to fraud an d
should consider that assessment in designing the audit procedures to be performed ." AU §
316.12; AU § 316.05 ("The auditor should assess the risk that fraud may cause the financial
statements to contain a material misstatement."). When examining risk factors provided in AU
Section 316 , it is obvious that Ernst & Young should have identified ri sks for fraudulent
reporting virtually everywhere . Among the conditions that should cause the auditor to conside r
40699 .1 236 that a client has attempted financial fraud are discrepancies in the accounting records, such as
transactions not properly recorded as to amount, or unsupported or unauthorized balances or
transactions; conflicting or missing evidential matter, such as significant unexplained items on
reconciliations; or denied access to records . AU §§ 316.25, 317.09, AU §§ 316.21, 317.09. To
limit the risk of financial statement misstatement as a result of fraud, the auditor should perform
procedures, including a detailed review of the client's quarter-end and year-end adjustin g
journal entries and an investigation of any entries that appear unusual as to nature or amount an d
of significant and unusual transaction, particularly those occurring at or near quarter-or year-
end. AU § 316.29. Ernst & Young violated GAAS because it failed to properly consider the
risk that AOL and AOL Time Warner's financial statements would be materially misstated as a
result of fraud.
614. In its role as auditor, starting at least as early as the quarter ended December 31 ,
1998, and throughout the Class Period, Ernst & Young knew of extraordinary audit risk factors
("red flags") at AOL and AOL Time Warner which Ernst & Young intentionally ignored or
recklessly disregarded, allowing AOL and AOL Time Warner to artificially inflate their
advertising revenue. Significant audit risk factors which existed at AOL and AOL Time Warner
throughout the Class Period and Ernst & Young audit failures include the following :
a. Ernst & Young knowingly or recklessly failed to design its audits to consider that a significant portion of management's compensation was represented by bonuses , stock options, or other incentives, the value of which was contingent upon AOL and AOL Time
Warner achieving unduly aggressive revenue or earnings targets . Ernst & Young was aware o f the overwhelming motivation for management to engage in fraudulent financial reporting, whic h included the personal motive that Individual Defendants had to maintain a high stock price ,
40699.1 237 AOL's need to maintain its stock price in order to consummate the Merger and the Company' s
need to maintain its "investment grade" credit rating in order to sell $10 billion in bonds pursuan t
to the Bond Offerings in 2001 and 2002 .
b. Ernst & Young knowingly or recklessly failed to properly consider th e
excessive interest by management in maintaining or increasing AOL and AOL Time Warner' s
stock price or advertising revenue growth trends through the use of unusually aggressive
accounting practices . Ernst & Young was aware that AOL and AOL Time Warner entered into many complex and aggressive transactions , and that material amounts of the advertising revenue that came in at the end of the quarters which allowed AOL and AOL Time Warner to hit its advertising revenue targets were based on such practices . Many deals entailed reciprocal or round-trip transactions whereby AOL and AOL Time Warner's own money was cycled back to them as revenues, or barter instruments that were difficult to value, while others, like
PurchasePro, improperly converted cash flows of an entirely different nature into adve rtising revenues.
Ernst & Young was aware of the significant problems that AO L experienced with the SEC on several occasions in connection with its accounting practices, including the May 2000 imposition of a cease and desist order and $3 .5 million fine against AOL and the requirements on several occasions that AOL restate prior financial statements . Ernst &
Young was therefore aware of the SEC's significant concerns with AOL 's accounting practices, as well as with internet companies generally . Further, Ernst & Young knew of the importance the SEC attached to making sure that AOL and AOL Time Warner's financial statements did not
"reflect the desire of management rather than the underlying financial performance of the company" and did not "stretch the rules through aggressive accounting."
40699 .1 238 d. Ernst & Young knowingly or recklessly failed to design its tests or
execute its audits properly to investigate the nature, timing and amount of revenues which Ernst
& Young knew were being recorded at the eleventh hour at AOL and AOL Time Warner . Ernst
& Young knew that AOL and AOL Time Warner management had a practice of promising
analysts, creditors, and other third parties that the companies would achieve what appeared to b e
unduly aggressive or clearly unrealistic forecasts - AOL and AOL Time Warner were touted as
the industry powerhouse primarily because of their ability to meet and generally exceed undul y
aggressive forecasts. When the online advertising market was weakened , AOL and AOL Time
Warner communicated their superiority and insulation from any risk of loss . Ernst & Young
knew the positive impact the announcement of a large advertising deal would have on the AOL
and the AOL Time Warner share price, and knew that AOL and AOL Time Warner were
extraordinarily intent on hitting advertising revenue targets . Ernst & Young knew that AOL's
"BA Specials" that would come through near the end of a reporting period consistently aided
AOL and AOL Time Warner in meeting or exceeding the market's high expectations .
e. Ernst & Young did not adjust its audit procedures despite a failure b y
AOL and the Company's management to display and communicate an appropriate attitud e regarding internal controls in the financial reporting process . As the long-term auditing and
accounting firm of AOL and AOL Time Warner, Ernst & Young was very aware that AOL and
AOL Time Warner placed significant emphasis on hitting earnings targets and analyst expectations at the expense of fiscal responsibility and proper accounting practice . In this regard, Ernst & Young knew of the high pressure and focused environment at the companies to report revenue, especially advertising revenue, as high as possible . This included AOL and AOL
Time Warner's senior management continuously setting unduly aggressive and unattainabl e
40699.1 239 revenue targets and expectations for operating personnel, as opposed to targets and expectation s based on the operational realities at the companies and within the internet industry, thereb y setting up enormous pressure on the AOL and AOL Time Warner management to employ improper advertising revenue recognition practices . Despite this attitude and corporate culture ,
Ernst & Young failed to address the risks of overstated revenues .
f. Ernst & Young knowingly or recklessly failed to inquire of all partie s involved in the complex barter/roundtrip transactions, did not perform substantive tests t o determine proper valuation (such as present value analyses or comparable market pricing t o estimate fair market value) and did not investigate whether advertising revenue was truly earne d or realizable. In order to determine such, investigations as to the value of deals touted in AOL and AOL Time Warner's SEC filings, specifically the collectibility of receivables or restricted stock transactions should have been examined .
g. Ernst & Young did not appropriately design or execute its audits t o
properly address the impairment of AOL Time Warner' s tangible and intangible assets. AOL
Time Warner ignored the requirements in the then present literature regarding goodwil l
impairment, choosing to wait to apply subsequent standards and claim the impairment loss wa s
a result of new accounting literature.
h. Ernst & Young knowingly or recklessly failed to increase its substantiv e
testing to determine how or why AOL and AOL Time 'Warner continued to show growth o f
large proportions when competitors and the industry as a whole was declining . Additional
testing should have included comprehensive tracking of relationships (to expose th e
roundtripping/barter transactions, procedures should have been put in place to identify th e
reciprocal patterns of purchases and sales) and examination of pricing (including discounts) o f
40699 .1 240 counterparties' bartering instruments (AOL and AOL Time Warner paid inflated prices for
customer goods or services to generate inflated sales for itself). Ernst & Young knew that AOL
and AOL Time Warner faced a high degree of competition in a market facing declining
margins. Not only this, but the industry as a whole was suffering with increasing busines s
failures and significant declines in customer demand . Ernst & Young was aware that AOL an d
AOL Time Warner faced the reality that their advertising revenue was a critical indicator of
performance, while the industry was experiencing declining advertising demand .
Ernst & Young knowingly or recklessly failed to audit the controls aroun d
the disclosures, classification and timing for advertising revenue, allowing classification a s
revenues rather th an gains/losses on contracts. As AOL and AOL Time Warner 's dot-com
customers were failing and the related revenue streams were drying up, Ernst & Young wa s
aware that AOL and AOL Time Warner began to reduce commitments and accelerate
collections from these customers and that AOL and AOL Time Warner would allow the dot-
corns to pay their way to a shortened or terminated deal, saving the dot-com years of payments
and generating immediate cash flow for the companies.
615. Ernst & Young was also aware of significant audit risks ("red flags") relating to
the operating characteristics and fin ancial stability of the AOL and AOL Time Warner, yet
failed to plan and perform the nature, timing and extent of its audit procedures, including :
a. Ernst & Young was aware of and knowingly or recklessly failed t o
examine the nature, timing and classification of round-tripping and barter transactions . In order
to appropriately account for the transactions, further investigation beyond reading the contract s
was required. Ernst & Young knew that AOL and AOL Time Warner regularly entered into
40699.1 241 roundtripping or barter transactions that generated gains or earnings growth while the amount s
of cash transacted were simply exchanges of like amounts .
b . Ernst & Young knowingly or recklessly failed to plan its audits to consider
the fact that AOL and AOL Time Warner's financial reporting was based on significant
estimates that involved unusually subjective judgments or uncertainties, or that were subject to
potential significant changes in the near term that were financially disruptive on the entity (e .g.
ultimate collectibility of receivables, timing of revenue recognition, or realizability of financia l
instruments based on the highly subjective valuation of collateral or difficult-to-asses s
repayment sources ). Ernst & Young knew that AOL and AOL Time Warner entered into barter
transactions on a regular basis that included goods and services of an estimated value . Ernst &
Young failed to design substantive tests to determine the reasonableness of these estimate d
values. Ernst & Young failed to examine the counterparties' competitive pricing and standard
discounts for similar transactions - there were cases where AOL and AOL Time Warner
overpaid for goods and services to provide incentive to the counterparty to purchase from AO L
and AOL Time Warner and valued the transactions at the inflated amounts .
c. Ernst & Young did not properly ascertain materiality as it related to AO L
and AOL Time Warner and its transactions. Materi ality applies to both the quantitative and
qualitative factors Ernst & Young knowingly or recklessly failed to consider the impact o f
overstated advertising revenue on the stock price and investors' decision-making . Ernst &
Young was aware that AOL and AOL Time Warner had significant, unusual , and highly
complex transactions, especially those close to quarter or year end, that posed difficul t
"substance over form" questions. Most of AOL and AOL Time Warner 's barter/roundtripping
40699.1 242 transactions, in addition to advertising deals with companies who were obligated to remit
litigation settlements to the company, fell into this risk category.
d. Ernst & Young knowingly or recklessly failed to examine transactions fo r
substance over form, proper valuation and business use . Ernst & Young was aware that AOL
and AOL Time Warner had contractual arrangements without apparent business purpose. AOL
and AOL Time Warner entered into deals with companies who had no business purpose fo r
advertising online.
e. Ernst & Young knew, but knowingly or recklessly failed to ascertain why ,
AOL and AOL Time Warner outperformed everyone in the marketplace, accepting the eas y
answer that the proof was in the numbers . Ernst & Young had the responsibility to exercise
skepticism in investigating the revenue recognition policies, including valuation, timing and
collectibility of the barter transactions, and the "multi-million dollar" deals with companies with
questionable futures. It did not carry out its responsibility.
616. Given Ernst & Young's actual knowledge and disregard of such significant audi t
risk factors ("red flags") at AOL and AOL Time Warner, particularly in the context of how
sensitive advertising revenue recognition issues were, and are, for internet-based companies ,
Ernst & Young either knew of or recklessly disregarded, the various sham and improperl y
accounted for AOL and AOL Time Warner transactions desc ribed in this Complaint. Ernst &
Young's total abdication of professional skepticism in not challenging the economic substanc e
and reality of the subject transactions resulted in the issuance of a "clean" or unqualified audit
opinion on financial statements that were known or would have been known had Ernst & Young
conducted its audits in accordance with GAAS, to be materially misstated.
40699 .1 243 b. Ernst & Young Failed to Maintain Independence
617. Ernst & Young violated GAAS General Standard No . 2, which requires the
auditor to maintain an independence in mental attitude in all matters relating to the audit . The
independent auditor must comply with the rules of independence, including AU § 150.02 which provides that. Similarly, AU § 220.02 states :
"In all matters relating to the assignment, an independence in mental attitude is to b e
maintained by the auditor or auditors. Similarly, AU § 220 .02 states:
[T]he auditor must be independent . . . .he must be without bias with respect to the client since otherwise he would lack that impartiality necessary for the dependability of his findings, however excellent his technical proficiency may be. However, independence does not imply the attitude of a prosecutor but rather a judicial impartiality that recognizes an obligation for fairness not only to management and owners of a business but also to creditors and those who may otherwise rely (in part, at least) upon the independent auditor's report, as in the case of prospective owners or creditors . AU § 220.02.
618. Ernst & Young knew that its various other business dealings with AOL and AOL
Time Warner through which it earned enormous fees presented conflicts of interest for Ernst &
Young, which motivated it to appease the companies rather than perform its auditing
responsibilities for the benefit of the companies' shareholders .
c. Ernst & Young Violated GAAS By Reporting That The Financial Statements Were Presented in Accordance With GAAP When They Were Not
619. Standard of Reporting No . I states :
The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. AU § 150.02 .
Professional standards set forth the following requirements with respect to this standard :
The term "generally accepted accounting principles" as used in reporting standards is construed to include not only accounting principles and practices but also the methods of applying them. AU § 410.02.
40699.1 244 The phrase "generally accepted accounting principles" . . . includes not only broad guidelines of general application , but also detailed practices and procedures . . . . AU§411 .02.
The auditor ' s opinion that financial statement present fairly an entity's financial position, results of operations, and cash flow in conformity with generally accepted accounting p rinciples should be based on his or her judgment as to whether (a) the accounting principles selected and applied have general acceptance ; (b) the accounting p rinciples are appropriate in the circumst ances . . . (e) the financial statements reflect the underlying transactions and events in a manner that presents the financial position, results of operations, and cash flows stated within a range of acceptable limits, that is, limits that are reasonable and practicable to attain in financial statements . AU § 411 .04 .
620. Ernst & Young violated GAAS Reporting Standard No . 1, which requires th e
audit report to state whether the financial statements are presented in accordance with GAAP, as
Ernst & Young's audit opinions falsely represented that the AOL and AOL Time Warner
financial statements complied with GAAP when, in fact, those financial statements wer e
materially misstated.
d. Ernst & Young Failed to Obtain Sufficient and Competent Evidential Matter.
621 . "Most of the independent auditor's work in forming his or her opinion on
financial statements consists of obtaining and evaluating evidential matter concerning th e
assertions in such financial statements ." AU § 326.02. "The independent auditor's direct
personal knowledge, obtained through physical examination, observation, computation, an d
inspection, is more persuasive than information obtained indirectly ." AU § 326.21 .
Representations from management "are not a substitute for the application of those auditin g
procedures necessary to afford a reasonable basis for an opinion regarding the financia l
statements under audit." AU § 333 .02; AU § 333 .02 . "The books of original entry, the general
and subsidiary ledgers, related accounting manuals, and records such as work sheets an d
spreadsheets supporting cost allocations, computations, and reconciliations all constitut e
40699.1 245 evidence in support of the financial statements ." "[W]ithout adequate attention to the propriety and accuracy of the underlying accounting data, an opinion on financial statements would not b e warranted." AU § 326.16, AU § 326 .15. Ernst & Young violated GAAS by failing to obtain sufficient and competent evidential matter .
622 . For example, Ernst & Young failed to obtain sufficient competent evidential matter with respect to AOL and AOL Time Warner' s excessive valuation and completion of earnings process in connection with barter transactions . Ernst & Young failed to :
a. Perform an adequate test of the fair market value of the goods, services and equity exchanged for advertising;
b. Inquire of lower level staff responsible for putting goods into service to determine the benefit received by AOL and AOL Time Warner; and
c. Inquire of customers as to the value received by the customer.
623 . Further, Ernst & Young failed to obtain sufficient competent evidential matter with respect to AOL and AOL Time Warner 's overpayments for goods or services in order to generate reciprocal sales. Ernst & Young failed to :
a. Obtain standard price lists, large customer and volume discounts, etc . from vendors to determine the reasonableness of p rices being paid by AOL and AOL Time Warner; and
b. Compare such transactions with similar purchases made in the past t o determine whether an overpayment was made .
624. Ernst & Young also failed to gather sufficient competent evidential matter t o corroborate AOL and AOL Time Warner' s management representations as to the earnings process completed in connection with "jackpotting." Ernst & Young failed to :
40699.1 246 a. Examine the times and sites on which ads ran which would have demonstrated the lack of a true earnings process and in turn revealed a mechanism used simpl y to generate revenue;
b. Inquire of lower level staff responsible for placing the advertisements o n
AOL's web site; and
c. Inquire of customers who expressed dissatisfaction over "jackpotting ."
e. Ernst & Young Failed to Exercise Due Professional Care and Professional Skepticism .
625 . "Due professional care requires the auditor to exercise professional skepticism ."
This requires the auditor to "diligently perform, in good faith and with integrity, the gatherin g
and objective evaluation of evidence ." "In exercising professional skepticism, the auditor
should not be satisfied with less than persuasive evidence because of a belief that managemen t
is honest." AU §§ 230.07-09, AU § 316 .16-21 (professional skepticism is required in plannin g
and performing an audit) . The auditor also "must be without bias with respect to the client sinc e
otherwise he would lack [the] impartiality necessary for the dependability of his findings ." AU
§ 220.02. Notwithstanding these requirements, in connection with its planning and performin g
audit procedures concerning, among other things, recognition of advertising revenue, and
certain other matters described herein, Ernst & Young relied almost exclusively o n
representations from AOL and AOL Time Warner management and failed to exercise
professional skepticism, failed to maintain an independent mental attitude and failed to exercis e
due professional care in the exercise of its audits .
f. Ernst & Young Failed to Properly Plan and Supervise .
626. The auditor must adequately plan its audit and properly supervise the work o f
associates so as to establish and carry out procedures reasonably designed to search for and
40699.1 247 direct the existence of fraud that could have a material effect on the financial statements . AU § §
310, 320, 327. The auditor must also obtain a level of knowledge of its clients' businesses
sufficient to enable it to "obtain an understanding of the events, transactions, and practices that ,
in his judgment, may have a significant effect on the financial statements." AU § 311 .06.
. . . The auditor may decide to consider further management's selection and application of significant accounting policies, particularly those related to revenue recognition, asset valuations, or capitalizing versus expensing . In this respect, the auditor may have a greater concern about whether the accounting principles selected and policies adopted are being applied in an inappropriate manner to create a material misstatement of the financial statements . AU § 316A.27. (Emphasis added .)
627 . For example, Ernst & Young failed to obtain sufficient knowledge, and plan it s
audit accordingly, with respect to AOL and AOL Time Warner's accounting and repo rting
systems to recognize, among other things :
a. The methods AOL employed to generate substantial advertising sales activities near the end of reporting periods along with any weaknesses of failures within th e internal control system that would ensure such sales ' validity. AOL had "BA specials" - that were generated at the eleventh hour of a given reporting period and provided revenue figure s necessary to hit earnings targets, but later would be deemed uncollectible or impaired ;
b. Weaknesses associated with AOL's accounting policies related to revenue/gain classification. AOL renegotiated deals for a buy-out or early termination wit h failing dot-corns which were construed as sales revenues rather than a gain or other revenues ; and
c. Litigation settlements that were converted to advertising revenue on more than one occasion . There appeared to be little or no internal controls governing such classification practices, nor did Ernst & Young plan their audits accordingly based on thes e
40699.1 248 weaknesses within the internal control system . In connection with planning and supervising it s
audit procedures, Ernst & Young violated GAAS.
628. In addition, Ernst & Young failed to obtain sufficient knowledge upon which t o
assess the environment under which AOL and AOL Time Warner's accounting data, were
produced and processed :
a. Revenues/profitability were not consistent with industry trends (AOL wa s
able to show increased advertising revenues in an industry facing
significant decline);
b. The rate of change within the industry was rapid ;
c. AOL and AOL Time Warner operated within a highly competitive
environment;
d. Direction of change within industry was declining with business failures ;
e. Management demonstrated an attitude toward financial reporting that wa s
unduly aggressive;
f. Management placed undue emphasis on meeting revenue/earnings
projections;
g. Management's compensation was tied to meeting aggressive targets ;
h. Many contentious or difficult accounting issues were present ; and
i. Significant difficult-to-audit transactions or balances were present.
g. Ernst & Young Failed to Properly Evaluate Audit Findings.
629 . "The risk of material misstatement of the financial statements is generally greate r
when account balances and classes of transactions include accounting estimates rather than
essentially factual data because of the inherent subjectivity in estimating future events ."
40699.1 249 Estimates are subject "to misstatements that may arise from using inadequate or inappropriate
data or misapplying appropriate data." AU § 312 .36. "Even when management 's estimation
process involves competent personnel using relevant and reliable data, there is potential for bias
in the subjective factors ." Accordingly, the auditor should consider estimates "with an attitude
of professional skepticism." AU § 342 .04. "[T]he auditor should obtain an understanding of
how management developed the estimate," AU § 342 . 10, and should "obtain sufficient
competent evidential matter to provide reasonable assurance " that, among other things,
estimates are reasonable in the circumstances and are presented in conformity with GAAP, AU
§ 342.07 . Ernst & Young violated GAAS, because it failed to obtain sufficient competent
evidential matter concerning, and, therefore, failed to properly evaluate, AOL and AOL Time
Warner's estimates of, among other things , round-tripped transactions, bartered goods and
services, and goodwill impairments .
h. Ernst & Young Failed to Properly Consider AOL and AOL Time Warner's Lack of Internal Control.
630. "In all audits, the auditor should obtain an understanding of internal contro l
sufficient to plan the audit ." AU § 319 .02. "The auditor should obtain sufficient knowledge of
the information system relevant to financial reporting to understand," among other things, the
classes of significant transactions, "the accounting records , supporting information and specific
accounts in the financial statements involved in the processing and reporting of transactions,
the accounting processing involved in recording, processing, accumulating and reporting
transactions, and the financial repo rting process used to prepare financial statements." AU §
319 .49. Ernst & Young violated GAAS because it knowingly or recklessly failed to lea rn or to
consider that AOL and AOL Time Warner had grossly deficient internal controls and
procedures . For example , Ernst & Young failed to develop or plan its audits to consider:
40699.1 250 a. that AOL Time Warner had grossly deficient revenue recognition disclosure controls, including the lack of an appropriate system for determining amount, timin g and classification of revenues/gains, policies governing the calculation of fair market value i n the complex barter transactions, and integrity of revenue disclosures to report the true substance of transactions rather than their form which were many times quite different. This included a lack of control over a few key employees' ability to influence the accounting for advertisin g revenue; and
b. that efforts were not made to assure that all necessary adjustments to correctly and fairly present AOL and AOL Time Warner's quarterly financial position and results of operations.
L. The Materially False and Misleading Statements and Omissions of Material Facts In the Merger Registration Statement and Joint Proxy Statement-Prospectu s
631 . On February 11, 2000, AOL Time Warner filed with the SEC and disseminated t o
the public the Merger Registration Statement, which included the Joint Proxy Statement-
Prospectus. AOL Time Warner made four amendments to the Merger Registration Statement,
the last of which was filed with the SEC on May 19, 2000 .
632 . The Merger Registration Statement was signed by J. Michael Kelly, Executiv e
Vice President and Chief Financial Officer, Gerald M . Levin, Chief Executive Officer, an d
Paul T. Cappuccio, Vice President and Director.
633 . The Joint Proxy Statement-Prospectus was signed by Defendant Case, a s
Chairman and Chief Executive Officer of AOL, and Defendant Levin, as Chairman of Tim e
Warner, and sent to shareholders of both companies on or about May 23, 2000 .
634. The Merger Registration Statement and Joint Proxy Statement-Prospectu s
included the Second Amended and Restated Agreement and Plan of Merger (the "Merger
40699.1 251 Agreement") . The Merger Agreement was attached as Annex A to the Merger Registratio n
Statement and Joint Proxy Statement-Prospectus . In the Merger Agreement, AOL represente d
and warranted as follows:
4.1 Representations and Warranties of America Online . . .
(d) Reports and Financial Statements.
(i) America Online has filed all required registration statements, prospectuses, reports, schedules, forms, statements and other documents required to be filed by it with the SEC since July 1, 1997 (collectively, including all exhibits thereto, the "America Online SEC Reports") . . . . None of the America Online SEC Reports, as of their respective dates (and, if amended or superseded by a filing prior to the date of this Agreement, then on the date of such filing), contained or will contain any untrue statement of a material fact or omitted or will omit to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading . Each of the financial statements (including the related notes) included in the America Online SEC Reports presents fairly, in all material respects, the consolidated financial position and consolidated results of operations and cash flows of America Online and its consolidated Subsidiaries as of the respective dates or for the respective periods set forth therein, all in conformity with United States generally accepted accounting principles ("GAAP") consistently applied during the periods involved except as otherwise noted therein, and subject, in the case of the unaudited interim financial statements, to the absence of notes and normal year-end adjustments that have not been and are not expected to be material in amount. All of such America Online SEC Reports, as of their respective dates (and as of the date of any amendment to the respective America Online SEC Report), complied as to form in all material respects with the applicable requirements of the Securities Act and the Exchange Act and the rules and regulations promulgated thereunder .
(e) Information Supplied.
(i) None of the information supplied or to be supplied by America Online for inclusion or incorporation by reference in (A) the Form S-4 (as defined in Section 6 .1) will, at the time the Form S-4 is filed with the SEC, at any time it is amended or supplemented or at the time it becomes effective under the Securities Act, contain any untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading and (B) the Joint Proxy Statement/Prospectus (as defined in Section 6.1) will, on the date it is first mailed to Time Warner stockholders or America Online stockholders or at the time of the Time Warner Stockholders Meeting or the America Online Stockholders Meeting (each as defined in Section 6 .1), contain any
40699.1 252 untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary in order to make the statements therein . in light of the circumstances under which they were made, not misleading . The Form S-4 and the Joint Proxy Statement/Prospectus will comply as to form in all material respects with the requirements of the Exchange Act and the Securities Act and the rules and regulations of the SEC thereunder.
(Emphasis added.)
635 . The Joint Proxy Statement-Prospectus included the following message to
shareholders: "The boards of directors of both America Online and Time Warner have approve d
the merger and recommend that their respective stockholders vote FOR the merger proposal .
Information about the merger is contained in this joint proxy statement-prospectus ."
636. The Joint Proxy Statement-Prospectus continued :
Your vote is very important, regardless of the number of shares you own . Whether or not you plan to attend the special meeting, please vote as soon as possible to make sure that your shares are represented at the meeting . If -You do not vote, it will have the same effect as voting against the merger . We strongly support this combination of our companies and join with our boards of directors in enthusiastically recommending that you vote in favor o f the merger .
(Emphasis added.)
637. The Joint Proxy Statement-Prospectus explained that the record date of eligibility
to vote on the Merger was May 18, 2000, and that the Special Stockholder Meetings for AO L
and Time Warner shareholders would both take place on June 23, 2000 .
638. The Merger required and received the affirmative vote of the AOL and Tim e
Warner shareholders at the respective Special Stockholder Meetings .
639. The Merger Registration Statement and Joint Proxy Statement-Prospectu s
included selected historical financial data of AOL, including the audited consolidated fin ancial
40699.1 253 statements of AOL for the year ended June 30, 1999 and unaudited consolidated financia l statements for the nine months ended March 31, 1999 and 2000 .
640. In addition, the Merger Registration Statement and Joint Proxy Statement-
Prospectus included unaudited pro forma consolidated financial data of AOL Time Warner.
The pro forma financial results were presented on two different bases due to AOL's and Time
Warner's different fiscal years - a June 30 fiscal year basis and a December 31 calendar year basis. The AOL Time Warner pro forma financial data included revenue data for the nine months ended March 31, 2000, the year ended June 30, 1999, the three months ended March 31 ,
2000 and the year ended December 31, 1999.
641 . The Merger Registration Statement also included the pro forma consolidate d condensed balance sheet of AOL Time Warner as of March 31, 2000 which purported to reflect the historical financial position of AOL at March 31, 2000 and also set fo rth the amount allocated to goodwill as a result of the Merger .
642 . The Merger Registration Statement and Joint Proxy Statement-Prospectus als o incorporated by reference, inter alia, the documents set forth below, each of which included some or all of the materially untrue and misleading financial statements and information referred to herein :
a. America Online's Annual Report on Form 10-K for the fiscal year ended June 30, 1999 (filing date August 13, 1999) ;
b. America Online's Quarterly Report on Form 10-Q, for the quarterly period ended September 30, 1999 (filing date November 2, 1999);
c. Ameri ca Online's Quarterly Report on Form 10-Q, for the quarterly period ended December 31, 1999 (filing date February 14, 2000);
40699.1 254 d. America Online's Quarterly Report on Form 10-Q/A, for the quarterly period ended March 31, 2000 (filing date May 17, 2000), which contains financial statements and related information that restate and supersede the financial statements and related information in America Online's Annual Report on Form 10-K for the fiscal year ended June 30, 1999, filed August 13, 1999 ;
e. America Online's Current Report on Form 8-K dated January 19, 2000 (filing date January 20, 2000) incorporating AOL's press release, dated January 19, 2000, announcing AOL's financial results for the quarter ended December 31, 1999 ;
f. America Online's Current Report on Form 8-K dated January 10, 2000 (filing date February 11, 2000) incorporating AOL Time Warner pro forma consolidated condensed financial statements for the three months ended September 30, 1999, the year ended June 30, 1999, nine months ended September 30, 1999 and year ended December 31, 1998 ;
g. America Online's Current Report on Form 8-K dated April 3, 2000 (filing date April 3, 2000) incorporating AOL Time Warner pro forma consolidated condensed financial statements for the six months ended December 31, 1999, the year ended June 30, 1999, and the year ended December 31, 1999 ;
h. America Online's Current Report on Form 8-K dated April 18, 2000 (filing date April 21, 2000) incorporating AOL's press release, dated April 18, 2000, announcing AOL's financial results for the quarter ended March 31, 2000 ; and
i. The Joint Proxy Statement and Prospectus filed with the SEC on or about May 19, 2000 and sent to Time Warner and AOL shareholders on or about May 23, 2000 relating to the Merger of AOL and Time Warner .
643 . The Merger Registration Statement and Joint Proxy Statement-Prospectus
included the January 9, 2000 opinion of Morgan Stanley to Time Warner shareholders that th e
exchange ratio was "fair from a financial point of view" to the holders of Time Warner stock.
644. Ernst & Young consented to the incorporation by reference in the Merger
Registration Statement and Joint Proxy Statement-Prospectus of its unqualified audit report ,
dated July 21, 1999, on AOL's 1999 consolidated financial statements as set fo rth in AOL's
40699 .1 255 1999 SEC Form 10-K for the year ended June 30, 1999 and consented to all references to Erns t
& Young in the Merger Registration Statement and Joint Proxy Statement-Prospectus, whic h
included a reference to it under the caption "Experts ." In a subsequent amendment to the
Merger Registration Statement, Ernst & Young consented to the reference to itself a s
"Experts" and to the use of its report dated July 21, 1999, except for Note 3, which is dated
May 12, 2000, with respect to the consolidated financial statements of AOL for the three years
ended June 30, 1999 incorporated by reference as Exhibit 99 to AOL's SEC Form 10-Q/A fo r
the quarterly period ended March 31, 2000, incorporated by reference and made a part of th e
Merger Registration Statement and Joint Proxy Statement-Prospectus . In that amendment ,
Ernst & Young also consented to the incorporation by reference in the Merger Registratio n
Statement and Joint Proxy Statement-Prospectus, and to the reference to itself as "Experts," o f
its May 19, 2000 report with respect to the consolidated balance sheet of AOL Time Warner as
of March 31, 2000. Finally, Ernst & Young consented to the incorporation by reference in the
Merger Registration Statement and Joint Proxy Statement-Prospectus of its report dated Jul y
20, 2000, with respect to the consolidated financial statements of AOL included in its SEC
Form 10-K for the year ended June 30, 2000 . These reports were incorporated in the Merge r
Registration Statement and Joint Proxy Statement-Prospectus "in reliance on Ernst & Young' s
report, given on their authority as experts in accounting and auditing ."
645 . AOL Time Warner further represented in the Merger Registration Statemen t
and Joint Proxy Statement-Prospectus that Ernst & Young had audited the consolidate d
balance sheet of AOL Time Warner at March 31, 2000 and audited the consolidated financia l
statements of AOL for the three years ended June 30, 1999 and that such financials wer e
incorporated in the Merger Registration Statement and Joint Proxy Statement-Prospectus unde r
40699.1 256 "Experts" "in reliance on Ernst & Young LLP's report, given on their authority as experts in accounting and auditing."
646. The pro forma consolidated condensed financial statements included in th e
Merger Registration Statement and Joint Proxy Statement-Prospectus were "presented to illustrate the effects of the Merger." The pro forma financial statements represented that as a result of the Merger an estimated amount of $94 .705 billion would be allocated to goodwil l due to the excess purchase price over identifiable tangible and other intangible assets. The pro forma financial statements also estimated a useful life of 25 years for the goodwill .
647 . The Company's Merger Registration Statement and AOL's and Time Warner's
Joint Proxy Statement-Prospectus represented that :
AOL Time Warner will periodically review the carrying value of the acquired goodwill for acquired businesses to determine whether an impairment may exist . AOL Time Warner will consider relev ant cash flow information, including estimated future operating results , trends and other available information, in assessing whether the carrying value of goodwill c an be recovered . If it is determined that the carrying value of goodwill will not be recovered from the undiscounted future cash flows of acquired businesses, the carrying value of such goodwill would be considered impaired and reduced by a charge to operations in the amount of the impairment .
(Emphasis added.) In addition, the Merger Registration Statement and Joint Proxy Statement-
Prospectus represented that an "impairment charge" would be "measured as any deficiency in the amount of estimated undiscounted cash flows of acquired businesses available to recover th e carrying value related to goodwill ."
648. All of the financial statements of AOL contained or incorporated by reference in the Merger Registration Statement and Joint Proxy Statement-Prospectus were untrue becaus e they materially overstated AOL advertising and commerce revenue, and/or AOL advertising and
40699.1 257 commerce backlog, and/or percentage increases in such amounts in year over year comparisons ,
for various fiscal periods as set forth in ¶¶ 257-374 and 409 .
649. All of the pro forma financial statements for AOL Time Warner, including the
Company's pro forma consolidated condensed balance sheet as of March 31, 2000, contained o r
incorporated by reference in the Merger Registration Statement and Joint Proxy Statement-
Prospectus were untrue because they mate rially overstated AOL advertising and commerce
revenue, as set forth in 11252-374 and 409, and because they materially overstated the real
value of goodwill and its useful life, as set forth in 11 412-449.
650. All of the financial statements and pro forma fin ancial statements contained o r
incorporated by reference in the Merger Registration Statement and Joint Proxy Statement-
Prospectus failed to disclose the sham transactions and improper accounting that resulted in th e
overstated advertising revenue and backlog, and percentage comparisons referred to above ; the
true current and anticipated condition of AOL's advertising revenue and business ; and the true
fair value of goodwill created by the Merger and its useful life was materially overstated .
651 . The Fairness Opinion of Morgan Stanley included or incorporated by reference i n
the Merger Registration Statement and Joint Proxy Statement-Prospectus falsely represente d
that the exchange ratio was "fair from a financial point of view" to Time Warner stockholder s
because AOL stock was overvalued and AOL had engaged in sham transactions and imprope r
accounting.
652. All of the financial statements of AOL contained or incorporated by reference i n
the Merger Registration Statement and Joint Proxy Statement-Prospectus falsely represente d
that they were prepared in accordance with GAAP and Article 10 of Regulation S-X .
40699.1 258 653. With respect to the audited financial statements of AOL included or incorporated
by reference in the Merger Registration Statement and Joint Proxy Statement-Prospectus, Erns t
& Young falsely represented that they were audited in conformance with GAAS .
654. All of the financial statements of AOL contained or incorporated by reference in
the Merger Registration Statement and Joint Proxy Statement-Prospectus falsely represente d
that they fairly represented the results of AOL operations, particularly with respect to th e
advertising revenue and business of AOL .
655 . For the same reasons set forth above, AOL's representations and warranties in the
Merger Agreement attached as Annex A to the Merger Registration Statement and Joint Proxy
Statement-Prospectus that: (1) AOL's financial statements were prepared in conformity with
GAAP; and (2) AOL's SEC filings were free of material misstatements and omissions were
similarly untrue and misleading .
M. The Materially False and Misleading Statements and Omissions of Material Facts In AOL Time Warner's Bond Registration Statement for the April 2001 and April 2002 Bond Offerings
656. The Merger, which was finalized on January 11, 2001, was important to the ne w
Company's credit ratings . Time Warner bonds were among the most widely-held issues, and
were considered a benchmark media name in the investment-grade bond market . The Merger
was expected to increase the credit ratings for the two major subsidiaries of AOL Time Warner-
AOL and Time Warner . On January 10, 2000, the Dow Jones Capital Markets Report reported :
Investors and analysts say that AOL's acquisition of Time Warner could mean a boost for the combined company's credit ratings.
"The leverage looks better on a market cap basis for the merged entity," said Peter Palfrey, portfolio manager at Back Bay Advisors LP, Boston . "It's a positive for their credit quality," said Marion Boucher Sopor, director of high-grade research at Bear Stearns .
40699 .1 259 657. Indeed, on January 14, 2001, AFXNews reported that the new Company's credit
ratings were to be raised:
Standard and Poor's Corp . said it raised its ratings on America Online, Inc . and Time Warner, Inc . to BBB+ following the completion of their merger of the two companies.
Standard and Poor's also said that all ratings have been removed from CreditWatch and the current outlook is stable .
658. On January 17, 2001, Business Wire reported:
Fitch has upgraded the senior unsecured debt rating of Time Warner Inc . and subsidiaries (Time Warner) to 'BBB+' from 'BBB' following the close of Time Warner's merger with America Online, Inc . (AOL).
The rating upgrade reflects the expanded business base, leading market position of major businesses, significant opportunities for synergies, and solid credit measures . The merger of AOL and Time Warner is expected to provide for a mutual enhancement of business opportunities that will strengthen the combined operations relative to the stand-alone businesses of either company.
659. Based on Defendants ' representations of AOL Time Warner as "the world's
preeminent Internet-powered media and communications company" with solid credit ratings an d
substantial revenue growth , AOL Time Warner was able to generate significant demand for the
offerings of AOL Time Warner bonds.
660. In April 2001 and April 2002, Defendant AOL Time Warner offered and sol d
approximately $10 billion of Bonds to the public . In so doing, the Company offered and sol d
the Bonds pursuant to "Amendment No . 1 to Form S-3 Registration Statement Under Th e
Securities Act of 1933," dated February 26, 2001 ("Bond Registration Statement"). For
purposes of the April 2001 Offering, a Prospectus Supplement, dated April 11, 2001 ,
supplemented the Bond Registration Statement. For purposes of the April 2002 Offering, a
Prospectus Supplement, dated April 3, 2002, further supplemented the Bond Registratio n
40699 .1 260 Statement. The proceeds from the Offerings were intended to be used for "general corporate
purposes."
661 . The MSBI purchased bonds in April 2001 and April 2002 pursuant to the AOL
Time Warner Bond Offerings from Defendant Underwriters. The bonds purchased by the MSB I
pursuant to the 2001 Bond Offering were bought on or about April 11, 2001, and the settlemen t
of the transactions took place on or about April 19, 2001 . The bonds purchased by the MSBI
pursuant to the 2002 Bond Offering were bought on or about April 3, 2002 and the transaction s
were settled on or about April 8, 2002 . Numerous other members of the Class similarl y
purchased the AOL Time Warner bonds through underwriters, including all of the Defendan t
Underwriters, pursuant to the April 2001 and 2002 Offerings . The MSBI and numerous other
members of the Class also purchased AOL Time Warner bonds in the secondary market that are
traceable to the Bond Offerings .
662. The Bond Registration Statement was, among others, signed by or on behalf of
the following Individual Defendants :
J . Michael Kelly Barry M. Schuler Gerald M. Levin Joseph A. Ripp Stephen M . Case Paul T. Cappuccio Richard D. Parsons James W. Barge Robert W . Pittman Wayne H . Pace Kenneth J. Novack Frank J. Caufield Daniel F . Akerson Stephen F. Bollenbach Miles R. Gilburne Franklin D . Raines
663. The Bond Registration Statement incorporated by reference, inter alia, the
documents set forth below, each of which included some or all of the materially untrue an d
misleading financial statements and information referenced herein :
40699 .1 261 a. America Online's Annual Report on Form 10-K for fiscal year ended June 30, 2000 (filing date September 22, 2000), as amended Form 10-K/A (filing date October 30, 2000) ;
b. AOL's Form 10-Q for quarter ended September 30, 2000 (filing date November 9, 2000), as adjusted by AOL Time Warner's Form 8-K, dated January 18, 2001 (filing date January 26, 2001);
c. AOL Time Warner's Joint Proxy Statement-Prospectus, included in the Merger Registration Statement, which became effective May 19,2000; and
d. AOL Time Warner's Form 8-K, dated January 11, 2001 and 8-K/A dated January 11, 2001 (filing dates January 12 and 26, 2001 respectively) incorporating, inter alia, the Merger Agreement between AOL and Time Warner (Form 8-K), the AOL Time Warner consolidated balance sheet as of December 31, 2000 and AOL Time Warner pro forma consolidated condensed financial statements for the three months ended September 30, 2000, year ended June 30, 2000, nine months ended September 30, 2000 and year ended December 31, 1999 (Form 8-K/A) .
664. The Prospectus Supplement, dated April 11, 2001, incorporated by reference th e
same documents referenced in ¶ 663 above .
665. The Prospectus Supplement, dated April 3, 2002, also incorporated by reference
the same documents referenced in ¶ 663 above . In addition, this Prospectus Supplement
incorporated by reference AOL Time Warner's Form 10-K for the fiscal year ended Decembe r
31, 2001 (filing date March 25, 2002), as amended by Amendment No . 1 (filing date March 26 ,
2002), which included the Company's financial statements for the three years ended Decembe r
31, 2001 . This Form 10-K was incorporated by reference in the Supplement and Bond
Registration Statement under "Experts" in reliance on Ernst & Young's report, given on thei r
authority as experts in accounting and auditing.
666. The Bond Registration Statement and Prospectus Supplements thereto eac h
provided, inter alia, that all documents filed by AOL Time Warner or AOL "pursuant to Sectio n
40699.1 262 13(a), 13(c), 14 or 15(d) of the Securities Exchange Act of 1934 after the date of [this
prospectus or supplement] and prior to the termination of the offering of the securities, ar e
incorporated by reference into and are deemed to be a part of [this prospectus or supplement ]
from the date of filing of those documents ." (Emphasis added.)
667. Financial statements audited and reported by Ernst & Young were incorporated
into the Bond Registration Statement and Prospectus Supplements. Specifically, Ernst & Young
consented to : (1) the incorporation by reference of its report dated July 20, 2000, and to th e
reference to E rnst & Young under the caption "Experts," with respect to AOL's consolidated
financial statements included in AOL's SEC Form 10-K for the year ended June 30, 2000 ; (2)
the incorporation by reference of Ernst & Young's report dated January 18, 2001 and to th e
reference to Ernst & Young under the caption "Experts" with respect to the consolidated
balance sheet of AOL Time Warner as of December 31, 2000, included in AOL Time Warner' s
Current Report on Form 8-K/A dated January 11, 2001 ; (3) the incorporation of Ernst &
Young's report dated January 31, 2001, except for Note 2 as to which the date is March 21 ,
2001, with respect to the consolidated financial statements of AOL included in the Annual
Report on SEC Form 10-K for the year ended December 31, 2000 (which included an opinio n
by Ernst & Young for the period ended December 31, 1999) ; and (4) the incorporation of Ernst
& Young's report dated January 28, 2002 with respect to the consolidated financial statement s
of AOL Time Warner for the year ended December 31, 2001 . These reports were incorporated
in the Bond Registration Statement "in reliance on Ernst & Young's report, given on thei r
authority as experts in accounting and auditing ."
668. An amended Bond Registration Statement, filed with the SEC on February 26 ,
2001 incorporated AOL's consolidated financial statements for the three years ended June 30,
40699.1 263 2000, included in AOL's Form 10-K for the year ended June 30, 2000, "in reliance on Ernst &
Young's report, given on their authority as experts in accounting and auditing ."
669. In addition, in the Prospectus Supplement , dated April 11, 2001, AOL' s
consolidated financial statements for the three years ended December 31, 2000 and AOL Time
Warner's consolidated balance sheet as of December 31, 2000, as included in AOL Tim e
Warner's Form 10-K for the year ended December 31, 2000 and Form 8-K/A dated January 11 ,
2001, respectively, were incorporated by reference into the Prospectus Supplement and Bon d
Registration Statement under "Experts" "in reliance on Ernst & Young's report, given on thei r
authority as experts in accounting and auditing ."
670. The Bond Registration Statement included pro forma financial statements whic h
represented that as a result of the Merger an estimated amount of $94.705 billion would b e
allocated to goodwill due to the excess purchase price over identifiable tangible and other
intangible assets. The pro forma financial statements also estimated a useful life of 25 years
for the goodwill.
671 . All of the financial statements of AOL and AOL Time Warner contained or
incorporated by reference in the Bond Registration Statement and Prospectus Supplements wer e
untrue because they materially overstated AOL advertising and commerce revenue, and/or AO L
advertising and commerce backlog, and/or percentage increases in those amounts in year over
year comparisons, for various fiscal periods as set forth in ¶¶ 257-411 .
672. All of the pro forma financial statements for AOL Time Warner contained and/or
incorporated in the Bond Registration Statement and Prospectus Supplements were untru e
because they materially overstated AOL's and the Company's advertising and commerce
40699.1 264 revenu , as set forth in 11 257-41 1, and because they materially overstated the real value of
goodwill and its useful life, as set forth in IT 412-449 .
673. All of the financial statements of AOL and the Company contained or
incorporated by reference in the Bond Registration Statement and Prospectus Supplement s
falsely represented that they were prepared in accordance with GAAP and Article 10 o f
Regulation S-X.
674. With respect to the audited financial statements of AOL and the Company audited
by Ernst & Young, which were incorporated by reference in the Bond Registration Statemen t
and Prospectus Supplements, Ernst & Young falsely represented that they were audited in
conforniance with GAAS.
675 . All of the financial statements of AOL and the Company included or incorporated
by reference in the Bond Registration Statement and Prospectus Supplements falsely
represented that they fairly represented the results of the companies' operations, particularl y
with respect to the advertising revenue and business of AOL .
$76. For the same reasons as set forth above, AOL's representations and warranties in
the Merger Agreement incorporated into the Bond Registration Statement that (1) AOL's
financial statements were prepared in conformity with GAAP, and (2) AOL's SEC filings were
free of material misstatements and omissions, were similarly untrue and misleading .
VII. APPLICABILITY OF PRESUMPTION OF RELIANCE : FRAUD-ON-THE-MARKET DOCTRIN E
677. At all relevant times, the market for AOL and AOL Time Warner securities,
including its common stock and bonds, was an efficient market for the following reasons ,
among others:
40699.1 265 a. AOL's and the AOL Time Warner' s securities met the requirements for
listing, and were listed and actively traded on the NYSE, a highly efficient and automated
market;
b. As regulated issuers, AOL and AOL Time Warner filed periodic publi c
reports with the SEC and the NYSE ;
c. AOL and AOL Time Warner regularly communicated with publi c
investors via established market communication mechanisms, including through regula r
dissemination of press releases on the national circuits of major newswire services an d
through other wide-ranging public disclosures, such as communications with the financial
press and other similar reporting services and regular periodic conferences with groups o f
market analysts; and
d. AOL and AOL Time Warner were followed by numerous securities
analysts employed by major brokerage firms who wrote reports which were distributed t o
the sales force and certain customers of their respective brokerage firms . Each of these
reports was publicly available and entered the public marketplace .
678. As a result of the foregoing, the market for AOL's and the Company's stock an d
bonds promptly digested current information from all publicly available sources and reflecte d
such information in AOL's and the Company 's stock and bond prices. Under these
circumstances, all purchasers of AOL and the Company's stock and bonds during the Class
Period suffered similar injury through their purchase of such securities at artificially inflate d
prices and a presumption of reliance applies .
40699.1 266 VIII. NO SAFE HARBOR
9. The statutory safe harbor provided for forward-looking statements under ce rtain
does not apply to any of the allegedly false statements pleaded in this Complaint .
Many of the specific statements pleaded herein were not identified as "forward-lookin g
when made, nor was it stated that actual results could differ materially from thos e
nor did meaningful cautionary statements identifying important factors that coul d
cause actual results to differ materially from those in the forward-looking statements accompan y
those forward-looking statements. Alternatively, to the extent that the statutory safe harbor doe s
apply to~ any forward-looking statements pleaded herein, defendants are liable for those fals e
forwardtlooking statements because at the time each of those forward-looking statements wa s
made, the particular speaker knew that the particular forward-looking statement was false ,
and/or the forward-looking statement was authorized and/or approved by an executive officer o f
Online and/or the Company who knew that those statements were false when made .
IX. COUNTS
COUNT ONE
AOL Time Warner for Violations of § 11 of the Securities Act in Connection with the Merger Registration Statement)
Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
herein any allegations of fraud in connection with this Count. This Count is
asserted against AOL Time Warner for violation of Section 11 of the Securities Act, 15 U .S .C . §
77k, on behalf of all Class members who acquired AOL Time Warner common stock pursuan t
and/or traceable to the Merger Registration Statement, including in exchange for Time Warne r
common stock.
40699 .1 267 681 . The Merger Registration Statement contained untrue statements of material fact s
and omitted to state material facts necessary to make the statements made therein no t
mislead ng. As referenced in this Complaint, the untrue statements of material fact contained in ,
and the material facts omitted from the Merger Registration Statement include:
a. AOL's untrue financial statements which artificially inflated AOL advertising revenue ;
b. AOL Time Warner's untrue pro forma financial statements which contained artificially inflated AOL advertising revenue;
c. AOL Time Warner's untrue pro forma financial statements which falsely represented the true value of goodwill created in connection with the Merger, and the useful life of the goodwill;
d. Failure to disclose that the AOL advertising revenue in the financial statements and pro forma financial statements was based on sham transactions and improper accounting; the true current and anticipated condition of AOL's advertising revenue and business ; and that the true fair value of goodwill created by the Merger and its useful life was materially overstated ;
e. The untrue representation that AOL's financial statements had been prepared in conformity with GAAP ; and
f. AOL's untrue representations and warranties in the Merger Agreement.
2. AOL Time Warner is the registrant for the shares issued pursuant to the Merge r
and filed and signed the Merger Registration Statement as the issuer of its common stock . AOL
Time Warner is therefore absolutely liable under Section 11 of the Securities Act, 15 U .S .C. §
77k, to Plaintiff and other members of the Class for the material misrepresentations or omission s
in the Merger Registration Statement.
. At the time Plaintiff and other Class members acquired AOL Time Warner
stock pursuant and/or traceable to the Merger Registration Statement, they did no t
40699 .1 268 know of the facts concerning the untrue and misleading statements and omissions alleged
herein.
684. In connection with issuing the Merger Registration Statement, AOL Time Warne r
used the means and instrumentalities of interstate commerce and the U.S . mails.
685. By reason of the foregoing , AOL Time Warner is absolutely liable for violations
of Section 11 of the Securities Act to Plaintiff and the other members of the Class who acquired
AOL Time Warner common stock pursuant and/or traceable to the Merger Registratio n
Statement, including in exchange for Time Warner common stock, each of whom has bee n
damaged by reason of such violations.
COUNT TWO
(Against Defendants Case, Levin, Kelly, Cappuccio, Novack, and Pittman for Violation of Section 11 of the Securities Act in Connection with the Merger Registration Statement)
686. Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count. This Count is
asserted against Defendants Stephen Case, Gerald M . Levin, J. Michael Kelly, Paul T.
Cappuccio, Kenneth J . Novack, and Robert W. Pittman for violations of Section 11 of the
Securities Act, 15 U .S .C. § 77k, on behalf of all Class members who acquired AOL Time
Warner common stock pursuant and/or traceable to the Merger Registration Statement ,
including in exchange for Time Warner common stock .
687. The Merger Registration Statement contained untrue statements of material facts
and omitted to state material facts necessary to make the statements made therein no t
misleading, as referenced in ¶ 681 .
40699 .1 269 688. Defendant Stephen Case signed the Joint Proxy Statement-Prospectus which wa s
incorporated into the Merger Registration Statement . Defendant Gerald Levin signed the Joint
Proxy Statement-Prospectus and the Merger Registration Statement . Defendants J. Michael
Kelly and Paul Cappuccio signed the Merger Registration Statement . Defendants Stephen Case,
Kenneth J. Novack and Robert W. Pittman, all consented to being named in the Merger
Registration Statement as being or about to become directors of AOL Time Warner. All are
therefore liable under Section 11 of the Securities Act, 15 U .S .C. § 77k(a)(1) and (3), to Plaintiff
and other members of the Class for the mate rial misrepresentations or omissions contained i n
the Merger Registration Statement .
689. At the time Plaintiff and the other Class members acquired AOL Time Warner
common stock pursuant and/or traceable to the Merger Registration Statement, they did no t
know of the facts concerning the untrue and misleading statements and omissions allege d
herein.
690. In connection with issuing the Merger Registration Statement, the individual
Defendants named in this Count used the means and instrumentalities of interstate commerc e
and the U .S. mails.
691 . By reason of the foregoing, the Defendants named in this Count violated Sectio n
11 of the Securities Act and are liable to Plaintiff and the other members of the Class wh o
acquired AOL Time Warner common stock pursuant and/or traceable to the Merger Registratio n
Statement, including in exchange for Time Warner common stock, each of whom has been
damaged by reason of such violations .
40699 .1 270 COUNT THRE E
(Against Ernst & Young for Violations of § 11 of the Securities Act in Connection with the Merger Registration Statement)
692 . Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against Ernst & Young for violations of Section 11 of the Secu rities Act, 15 U.S.C. §
77k, on behalf of all Class members who acquired AOL Time Warner common stock pursuan t
and/or traceable to the Merger Registration Statement, including in exchange for Time Warne r
common stock .
693. Ernst & Young consented to the incorporation by reference in the Merger
Registration Statement of its unqualified audit report, dated July 21, 1999, on AOL's 1999
consolidated financial statements as set fo rth in AOL's 1999 Form 10-K for the year ended Jun e
30, 1999 and consented to all references to Ernst & Young in the Merger Registratio n
Statement, which included a reference to it under the caption "Experts ." In a subsequent
amendment to the Merger Registration Statement, Ernst & Young consented to the reference t o
itself as "Experts" and to the use of its report dated July 21, 1999, except for Note 3, which i s
dated May 12, 2000, with respect to the consolidated financial statements of AOL for the three
years ended June 30, 1999 incorporated by reference as Exhibit 99 to AOL's Form I0-Q/A fo r
the quarterly period ended March 31, 2000, incorporated by reference and made a part of th e
Merger Registration Statement and Joint Proxy Statement-Prospectus . Ernst & Young also
consented to the incorporation by reference in the Merger Registration Statement of its repor t
dated July 20, 2000, with respect to the consolidated financial statement of AOL included in it s
Form 10-K for the year ended June 30, 2000. Ernst & Young opined that AOL's financial
40699.1 271 statements for fiscal year ended June 30, 1999 and 2000, which were incorporated in the Merge r
Registration Statement, were prepared in conformity with GAAP. Further, as set forth under the
caption "Experts," AOL's financial statements were included "in reliance on Ernst & Young's
report, given on their authority as experts in accounting and auditing ." Ernst & Young i s
therefore liable under Section 11 of the Secu rities Act, 15 U.S.C. § 77k(a)(4).
694. In the Merger Registration Statement, the parts that Ernst & Young prepared an d
incorporated within the document, specifically, its audit reports dated July 21, 1999, excep t
Note 3 which is dated May 12, 2000 and July 20, 2000, and the parts that it audited, specifically ,
AOL's annual financial statements, contained untrue statements of material facts and omitted t o
state material facts necessary to make the statements made therein not misleading . In particular,
as discussed in ¶¶ 257-374, 409 and 413-449 above, the untrue statements include the
overstatement of advertising revenue, and backlog, and percentage increases in the amounts and
the overstatement of the value of goodwill created in the Merger for the va rious fiscal periods as
set forth in ¶ 644, and the statements in E rnst & Young's audit reports that: (i) it had audited
AOL's financial statements for each of the three years ended June 30, 1999 and the year ended
June 30, 2000 in accordance with GAAS; (ii) it had planned and performed those audits "to
obtain reasonable assurance about whether the financial statements are free of mate rial
misstatements;" (iii) in its opinion, AOL's financial statements "present fairly, in all material
respects, the consolidated financial position" of AOL at June 30, 1999 and 1998 and June 30,
2000 in conformity with "generally accepted" accounting principles ; and (iv) its audits provided
"a reasonable basis for [Ernst & Young's] opinions ."
695. At the time Plaintiff and the other Class members acquired AOL Time Warner
common stock pursuant and/or traceable to the Merger Registration Statement, they did no t
40699.1 272 know of the facts concerning the untrue and misleading statements and omissions allege d
herein.
696. In connection with the issuance of the Merger Registration Statement, Ernst &
Young directly or indirectly, used the means and instrumentalities of interstate commerce an d
the U. S . mails.
697. By reason of the foregoing, Ernst & Young violated Section 11 of the Securities
Act and is liable to Plaintiff and the other members of the Class who acquired AOL Time
Warner common stock pursuant and/or traceable to the Merger Registration Statement,
including in exchange for Time Warner common stock, each of whom has been damaged by
reason of such violations .
COUNT FOUR
(Against Morgan Stanley for Violations of § 11 of the Securities Act in Connection with the Merger Registration Statement)
698 . Plaintiff repeats and realleges each and every allegation contained above as i f
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does not
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against Morgan Stanley for violations of Section 11 of the Secu rities Act, 15 U.S.C. §
77k, on behalfof all Class members who acquired AOL Time Warner common stock pursuant
and/or traceable to the Merger Registration Statement, including in exchange for Time Warner
common stock .
699. The Merger Registration Statement included the January 9, 2000 opinion o f
Morgan Stanley to Time Warner shareholders that the exchange ratio was "fair from a financia l
point of view" to the holders of Time Warner stock . Morgan Stanley consented to the
incorporation by reference in the Merger Registration Statement of its opinion and to al l
40699.1 273 references to Morgan Stanley in the Merger Registration Statement . Morgan Stanley i s
therefore liable under Section 11 of the Securities Act, 15 U .S .C. § 77k(a)(4).
700. The Morgan Stanley Fairness Opinion was false because the value of AOL stoc k
was overvalued, and therefore the exchange ratio was not "fair from a financial point of view "
to Time Warner shareholders .
701 . At the time Plaintiff and other Class members acquired AOL Time Warner
common stock pursuant and/or traceable to the Merger Registration Statement, they did not
know of the facts concerning the untrue and misleading statements and omissions allege d
herein.
702. In connection with the issuance of the Merger Registration Statement, Morga n
Stanley, directly or indirectly, used the means and instrumentalities of interstate commerce and
the U.S. mails.
703 . By reason of the foregoing, Morgan Stanley violated Section 11 of the Securitie s
Act and is liable to Plaintiff and the other members of the Class who acquired AOL Time
Warner common stock pursuant and/or traceable to the Merger Registration Statement ,
including in exchange for Time Warner common stock, each of whom has been damaged b y
reason of such violations.
COUNT FIVE
(Against AOL Time Warner for Violations of § 11 of the Securities Act In Connection with the Bond Registration Statement and Prospectus Supplements Thereto )
704. Plaintiff repeats and realleges each and every allegation contained above as i f
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count i s
asserted against AOL Time Warner for violations of Section 11 of the Securities Act, 15 U .S.C.
40699.1 274 § 77k, on behalf of all Class members who purchased or acquired AOL Time Warner Bonds ,
issued in the April 2001 and April 2002 Offerings, pursuant and/or traceable to the Bond
Registration Statement and Prospectus Supplements thereto .
705 . The Bond Registration Statement, and Prospectus Supplements thereto , issued in
connection with both the April 2001 and April 2002 Bond Offerings , contained untrue
statements of material fact and omitted to state material facts necessary to make the statements
made therein not misleading, including :
a. AOL's and AOL Time Warner's untrue financial statements which artificially inflated AOL advertising revenue;
b . AOL Time Warner's untrue pro forma financial statements which contained artificially inflated AOL advertising revenue;
c. AOL Time Warner' s untrue pro forma financial statements which falsely represented the true value of goodwill created in connection with the Merger, and the useful life of the goodwill;
d. Failure to disclose that the AOL advertising revenue in the financial statements and pro forma financial statements was based on sham transactions and improper accounting; the true current and anticipated condition of AOL's advertising revenue and business ; and that the true fair value of goodwill created by the Merger and its useful life was materially overstated;
C. The untrue representation that AOL's and AOL Time Warner's financial statements had been prepared in conformity with GAAP; and
f. AOL' s untrue representations and warranties in the Merger Agreement .
706. AOL Time Warner is the registrant for the bonds issued pursuant to the Apri l
2001 and April 2002 Bond Offerings . As the issuer of the bonds, AOL Time Warner filed an d
signed the Bond Registration Statement. AOL Time Warner is therefore absolutely liable under
Section 11 of the Securities Act, 15 U.S.C. § 77k, to Plaintiff and other members of the Class
40699 .1 275 for the material misrepresentations or omissions contained in the April 2001 and April 200 2
Bond Registration Statement and Prospectus Supplements thereto.
707. At the time Plaintiff and other Class members purchased or acquired AOL Time
Warner bonds pursuant and/or traceable to the Bond Registration Statement and Prospectus
Supplements thereto, they did not know of the facts concerning the untrue and misleading
statements and omissions alleged herein .
708. In connection with the issuance of the Bond Registration Statement an d
Prospectus Supplements thereto , AOL Time Warner used the means and instrumentalities o f
interstate commerce and the U.S . mails.
709. By reason of the foregoing, AOL Time Warner is absolutely liable for violation s
of Section 11 of the Securities Act to Plaintiff and the other members of the Class who acquired
AOL Time Warner bonds pursuant and/or traceable to the Bond Registration Statement, an d
Prospectus Supplements thereto, each of whom has been damaged by reason of such violations .
COUNT SIX
(Against Defendants Akerson, Barge, Bollenbach , Cappuccio, Case, Caufield, Colburn, Gilburne, Keller, Kelly, Levin, Novack, Pace, Parsons, Pittman , Raines, Ripp and Schuler for Violations of § 11 of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto)
710. Plaintiff repeats and realleges each and every allegation contained above as i f
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count i s
asserted against Daniel F. Akerson, James W. Barge, Stephen F. Bollenbach, Paul T. Cappuccio,
Stephen M. Case, Frank J. Caufield, David M. Colburn, Miles R. Gilburne, Eric Keller, J .
Michael Kelly, Gerald M . Levin, Kenneth J. Novack, Wayne H . Pace, Richard D . Parsons,
Robert W. Pittman, Franklin D. Raines, Joseph A . Ripp and Barry M. Schuler for violations o f
40699.1 276 Section 11 of the Securities Act, 15 U.S .C. § 77k, on behalf of all Class members who
purchased or acquired AOL Time Warner Bonds issued in the April 2001 and/or April 2002
Offerings, pursuant and/or traceable to the Bond Registration Statement and Prospectu s
Supplements thereto.
711 . The Bond Registration Statement and Prospectus Supplements thereto, issued i n
connection with both the April 2001 and April 2002 Bond Offerings contained untrue
statements of material fact and omitted to state material facts necessary to make the statements
made therein not misleading, as referenced in ¶ 705.
712. Defendants Gerald M. Levin, J . Michael Kelly, James W. Barge, Stephen M.
Case, Frank J. Caufield, Richard D . Parsons, Robert W . Pittman, Kenneth J. Novack, Daniel F.
Akerson, Stephen F . Bollenbach, Miles R . Gilburne, Franklin D . Raines, Barry M . Schuler,
Joseph A. Ripp, Paul T Cappuccio and Wayne H . Pace, signed the Bond Registration Statement ,
and are therefore liable under Section 11 of the Securities Act, 15 U.S .C. 77k(a)(1) to Plaintiff
and other members of the Class for the material misrepresentations or omissions contained i n
the Bond Registration Statement.
713 . At the time Plaintiff and other Class members purchased or acquired AOL Time
Warner Bonds pursuant and/or traceable to the April 2001 and April 2002 Offerings, they di d
not know of the facts concerning the untrue and misleading statements and omissions allege d
herein.
714. The means and instrumentalities of interstate commerce and the U.S. mails were
used in connection with the issuance of the Bond Registration Statement and Prospectu s
Supplements thereto.
40699.1 277 715. By reason of the foregoing , the Individual Defendants named in this Count are
liable for violations of Section 11 of the Securities Act to Plaintiff and the other members of th e
Class who acquired AOL Time Warner bonds pursuant and/or traceable to the Bon d
Registration Statement, and Prospectus Supplements thereto, each of whom has been damage d
by reason of such violations .
COUNT SEVEN
(Against Defendant Ernst & Young for Violations of § 11 of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto )
716. Plaintiff repeats and realleges each and every allegation contained above as i f
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count i s
asserted against E rnst & Young for violations of Section 11 of the Securities Act, 15 U.S .C. §
77k, on behalf of all Class members who purchased or acquired AOL Time Warner Bonds in th e
April 2001 and/or April 2002 Offerings pursuant and/or traceable to the Bond Registratio n
Statement and Prospectus Supplements thereto .
717. Ernst & Young consented to the incorporation by reference in the Bond
Registration Statement and Prospectus Supplements of (1) its report dated July 20, 2000, and t o
the reference to itself under the caption "Experts," with respect to the AOL' s consolidated
financial statements included in its SEC Form 10-K for the year ended June 30, 2000 ; (2) its
report dated January 31, 2001, except for Note 2 as to which the date is March 21, 2001, with
respect to the consolidated financial statements of AOL included in the Annual Report on SEC
Form 10-K for the year ended December 31, 2000 (which included an opinion by Ernst &
Young for the period ended December 31, 1999); and (3) its report dated January 28, 2002 wit h
respect to the consolidated financial statements of AOL Time Warner for the year ended
40699.1 278 December 31, 2001 . These financials were incorporated in the Bond Registration Statement "i n
reliance on Ernst & Young's report, given on their authority as experts in accounting and
auditing." Ernst & Young is therefore liable under Section 11 of the Secu rities Act, 15 U.S .C . §
77k(a)(4).
718. In the Bond Registration Statement, the parts that Ernst & Young prepared an d
incorporated within the document, specifically , its audit reports dated July 20, 2000, January 31,
2001, except for Note 2 as to which the date is March 21, 2001 and January 28, 2002 , and the
parts that it audited, specifically, AOL's annual financial statements, contained untrue
statements of material facts and omitted to state mate rial facts necessary to make the statements
made therein not misleading. In particular, as discussed in ¶¶ 257-449 above, the untrue
statements include the overstatement of advertising revenue, and backlog, and percentag e
increases in the amounts and the overstatement of the value of goodwill created in the Merge r
for the various fiscal periods as set forth in ¶ 667, and the statements in Ernst & Young's audit
reports that: (i) it had audited AOL's financial statements for the fiscal year ended June 30,
2000, the year ended December 31, 2000 and AOL Time Warner's year ended December 31,
2001 in accordance with GAAS ; (ii) it had planned and performed those audits "to obtai n
reasonable assurance about whether the financial statements are free of material misstatements ;"
(iii) in its opinion, AOL and AOL Time Warner's financial statements "present fairly, in all
material respects, the consolidated financial position" of AOL at June 30, 2000, December 31,
2000 and December 31, 1999 and AOL Time Warner at December 31, 2001, "in conformity
with `generally accepted' accounting principles ;" and (iv) its audits provided "a reasonable basi s
for [Ernst & Young' s] opinions."
40699 .1 279 719 . At the time Plaintiff and other class members acquired AOL Time Warne r common stock pursuant and/or traceable to the Merger Registration Statement, they did no t know of the facts concerning the untrue and misleading statements and omissions allege d herein.
720. In connection with the issuance of the Bond Registration Statement and
Prospectus Supplements thereto, the means and instrumentalities of interstate commerce and th e
U.S . mails were used .
721 . By reason of the foregoing, Ernst & Young violated Section 11 of the Securities
Act and is liable to Plaintiff and the other members of the Class who acquired AOL Tim e
Warner bonds pursuant and/or traceable to the Bond Registration Statement and Prospectu s
Supplements thereto, each of whom has been damaged by reason of such violations .
COUNT EIGHT
(Against the Underwriter Defendants Morgan Stanley, Salomon Smith Barney, Citigroup, Inc., Banc of America, and J .P. Morgan for Violations of § 11 of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto )
722 . Plaintiff repeats and realleges each and every allegation contained above as i f fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t incorporate herein any allegations of fraud in connection with this Count . This Count is asserted against Morgan Stanley, Salomon Smith Barney, Citigroup, Banc of America, and J .P.
Morgan for violations of Section I 1 of the Secu rities Act, 15 U .S.C. § 77k, on behalf of all
Class members who purchased or acquired AOL Time Warner Bonds issued in the Ap ril 200 1 and/or April 2002 Offerings pursuant and/or traceable to the Bond Registration Statement an d
Prospectus Supplements thereto.
40699 .1 280 723 . The Bond Registration Statement and Prospectus Supplements thereto , issued in
connection with both the April 2001 and April 2002 Bond Offerings contained untrue
statements of material fact and omitted to state material facts necessary to make the statement s
made therein not misleading, as referenced in ¶ 705 .
724. As underwriters of the Bonds in a firm commitment underw riting, the
Underwriter Defendants are therefore liable under Section 11 of the Secu rities Act, 15 U .S.C.
77k(a)(5), to Plaintiff and other members of the Class for the material misrepresentations o r
omissions contained in the Bond Registration Statement .
725. At the time Plaintiff and other Class members purchased or acquired AOL Time
Warner Bonds pursuant and/or traceable to the April 2001 and April 2002 Offerings, they did
not know of the facts concerning the untrue and misleading statements and omissions allege d
herein.
726. The means and instrumentalities of interstate commerce and the U .S . mails were
used in connection with the issuance of the Bond Registration Statement and Prospectus
Supplements thereto.
727. By reason of the foregoing, the Underwriter Defendants are liable for violation s
of Section 11 of the Securities Act to Plaintiff and the other members of the Class who acquire d
AOL Time Warner bonds pursuant and/or traceable to the Bond Registration Statement, an d
Prospectus Supplements thereto, each of whom has been damaged by reason of such violations .
40699 .1 281 COUNT NINE
(Against Defendant AOL Time Warner for Violations o f § 12(a)(2) of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto )
728. Plaintiff repeats and realleges each and every allegation contained above as i f
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against AOL Time Warner for violations of Section 12(a)(2) of the Securities Act, 1 5
U.S .C. § 77e, on behalf of all Class members who purchased bonds issued in the April 2001
and/or April 2002 Offerings pursuant to the Bond Registration Statement and Prospectu s
Supplements thereto.
729. The Bond Registration Statement and Prospectus Supplements thereto, issued in
connection with the April 2001 and April 2002 Bond Offerings, contained untrue statements o f
material fact and omitted to state material facts necessary to make the statements made therei n
not misleading, as referenced in ¶ 705.
730. Defendant AOL Time Warner is a "seller" within the meaning of the Securities
Act because it, among other things, actively solicited the sale of the bonds by participating in
the preparation of the false and misleading Bond Registration Statement and Prospectus
Supplements thereto, and by signing the Bond Registration Statement . Moreover, the
solicitation to purchase the Bonds directed toward the Plaintiff and other members of the Clas s
was motivated, at least in part, by the desire to serve the significant financial interests of AO L
Time Warner, which received approximately $10 billion from the Bond Offerings to be used fo r
"general corporate purposes ."
40699 .1 282 731 . In connection with and in furtherance of the Bond Offerings, the Bon d
Registration Statement, and Prospectus Supplements thereto, were widely distributed t o
approximately several hundred or more individuals and/or entities, and thus the Bond Offering s
were a public offering. The Bond Registration Statement, and Prospectus Supplements thereto ,
also were prospectuses for purposes of the Securi ties Act. The Bond Offerings consisted of ne w
issues of securities.
732. The means and instrumentalities of interstate commerce and the U .S . mails were
used in connection with the issuance of the Bond Registration Statement and Prospectu s
Supplements thereto.
733. By reason of the foregoing , AOL Time Warner is liable for violations of Section
I2(a)(2) of the Securities Act to Plaintiff and the other members of the Class who acquired AO L
Time Warner Bonds pursuant to the Bond Registration Statement, and Prospectus Supplement s
thereto, each of whom has been damaged by reason of such violations .
COUNT TEN
(Against Defendants Levin, Kelly, Barge, Case, Canfield, Parsons, Pittman, Novack, Akerson, Bollenbach, Gilburne, Raines, Schuler, Ripp, Cappuccio an d Pace for Violations of Section 12(a)(2) of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto)
734. Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does not
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against Defendants Gerald M . Levin, J. Michael Kelly, James W. Barge, Stephen M.
Case, Frank J. Caufield, Richard D. Parsons, Robert W. Pittman, Kenneth J . Novack, Daniel F .
Akerson, Stephen F. Bollenbach, Miles R. Gilburne, Franklin D . Raines, Barry M . Schuler,
40699 .1 283 Joseph A . Ripp, Paul T Cappuccio and Wayne H . Pace for violations of Section 12(a)(2) of th e
Securities Act, 15 U.S.C. § 77e on behalf of Class members who purchased bonds in the April
2001 Offering and/or April 2002 Offerings pursuant to the Bond Registration Statement and
Prospectus Supplements thereto .
735. The Bond Registration Statement and Prospectus Supplements thereto, issued i n
connection with the April 2001 and April 2002 Bond Offe rings contained untrue statements o f
material fact and omitted to state material facts necessary to make the statements made therein
not misleading, as referenced in ¶ 705.
736. The Defendants named in this Count are "sellers" within the meaning of the
Securities Act because they, among other things, signed the Bond Registration Statements fo r
both Bond Offerings and therefore solicited the sales of those securities . Moreover, the
solicitation to purchase the Bonds directed towards the Plaintiff and other members of the Clas s
was motivated, at least in part, by the desire to serve the significant financial interests of AOL
Time Warner, which received approximately $10 billion from the Bond Offerings to be used for
"general corporate purposes ." Some or all of these Defendants also participated in the
preparation of the false and misleading Bond Registration Statement and Prospectus
Supplements thereto, the promotion of the securities, and the decision to hire the Underwriter
Defendants .
737. In connection with and in furtherance of the Bond Offerings, the Bon d
Registration Statement, and Prospectus Supplements thereto, were widely distributed to
approximately several hundred or more individuals and/or entities, and thus the Bond Offering s
were public offerings. The Bond Registration Statement, and Prospectus Supplements thereto ,
40699.1 284 were prospectuses for purposes of the Securities Act. The Bond Offerings consisted of new issues of securities .
738. At the time Plaintiff and other Class members purchased or acquired AOL Time
Warner bonds pursuant to the April 2001 and April 2002 Offerings, they did not know of th e facts concerning the untrue and misleading statements and omissions alleged herein .
739. The means and instrumentalities of interstate commerce and the U. S . mails were used in connection with the issuance of the Bond Registration Statement and Prospectus
Supplements thereto.
740. By reason of the foregoing, the Defendants named in this Count are liable for violations of Section 12(a)(2) of the Securities Act to Plaintiff and the other members of the
Class who acquired AOL Time Warner Bonds pursuant to the Bond Registration Statement an d
Prospectus Supplements thereto, each of whom has been damaged by reason of such violations .
COUNT ELEVEN
(Against Underwriter Defendants Morgan Stanley, Salomon Smith Barney, Citigroup, Banc of America and J.P. Morgan for Violations o f Section 12(a)(2) of the Securities Act in Connection with the Bond Registration Statement and Prospectus Supplements Thereto)
741 . Plaintiff repeats and realleges each and every allegation contained above as i f fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does not incorporate herein any allegations of fraud in connection with this Count . This Count is asserted against the Underwriter Defendants Morgan Stanley, Salomon Smith Barney ,
Citigroup, Banc of America and J .P. Morgan for violations of Section 12(a)(2) of the Securities
Act, 15 U.S.C. § 77e, on behalf of Class members who purchased bonds issued in the Ap ril
2001 Offering and/or April 2002 Offering.
40699.1 285 742. The Bond Registration Statement and Prospectus Supplements thereto, issued in connection with the April 2001 and April 2002 Bond Offerings, contained untrue statements o f material fact and omitted to state material facts necessary to make the statements made therei n not misleading, as referenced in ¶ 705.
743 . As underwriters of the Bonds in a firm commitment underwriting, the
Underwriter Defendants are sellers within the meaning of the Securities Act because they : (a) transferred title of the bonds to Plaintiff and other Class members ; (b)transferred title to the
Notes to other underwriters and/or broker-dealers that sold the bonds as agents for the
Underwriter Defendants; and (c) solicited the purchase of the bonds by Plaintiff and othe r
members of the Class, motivated at least in part by the desire to serve the Underwriter
Defendants' own financial interest and the interest of AOL Time Warner, including but not
limited to commissions on their own sales of the bonds and separate commissions on the sale o f
the bonds by non-underwriter broker-dealers .
744. In connection with and in furtherance of the Bond Offerings, the Bon d
Registration Statement, and Prospectus Supplements thereto, were widely distributed to
approximately several hundred or more individuals and/or entities, and thus the Bond Offerings
were public offerings . The Bond Registration Statement, and Prospectus Supplements thereto ,
were prospectuses for purposes of the Securities Act . The Bond Offerings consisted of new
issues of securities.
745 . At the time Plaintiff and other Class members purchased or acquired AOL Time
Warner bonds pursuant to the April 2001 and April 2002 Offerings, they did not know of th e
facts concerning the untrue and misleading statements and omissions alleged herein.
40699.1 286 746. The means and instrumentalities of interstate commerce and the U .S. mails were
used in connection with the issuance of the Bond Registration Statement and Prospectu s
Supplements thereto.
747. By reason of the foregoing , the Underw riter Defendants, and each of them, are
liable for violations of Section 12(a)(2) of the Securities Act to Plaintiff and the other members
of the Class who acquired AOL Time Warner Bonds pursuant to the Bond Registration
Statement and Prospectus Supplements thereto, each of whom has been damaged by reason o f
such violations .
COUNT TWELVE
(Against Defendants Case, Pittman, Kelly, Colburn, Ripp, Berlow, Schuler, Novack, Levin, Parsons and Pace for Liability Under § 15 of the Securities Ac t For Violations of § 11 of the Securities Act)
748. Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against Defendants Stephen M . Case, Robert W . Pittman, J. Michael Kelly, David M.
Colburn, Joseph A . Ripp, Myer Berlow, Barry Schuler, Kenneth J . Novack, Gerald M. Levin,
Richard D. Parsons and Wayne H . Pace for violations of Section 15 of the Securities Act, 1 5
U.S.C. § 77o, on behalf of all Class members who acquired AOL Time Warner common stock
in exchange for Time Warner common stock, pursuant to and/or traceable to the Merge r
Registration Statement, and/or all Class members who acquired bonds issued in the April 200 1
and April 2002 Offerings pursuant to and/or traceable to the Bond Registration Statements an d
Prospectus Supplements thereto .
40699.1 287 749. As alleged in Count One, AOL Time Warner violated Section 11 of the Securities
Act.
750. The Defendants named in this Count acted as controlling persons of AOL Time
Warner within the meaning of Section 15 of the Securities Act as alleged herein. These
Defendants had the power and authority to cause the Company to violate Section 11 of the
Securities Act.
751 . By virtue of their high-level positions as executives and/or directors at AOL and
AOL Time Warner during the Class Period and members of the Company's management team,
and/or their ownership and contractual rights, participation in and/or awareness of AOL's and
AOL Time Warner's operations, the Defendants named in this Count had the power to influence
and control and did influence and control, directly or indirectly, the decision-making of AOL
Time Warner, including the content and dissemination of the various statements which Plaintiff
contends are false and misleading. Each of the Defendants named in this Count, by virtue of hi s
responsibilities and activities as a senior officer and/or director of AOL and/or AOL Tim e
Warner was privy to and participated in the creation, development and reporting of AOL's and
AOL Time Warner's internal budgets, plans, projections and/or reports . These Defendants were
provided with or had unlimited access to copies of the reports, press releases, public filings and
other statements alleged by Plaintiff to be misleading prior to and/or shortly after thes e
statements were issued and had the ability to prevent the issuance of the statements or cause th e
statements to be corrected.
752. Because of their positions of control and authority as senior officers and director s of AOL and/or AOL Time Warner, these Defendants were able to, and did , control the content s of the Merger Registration Statement and Bond Registration Statement and Prospectu s
40699.1 288 Supplements thereto which contained materially false financial information and omitted facts necessary to make the facts stated therein not misleading.
753 . At the time Plaintiff and other Class members acquired AOL Time Warner common stock pursuant and/or traceable to the Merger in exchange for AOL and Time Warner common stock and/or bonds pursuant to the Bond Registration Statement and Prospectus
Supplements thereto, they did not know of the facts concerning the untrue and misleading statements and omissions alleged herein .
754. By reason of the foregoing, these Defendants are jointly and severally liable a s controlling persons pursuant to Section 15 of the Securities Act for the Company's violations o f
Section 11 to Plaintiff and the other members of the Class who acquired AOL Time Warne r
common stock pursuant and/or traceable to the Merger Registration Statement, including i n
exchange for Time Warner common stock, and/or acquired AOL Time Warner bonds pursuant
and/or traceable to the Bond Registration Statement, and Prospectus Supplements thereto, eac h
of whom has been damaged by reason of such violations.
COUNT THIRTEE N
(Against Defendants Case, Pittman, Kelly, Colburn, Ripp, Berlow, Schuler, Novack, Levin, Parsons and Pace for Liability Under § 15 of the Securities Act For Violations of § 12(a)(2) of the Securities Act)
755 . Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against Defendants Stephen M. Case, Robert W . Pittman, J. Michael Kelly, David M.
Colburn, Joseph A . Ripp, Myer Berlow, Barry Schuler, Kenneth J . Novack, Gerald M . Levin,
Richard D . Parsons and Wayne H. Pace for violations of Section 15 of the Securities Act, 1 5
40699.1 289 U.S .C. § 77o, on behalf of all Class members who acquired bonds issued in the Ap ril 2001 and
April 2002 Offerings pursuant to the Bond Registration Statements and Prospectus Supplement s thereto.
756. As alleged in Count Nine, AOL Time Warner violated Section 12(a)(2) of th e
Securities Act.
757. The Defendants named in this Count acted as controlling persons of AOL Time
Warner within the meaning of Section 15 of the Securities Act as alleged herein . These
Defendants had the power and authority to cause the Company to violate Section 12 of the
Securities Act .
758 . By virtue of their high-level positions as executives and/or directors at AOL and
AOL Time Warner during the Class Period and members of the Company's management team,
and their ownership and contractual rights, participation in and/or awareness of AOL's and the
AOL Time Warner' s operations, the Defendants named in this Count had the power to influenc e
and control and did influence and control , directly or indirectly, the decision-making of AOL
Time Warner, including the content and dissemination of the various statements which Plaintif f
contends are false and misleading. Each of the Defendants named in this Count, by virtue of his
responsibilities and activities as a senior officer and/or director of AOL and/or AOL Time
Warner was privy to and participated in the creation, development and reporting of AOL's
and/or the AOL Time Warner's internal budgets, plans, projections and/or reports . These
Defendants were provided with or had unlimited access to copies of the reports, press releases ,
public filings and other statements alleged by Plaintiff to be misleading prior to and/or shortl y
after these statements were issued and had the ability to prevent the issuance of the statement s
or cause the statements to be corrected .
40699 .1 290 759. Because of their positions of control and authority as senior officers and director s of AOL Time Warner, the Defendants named in this Count were able to, and did , control the contents of the Bond Registration Statement and Prospectus Supplements thereto whic h contained materially false financial information and omitted facts necessary to make the fact s stated therein not misleading.
760. At the time Plaintiff and other Class members purchased or acquired AOL Tim e
Warner bonds pursuant to the Bond Registration Statement and Prospectus Supplements thereto , they did not know of the facts concerning the untrue and misleading statements and omission s alleged herein.
761 . By reason of the foregoing, the Defendants named in this Count are jointly an d
severally liable as controlling persons pursuant to Section 15 of the Securities Act for the
Company's violations of Section 12 to Plaintiff and the other members of the Class who
purchased or acquired AOL Time Warner bonds pursuant and to the Bond Registration
Statement, and Prospectus Supplements thereto, each of whom has been damaged by reason o f
such violations .
COUNT FOURTEE N
(Against AOL, Time Warner, and AOL Time Warner For Violations of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With the Joint Proxy Statement-Prospectus)
762. Plaintiff repeats and realleges each and every allegation contained above as i f
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does not
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against AOL, Time Warner, and AOL Time Warner in its own right and as successor to
AOL and Time Warner for violations of Section 14(a) of the Exchange Act, 15 U . S.C. § 78n(a),
40699.1 291 and Rule 14a-9 promulgated thereunder, 17 C.F.R. § 240.14a-9, on behalf of all Class member s
who held Time Warner common stock at the close of business on May 18, 2000, the record dat e
of eligibility to vote, and on June 23, 2000, the date of the Special Meetings in which th e
Merger was voted upon and approved .
763 . The Joint Proxy Statement -Prospectus desc ribed herein was a "proxy solicitation"
within the meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgate d
thereunder.
764. The Joint Proxy Statement-Prospectus contained untrue statements of materia l
facts and omitted to state material facts necessary to make the statements made therein no t
misleading, as referenced in ¶ 681 .
765. AOL and Time Warner sought to secure AOL and Time Warner shareholder
approval of the AOL Time Warner Merger by means of the materially false and misleading
Joint Proxy Statement-Prospectus and solicited proxies from Plaintiff and other members of th e
Class.
766. AOL and Time Warner, at the time it issued the Joint Proxy Statement-
Prospectus, acted negligently and without due care in distributing or causing to be distribute d
the Joint Proxy Statement-Prospectus containing the false and misleading statements an d
omissions.
767. The Merger required and received the affirmative vote of the AOL and Tim e
Warner shareholders at the respective Special Stockholder Meetings held on June 23, 2000 .
Accordingly, the materially false and misleading Joint Proxy Statement-Prospectus was a n
essential link in the accomplishment of the Merger.
40699 .1 292 768. In connection with issuing the Joint Proxy Statement-Prospectus, AOL Tim e
Warner used the means and instrumentalities of interstate commerce and the U .S. mails.
769 . By reason of the foregoing, AOL, Time Warner, and AOL Time Warner are liable to Plaintiff and other members of the Class who held Time Warner common stock on May 18 ,
2000 and June 23, 2000 for violations of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder, each of whom has been damaged by reason of such violations .
COUNT FIFTEEN
(Against Defendants Case, Levin, Kelly, Cappuccio, Novack and Pittman For Violations of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With the Joint Proxy Statement-Prospectus )
770. Plaintiff repeats and realleges each and every allegation contained above as i f fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does not incorporate herein any allegations of fraud in connection with this Count . This Count is asserted against Defendants Stephen Case, Gerald M . Levin, J. Michael Kelly, Paul T.
Cappuccio, Kenneth J . Novack, and Robert W. Pittman for violations of Section 14(a) of th e
Exchange Act, 15 U.S .C. § 78n(a), and Rule 14a-9 promulgated thereunder, 17 C .F.R. §
240.14a-9, on behalf of all Class members who held Time Warner common stock at the close o f business on May 18, 2000, the record date of eligibility to vote, and on June 23, 2000, the dat e of the Special Meetings in which the Merger was voted upon and approved.
771 . The Joint Proxy Statement-Prospectus described herein was a "proxy solicitation" within the meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgate d thereunder.
40699.1 293 772 . The Joint Proxy Statement -Prospectus contained untrue statements of materi al facts and omitted to state material facts necessary to make the statements made therein no t misleading, as referenced in ¶ 681 .
773 . The Defendants named in this Count sought to secure AOL and Time Warner shareholder approval of the Merger by means of the materially false and misleading Joint Prox y
Statement-Prospectus and solicited proxies from Plaintiff and other members of the Class .
774. The Defendants named in this Count, at the time it issued the Joint Prox y
Statement-Prospectus, acted negligently and without due care in distributing or causing to b e distributed the Joint Proxy Statement-Prospectus containing the false and misleading statements and omissions.
775 . The Merger required and received the affirmative vote of the AOL and Tim e
Warner shareholders at the respective Special Stockholder Meetings held on June 23, 2000 .
Accordingly, the materially false and misleading Joint Proxy Statement-Prospectus was a n essential link in the accomplishment of the AOL Time Warner merger.
776. In connection with issuing the Joint Proxy Statement-Prospectus, the means an d
instrumentalities of interstate commerce and the U.S. mails were used.
777. By reason of the foregoing, AOL, Time Warner, and AOL Time Warner are liabl e
to Plaintiff and other members of the class who held Time Warner common stock on May 18 ,
2000 and June 23, 2000 for violations of Section 14(a) of the Exchange Act and Rule 14a- 9 promulgated thereunder, each of whom has been damaged by reason of such violations .
40699 .1 294 COUNT SIXTEE N
(Against Ernst & Young For Violations of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With the Joint Proxy Statement-Prospectus)
778. Plaintiff repeats and realleges each and every allegation contained above as if
fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t
incorporate herein any allegations of fraud in connection with this Count . This Count is
asserted against Ernst & Young for violations of Section 14(a) of the Exchange Act, 15 U.S.C. §
78n(a), and Rule 14a-9 promulgated thereunder , 17 C.F.R. § 240.14a-9, on behalf of all Class
members who held Time Warner common stock at the close of business on May 18, 2000, the
record date of eligibility to vote, and on June 23, 2000, the date of the Special Meetings i n
which the Merger was voted upon and approved .
779. The Joint Proxy Statement-Prospectus described herein was a "proxy solicitation "
within the meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgate d
thereunder.
780. As set forth in ¶ 644, Ernst & Young permitted the use of its name in the Joint
Proxy Statement-Prospectus to solicit proxies from Plaintiff and other members of the Class .
781 . The Joint Proxy Statement-Prospectus contained untrue statements of material
facts by Ernst & Young and omitted to state material facts necessary to make the statement s
made therein by Ernst & Young not false and misleading, as alleged above in ¶ 694 .
782 . Ernst & Young acted negligently and without due care in making the false an d
misleading statements and omissions in the Joint Proxy Statement-Prospectus .
783 . The Merger required and received the affirmative vote of the AOL and Tim e
Warner shareholders at the respective Special Stockholder Meetings held on June 23, 2000 .
40699 .1 295 Accordingly, the materially false and misleading Joint Proxy Statement-Prospectus was a n essential link in the accomplishment of the Merger.
784. In connection with the issuance of the Joint Proxy Statement-Prospectus, the means and instrumentalities of interstate commerce and the U .S. mails were used.
785. By reason of the foregoing, Ernst & Young is liable for violations of Sectio n
14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder to Plaintiff and the othe r members of the Class, each of whom has been damaged by reason of such violations .
COUNT SEVENTEEN
(Against Morgan Stanley For Violations of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With the Joint Proxy Statement-Prospectus)
786. Plaintiff repeats and realleges each and every allegation contained above as i f fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t incorporate herein any allegations of fraud in connection with this Count . This Count i s asserted against Morgan Stanley for violations of Section 14(a) of the Exchange Act, 15 U.S.C.
§ 78n(a), and Rule 14a-9 promulgated thereunder, 17 C.F .R. § 240.14a-9, on behalf of all Clas s members who held Time Warner common stock at the close of business on May 18, 2000, the record date of eligibility to vote, and on June 23, 2000, the date of the Special Meetings i n which the Merger was voted upon and approved .
787. The Joint Proxy Statement-Prospectus described herein was a "proxy solicitation" within the meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgate d thereunder.
788 . The Joint Proxy Statement -Prospectus contained the opinion of Morgan Stanley that the Exchange Ratio by which AOL shares would be exchanged for AOL Time Warner shares was "fair, from a financial point of view" to the shareholders of Time Warner . As
40699 .1 296 alleged above in ¶ 700, this statement was materially false and misleading and omitted to stat e material facts necessary to make the statements made therein not misleading .
789. Morgan Stanley permitted the use of its name and its opinion in the Joint Prox y
Statement-Prospectus to solicit proxies from Plaintiff and other members of the Class .
790. Morgan Stanley acted negligently and without due care in making the false an d misleading statement in the Joint Proxy Statement-Prospectus .
791 . The AOL Time Warner merger required and received the affirmative vote of th e
AOL and Time Warner shareholders at the respective Special Stockholder Meetings held on
June 23, 2000 . Accordingly, the materially false and misleading Joint Proxy Statement-
Prospectus was an essential link in the accomplishment of the AOL Time Warner merger.
792 . In connection with the issuance of the Joint Proxy Statement-Prospectus, th e means and instrumentalities of interstate commerce and the U .S. mails were used.
793 . By reason of the foregoing, Morgan Stanley is liable for violations of Sectio n
14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder to Plaintiff and the othe r members of the Class, each of whom has been damaged by reason of such violations .
COUNT EIGHTEEN
Violations Of Section 10(b) Of The Exchange Act And Rule lOb-5 Promulgated Thereunder Against Defendant s AOL Time Warner, AOL and Case, Pittman, Kelly, Colburn, Keller, Ripp, Berlow, Schuler, Rinder, Novack, Levin, Parsons and Pac e
794. Except for the Counts not sounding in fraud, Plaintiff repeats and realleges eac h
and every allegation contained above as if fully set forth herein. This Count is asserted against
Defendants Case, Pittman, Kelly, Colburn, Keller, Ripp, Berlow, Schuler, Rinder, Novack,
Levin, Parsons and Pace for their violations of Section 10(b) of the Exchange Act 15 U .S.C.
78j(b) and Rule lOb-5, 17 C .F.R 240.10b-5, promulgated thereunder . This Count is also
40699.1 297 asserted against AOL Time Warner, as successor to AOL and in its own right, and AOL in it s own right.
795. During the Class Period, the Defendants named in this Count carried out a plan, scheme and course of conduct which was intended to and, throughout the Class Period, di d deceive the investing public, including Plaintiff and other Class members, as alleged herein an d caused Plaintiff and other members of the Class to purchase or otherwise acquire AOL and/or
AOL Time Warner securities at artificially inflated prices. In furtherance of this unlawful scheme, plan and course of conduct, Defendants, and each of them, took the actions set forth herein.
796. Defendants: (a) employed devices, schemes, and artifices to defraud ; (b) made untrue statements of material fact and/or omitted to state material facts necessary to make th e statements not misleading; and (c) engaged in acts, practices, and a course of business which operated as a fraud and deceit upon the purchasers of AOL' s or the Company 's securities in an effort to maintain artificially high market p rices for these securities in violation of Section 10(b) of the Exchange Act and Rule lOb-5. All Defendants named in this Count are sued as p rimary participants in the wrongful and illegal conduct charged herein.
797. Defendants, individually and in concert, directly and indirectly, by the use, mean s
or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a
continuous course of conduct to conceal adverse material information about the business ,
operations and future prospects of AOL and AOL Time Warner as specified herein.
798 . Defendants employed devices, schemes and artifices to defraud, while i n
possession of material adverse non-public information and engaged in acts, practices, and a
course of conduct as alleged herein in an effo rt to assure investors of AOL's and AOL Time
40699.1 298 Warner's value and performance and continued substantial growth, which included the making of, or the participation in the making of, untrue statements of material facts and omitting to state material facts necessary in order to make the statements made about AOL and AOL Tim e
Warner and their operating condition, advertising revenue, goodwill and future prospects in the light of the circumstances under which they were made, not misleading, as set forth more particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon those who purchased or otherwise acquired AOL or AOL
Time Warner securities during the Class Period .
799. As more fully described in the paragraphs relating to fraud (¶¶ 115-256, 257-41 1
and 412-449), the violations of GAAP (¶¶ 107-114 and 115-251) and the scienter of the
Defendants named herein (¶¶ 469-579), each of the Defendants' primary liability arises from
the following facts: (i) the Individual Defendants were high-level executives and/or directors at
AOL and AOL Time Warner during the Class Period and members of the Company's
management team or had control thereof; (ii) each of these Defendants, by virtue of his
responsibilities and activities as a senior officer and/or director of AOL and AOL Time Warner
was privy to and participated in the creation, development and reporting of AOL's and the
Company's internal budgets, plans, projections and/or reports ; (iii) each of these Defendants
enjoyed significant personal contact and familiarity with the other defendants and was advised
of and had access to other members of AOL's and the Company's management team, internal
reports and other data and information about AOL's and the Company's advertising revenue,
finances, operations, and sales at all relevant times ; and (iv) each of these Defendants was aware
of, participated in or caused the dissemination of information to the investing public of AOL
and AOL Time Warner filings with the SEC, press releases and registration statements . These
40699.1 299 statements and documents were materially false and misleading in that, among other things, they misrepresented, and failed to disclose, AOL's and AOL Time Warner' s sham transactions,
improper recognition of advertising revenue and improper accounting for goodwill, during th e
Class Period.
800. The Defendants had actual knowledge of the misrepresentations and omissions o f material facts set forth herein, or acted with reckless disregard for the truth, in that they failed t o ascertain and disclose such facts, even though such facts were available to them . Such
Defendants' material misrepresentations and/or omissions were made knowingly or recklessl y and for the purpose and effect of (1) concealing AOL's and AOL Time Warner 's operatin g condition, advertising revenue, goodwill and future business prospects from the investing public ;
(2) consummating the Merger and Bond Offerings ; and (3) supporting the artificially inflated prices of its securities. As demonstrated by Defendants' overstatements and misstatements o f
AOL's and the Company's business, operations, advertising revenue, goodwill, earnings and future business prospectus throughout the Class Period, Defendants, if they did not have actua l knowledge of the misrepresentations and omissions alleged, were reckless in failing to obtain such knowledge by deliberately refraining from taking those steps necessary to discover whethe r those statements were false or misleading.
801 . As a result of the dissemination of the materially false and misleading information
and failure to disclose mate rial facts, as set fo rth above, the market price of AOL and AO L
Time Warner securities were artificially inflated during the Class Period . In ignorance of the
fact that market prices of such publicly-traded securities were artificially inflated, and relying
directly or indirectly on the false and misleading statements made by Defendants, or upon th e
integrity of the market in which the securities trade, and/or on the absence of material advers e
40699.1 300 information that was known to or recklessly disregarded by Defendants, but not disclosed i n public statements by Defendants during the Class Period, Plaintiff and other class member s acquired such securities during the Class Period at artificially high prices and were damage d thereby.
802. At the time of said misrepresentations and omissions, Plaintiff and other member s of the Class were ignorant of their falsity, and believed them to be true. Had Plaintiff and the
other members of the Class and the marketplace known the truth regarding the problems that
AOL and AOL Time Warner were experiencing, which were not disclosed by Defendants,
Plaintiff and other members of the Class would not have purchased or otherwise acquired such
securities, or, if they had acquired such securities during the Class Period, they would not have
done so at the artificially inflated prices which they paid .
803 . By virtue of the foregoing, Defendants named in this Count have violated Sectio n
10(b) of the Exchange Act, and Rule lOb-5 promulgated thereunder . As a direct and proximate
result of Defendants' wrongful conduct, Plaintiff and the other members of the Class suffere d
damages in connection with their respective purchases or acquisitions of AOL and AOL Time
Warner' s securities during the Class Period.
COUNT NINETEEN
(Against Ernst & Young for Violations of & 10(b) of the Exchange Act and Rule 10b-5)
804. Except for the Counts not sounding in fraud, Plaintiff repeats and realleges each
and every allegation contained above as if fully set forth herein. This Count is asserted against
Ernst & Young for violations of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and
Rule lOb-5, 17 C.F.R 240. 106-5.
40699 .1 301 805 . Ernst & Young, individually and in concert with others, directly and indirectly, b y the use of means or instrumentalities of interstate commerce and/or of the mails, engaged an d participated in a continuous course of conduct that operated as a fraud and deceit upon Plaintiff and the other members of the Class ; made various untrue and/or misleading statements o f material facts and omitted to state material facts necessary in order to make the statement s made, in light of the circumstances under which they were made, not misleading ; made the
above statements with a severely reckless disregard for the truth ; and employed devices, and
artifices to defraud in connection with the purchase and sale of securities, which were intended
to, and did: (i) deceive the investing public, including Plaintiff, regarding, among other things,
AOL and AOL Time Warner's sham transactions, improper recognition of advertising revenue
and improper accounting for goodwill ; (ii) artificially inflate and maintain the market price o f
AOL and AOL Time Warner securities; and (iii) cause Plaintiff and class members to purchas e
AOL and AOL Time Warner securities at artificially inflated prices.
806. As more fully described in the paragraphs relating to the fraud, (¶¶ 115-256, 257-
411 and 412-449), the violations of GAAP (11 107-114 and 115-251) and Ernst & Young's
scienter (¶¶ 580-630), pursuant to the aforesaid plan and course of conduct, Ernst & Young
participated, directly and indirectly, in the preparation and/or issuance of the statements and
documents referred to above, including in AOL and AOL Time Warner filings with the SEC,
press releases, and registration statements . These statements and documents were materially
false and misleading in that, among other things, they misrepresented, and failed to disclose,
AOL's and AOL Time Warner's sham transactions, improper recognition of advertising revenue
and improper accounting for goodwill, during the Class Period.
40699.1 3 02 807 . Ernst & Young, among others, engaged in such a device, scheme or artifice t o misrepresent the financial condition and results of AOL and AOL Time Warner and to consummate the Merger and Bond Offerings, and maintain and/or inflate the prices of AOL and
AOL Time Warner's securities to, among other things, gain lucrative auditing and other consulting services from AOL and AOL Time Warner . Specifically, Ernst & Young knew or recklessly disregarded that AOL's reported annual financial results for fiscal years 1999, 2000
and the transition period for the year ended December 31, 2000 (including December 31, 1999)
and AOL Time Warner's reported annual financial results for 2001 as filed with the SEC in
AOL and AOL Time Warner's Forms 10-K, in the Merger and Bond Registration Statements
and other SEC filings, and disseminated to the investing public, were materially overstated and
were not presented in accordance with GAAP, that Ernst & Young's audits were not performed
in accordance with GAAS, and, therefore, that Ernst & Young's unqualified audit reports, a s
included or incorporated by reference in those annual reports on Forms 10-K and other SEC
filings, were materially false and misleading.
808. The SEC Form 10-Ks, the Merger and Bond Registration Statements and other
SEC filings were materially false and misleading; contained untrue statements of material facts ;
omitted to state material facts necessary to make the statements made in those filings, under the
circumstances in which they were made, not misleading ; and failed to adequately disclos e
material facts . As detailed herein, the misrepresentations contained in, or the material facts
omitted from, those SEC filings included, but were not limited to, the overstatement of
advertising revenue through sham transactions and improper recognition of revenue and backlog
and percentage increases in the amounts and the overstatement of the value of goodwill created
in the Merger, as well as the representations in Ernst & Young's unqualified audit reports issue d
40699.1 303 in connection with E rnst & Young' s audits of AOL and AOL Time Warner's financial statements and AOL Time Warner's balance sheet for those years, in which Ernst & Young certified that: (i) it had audited AOL and AOL Time Warner' s financial statements i n accordance with GAAS ; (ii) it had planned and performed those audits "to obtain reasonable assurance about whether the financial statements are free of material misstatements"; (iii) in its opinion, AOL and AOL Time Warner 's financial statements "present fairly , in all material respects, the consolidated financial position " of AOL and AOL Time Warner " in conformit y with generally accepted accounting principles" or "accounting principles generally accepted i n the United States;" and (iv) Ernst & Young' s audits provided a "reasonable basis" for its opinions. As detailed herein, Ernst & Young's audit reports were materially false an d misleading. Ernst & Young knew or recklessly disregarded that the statements described above , which were contained in the SEC Form 10-Ks, registration statements and incorporated by reference in other SEC filings, were untrue, were made with omissions of material facts, and were misleading .
809. Ernst & Young, with knowledge or reckless disregard of the falsity an d misleading nature of the statements contained in its unqualified reports, and in reckles s disregard of the true nature of its audits, caused the complained of public statements to contain misstatements and omissions of material facts as alleged herein . As described herein, Ernst &
Young's audit of AOL and AOL Time Warner' s financial statements for 1999, 2000, the 2000
AOL transition period ended December 31, 2000 (including December 31, 1999) and the yea r
December 31 , 2001 were not performed in accordance with GAAS, and, in fact , Ernst & Young had no basis for its unqualified opinions rendered in connection therewith . Ernst & Young's unqualified reports dated July 21, 1999, July 20, 2000, January 31, 2001 and January 28, 2002 ,
40699.1 304 issued in connection with those audits, as included in the SEC Form 10-Ks, registration statements and other SEC fillings, in which Ernst & Young opined, among other things, that its audits were performed in accordance with GAAS, were materially false and misleading.
810 . As described in detail above, Ernst & Young acted with scienter throughout th e
Class Period, in that it either had actual knowledge of the misrepresentations and omissions o f material facts set forth herein, or acted with reckless disregard for the truth, in that they failed t o ascertain and to disclose the true facts, even though such facts were available to them . Ernst &
Young was AOL's and AOL Time Warner's auditor, and, therefore, was directly responsible fo r the false and misleading statements and omissions disseminated to the public through it s unqualified audit reports .
811 . As a result of the dissemination of the materially false and misleading information and failure to disclose mate rial facts, as set forth above, AOL and AOL Time Warner securities were sold in the public market, and the market prices of such securities were artificially inflate d during the Class Period . In ignorance of the materially false and misleading nature of the reports and statements described above, Plaintiff and class members relied to their detriment o n the statements described above and/or on the integ rity of the market prices as reflecting the completeness and accuracy of the information disseminated in connection with their purchase s of the securities .
812. At the time of said misrepresentations and omissions, Plaintiff and the class wer e ignorant of their falsity, and believed them to be true . Plaintiff and the class members could not , in the exercise of reasonable diligence, have known the actual facts . Had Plaintiff and the class members known the truth, they would not have taken such action .
40699.1 305 813. By virtue of the foregoing, Ernst & Young has violated Section 10(b) of th e
Exchange Act and Rule IOb-5 promulgated thereunder . As a direct and proximate result of
Ernst & Young's wrongful conduct, Plaintiff and the other members of the Class suffered damages in connection with their respective purchases or acquisitions of AOL and AOL Time
Warner's securities during the Class Period .
COUNT TWENTY
Against Defendants Case, Kelly, Pittman, Colburn, Ripp, Berlow, Schuler, Novack, Levin, Parsons and Pace for Liability Under § 20(a) O f The Exchange Act For Violations Of § 10(b) Of The Exchange Act And Rule lOb-5 Promulgated Thereunde r
814. Plaintiff repeats and realleges each and every allegation contained above as i f fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t incorporate herein any allegations of fraud in connection with this Count. This Count i s asserted against Defendants Case, Kelly, Pittman, Colburn, Ripp, Berlow, Schuler, Novack ,
Levin, Parsons and Pace for their violations of Section 20 of the Exchange Act, 15 U .S.C. §
78t(a), on behalf of all Class members who purchased or acquired AOL and/or AOL Tim e
Warner securities during the Class period and were damaged thereby.
815. As alleged above in Count Eighteen AOL Time Warner, AOL and the Individual
Defendants violated Section I Ob-5 of the Exchange Act and Rule I Ob-5 promulgated hereunder.
816. The Defendants named in this Count acted as controlling persons of AOL and
AOL Time Warner within the meaning of Section 20 of the Exchange Act as alleged herein.
These Defendants had the power and authority to cause AOL and the Company to violat e
Section 10(b) of the Exchange Act and Rule I Ob-5 promulgated thereunder .
817. By virtue of their high-level positions as executives and/or directors at AOL and
AOL Time Warner during the Class Period and members of AOL and the Company' s
40699.1 306 management teams, and their ownership and contractual rights, participation in and/o r
awareness of AOL' s and the AOL Time Warner's operations, the Defendants named in thi s
Count had the power to influence and control and did influence and control, directly o r
indirectly, the decision-making of AOL and AOL Time Warner, including the content and
dissemination of the various statements which Plaintiff contends are materially false and
misleading. Each Defendant named in this Count, because of his responsibilities and activitie s
as a senior officer and/or director of AOL and/or AOL Time Warner, was privy to and
participated in the creation , development and reporting of AOL 's and the AOL Time Warner's
internal budgets, plans, projections and/or reports . The Individual Defendants were provide d
with or had unlimited access to copies of the reports, press releases, public filings and othe r
statements alleged by Plaintiff to be misleading p rior to and/or shortly after these statements
were issued and had the ability to prevent the issuance of the statements or cause the statement s
to be corrected.
818. In particular, each of these Individual Defendants had direct and supervisory
involvement in the day-to-day operations of AOL and AOL Time Warner and, therefore, is
presumed to have had the power to control or influence the particular transactions giving rise t o
the securities violations as alleged herein, and exercised the same .
819. The Individual Defendants were culpable participants because they were aware o f
the dissemination of information to the investing public which they knew or recklessly
disregarded was materially false and misleading. As a result, the Individual Defendants knew or
recklessly disregarded that AOL and AOL Time Warner were engaging in fraudulent conduct in
violation Section 10(b) of the Exchange Act and Rule I Ob-5 promulgated thereunder.
40699.1 307 820. By reason of the foregoing, the Individual Defendants are jointly and severall y
liable as controlling persons pursuant to Section 20 of the Exchange Act for AOL's and AOL
Time Warner's violation of Section 10(b) of the Exchange Act and Rule IOb-5 promulgate d
thereunder. As a direct and proximate result of the Individual Defendants' wrongful conduct,
Plaintiff and other members of the Class suffered damages in connection with their purchases o r
acquisitions of AOL and/or AOL Time Warner securities during the Class Period .
X. PRAYER FOR RELIE F
WHEREFORE, Plaintiff prays for relief and judgment, as follows :
(a) Determining that this action is a proper class action, and appointin g
Plaintiff as representative of the class under Rule 23 of the Federal Rules of Civil Procedure ;
(b) Awarding compensatory damages in favor of Plaintiff and the other Class members against all Defendants, jointly and severally, for all damages sustained as a result o f
Defendants' wrongdoing, in an amount to be proven at trial, including interest thereon;
(c) Awarding Plaintiff and the Class their reasonable costs and expense s incurred in this action, including fees for Plaintiff's counsel and experts;
(d) Awarding extraordinary, equitable and/or injunctive relief as permitted by law, equity and the federal statutory provisions sued hereunder, pursuant to Rules 64, 65, an d any other appropriate state law remedies ; and
(e) Such other and further relief as the Court may deem just and proper .
XI. JURY TRIAL DEMANDED
Plaintiff hereby demands a trial by jury .
40699.1 308 Dated: April , 2003 'Wk-Ak . Skirnick RS 2636) VRobert A MEREDITH COHEN GREENFOGEL & SKIRNICK, P.C. One Liberty Plaza, 35th Floor New York, NY 10006 (212) 240-0020 (212) 240-0021 Fax
Attorneys for Lead Plaintiff Minnesota State Board of Investment and Loca l Coups Class
amuel D. Heins Stacey L. Mills Bryan L. Crawford Alan I. Gilbert Daniel C. Hedlund HEINS MILLS & OLSON, P .L.C. 3550 IDS Center 80 South Eighth Street Minneapolis, MN 55402 (612) 338-4605 (612) 338-4692 Fax
Attorneys for Lead Plaintiff Minnesota State Board of Investment and Lead Counsel for the Class Exhibit A - Cases that Relate to Amended Complaint
Jennifer J. Fadem v. AOL Time Warner, Inc. et at, C .A. No. 1 :02-5575 (SWK) Steven Schmalz v . AOL Time Warner , Inc. et al, C.A. No. 1 :02-5616 (SWK) Marian Antin v. AOL Time Warner, Inc . et al, C.A. No. 1 :02-5633 (SWK) Mark Bluestein v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-5643 (SWK) Malka Birnbaum v. AOL Time Warner , Inc. et al, C.A. No . 1 :02-5705 (SWK) Ernest Hack v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-5777 (SWK) Harvey Matcovsky v. AOL Time Warner, Inc. et al, C.A. No . 1 :02-5778 (SWK) Delbert Currens v. AOL Time Warner, Inc. et at, C.A. No. 1 :02-5799(SWK) Howard Rosengarten v. AOL Time Warner, Inc. et al, C.A. No . 1 :02-5848 (SWK) Alan Russo v. AOL Time Warner , Inc. et al, C.A. No. 1 :02-5936 (SWK) Barbara Dietel v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-5966 (SWK) Earl Benne tt v. AOL Time Warner, Inc . et al , C.A. No. 1 :02-6067 (SWK) Jack L. McBride v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-6088 (SWK) Vardan Sarkisov v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-6128 (SWK) Sherry Weindorf v . AOL Time Warner, Inc. et al, C.A. No. 1 :02-6200 (SWK) Earl Mikolitch v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-6333 (SWK) John Pleggenkuhle v. AOL Time Warner, Inc. et al, C.A. No . 1 :02-6397 (SWK) Prena Smajlaj v. AOL Time Warner, Inc. et al, C.A. No . 1 :02-6564 (SWK) R. Gregory Warren v . AOL Time Warner , Inc. et al, C.A. No. 1 :02-7307 (SWK) Wayne Rome v. AOL Time Warner, Inc. et at, C.A. No. 1 :02-7292 (SWK) Minnesota State Board of Investment v. AOL Time Warner, Inc. et al, C.A. No . 1 :02-7431 (SWK) David Anderson v. AOL Time Warner , Inc. et al, C.A. No. 1 :02-9822 (SWK) Kenneth McClure, et al v. AOL Time Warner, Inc. et al, C .A. No. 1 :02-10063 (SWK) Howard J. Sevel v. AOL Time Warner, Inc. et al, C.A . No. 1 :02-10064 (SWK) Philip J. Goodman v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-10065 (SWK) Stuart Wollman v. AOL Time Warner , Inc. et al, C.A. No . 1 :03-0887 (SWK) Rodney W. Narbesky v . AOL Time Warner, Inc. et al, C .A. No. 1 :02-0888 (SWK) Amy C. Vasquez v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-7080 (SWK) Jason Walsh v. AOL Time Warner, Inc. et al, C.A. No. 1 :02-0889 (SWK) Charles Miller v. AOL Time Warner, Inc. et al, C.A. No. 1 :03-1544 (SWK)
41949 AOL Advertising and Commerce Revenue (Overstated (as Originally Reported) vs . Actual Advertising and Commerce Revenue ) 800
C 0 0 o goo C X VJ d) 600 - t a) a) a) 500 U N E 0 400 U Vc ca 0) 300 •~, -+-Artificially Inflated Advertising and Commerce Revenu e as Originally Reported { 200 -f-Actual Advertising and Commerce Revenue Befor e 0 Inflatio n 100 --- o Merger date
0 _ -----
oJ~ SP op op op oN o~ o~ oC? 5P ~~tio o\oo~tio o\~c ~~~\\q, 0,~20 o\~o~tio o\oo~tio ~~tio o\~\\rt 6\00\20
14P 114 p Quarters ended These numbers may decrease as knowledge about AOL's improper accounting practices increases with formal discove ry. Exhibit C
PLAINTIFF INDIVIDUAL COUNSEL FOR PLAINTIFF Universities Retirement System of Illinois Jeffrey C . Block Berman DeValerio Pease Tabacco Burt & Pucillo One Liberty Square Boston, MA 02109 Tel: (617) 542-8300 Fax: (617) 542-1194
Michael J. Pucillo Berman DeValerio Pease Tabacco Burt & Pucillo Northridge Centre Suite 170 1 515 North Flagler Drive West Palm Beach, FL 3340 1 Tel: (561) 835-9400 Fax : (561) 835-032 2 Jennifer J. Fadem Christopher Lovel l Victor E. Stewart Christopher J . Gray Lovell Stewart Halebian LL P 500 Fifth Avenue New York, NY 1011 0 Tel: (212) 608-1900 Fax: (212) 719-4677 Marian Antin Marian P. Rosner Wolf Popper LLP 845 Third Avenue New York, NY 10022 Tel: (212) 759-4600 Fax: (212) 486-2093
42011 PLAINTIFF INDIVIDUAL COUNSEL FOR PLAINTIFF Policemen & Firemen Retirement System of Javier Bleichmar the City of Detroit Eitan Misulovin Bernstein Litowitz Berger & Grossmann LLP 1285 Avenue of the Americas New York, NY 1001 9 Tel: (212) 554-1400 Fax: (212) 554-1444 Bruce Sobel Robert C. Susser Robert C. Susser, P.C. 6 East 43`d Street, Suite 1900 New York, NY 10017-4609 Tel : (212) 808-0298 Fax : (212) 949-0966
Brian Barry Law Offices of Brian Barry 1801 Avenue of the Stars, Suite 307 Los Angeles, CA 9006 7 Tel: (301) 788-083 1 Fax: (301 ) 788-084 1 Mary Kueser Ann D. White Mager White & Goldstein, LLP One Pitcairn Place, Suite 2400 165 Township Line Road Jenkintown, PA 19046 Tel : (215) 481-027 3 Fax: (215) 481-027 1 Jerry D. Simms Ann D. White Mager White & Goldstein, LLP One Pitcairn Place, Suite 2400 165 Township Line Road Jenkintown, PA 19046 Tel: (215) 481-027 3 Fax: (215) 481-027 1 Jules R. Cattie, III Paul J. Scarlato Brian D. Penny Weinstein, Kitchenoff Scarlato & Goldman Ltd. 1845 Walnut Street, Suite 1100 Philadelphia, PA 19103 Tel: (215) 545-7200 Fax : (215) 545-653 5
42011 13 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF George Crone, Jr. Steven N. Berk Mehri & Skalet 1300 19th Street NW, Suite 40 0 Washington, DC 20036 Tel: (202) 822-510 0 Fax: (202) 822-4997 Amy K. Hoffman Marc H. Edelson Hoffman & Edelson, LLC 45 W. Court Street Doylestown, PA 1890 1 Tel: (215) 230-8043 Fax: (215) 230-873 5 Peter Fisher Todd S. Collins Law Offices of Berger & Montague, P.C. 1622 Locust Street Philadelphia, PA 19103 Tel: (215) 875-3000 Fax: (215) (215) 875-4604
42011 14 PLAINTIFF INDIVIDUAL COUNSEL FOR PLAINTIFF Mark Bluestein Brian Murray Eric J. Belfi Rabin & Peckel LLP 275 Madison Avenue New York, NY 1001 6 Tel: (212) 682-181 8 Fax: (212) 682-1892
Todd S . Collins Michael T. Fantini Berger & Montague, P.C. 1622 Locust Street Philadelphia, PA 19103 Tel: (215) 875-3000 Fax : (215) 875-4604
Kurt Olsen The Olsen Law Firm 2121 K. Street, N.W. Suite 800 Washington, D .C. 20037 Tel: (703) 351-6565 Fax: (703) 351-591 1 Malka Birnbaum Mel E. Lifshitz Gregory M. Egleston Bernstein Liebhard & Lifshitz, LL P 10 East 40th Street New York, NY 1001 6 Tel: (212) 779-141 4 Fax: (212) 779-321 8 Ernest Hack Robert I . Harwood Mathew M. Houston Jeffrey M. Norton Wechsler Harwood LL P 488 Madison Avenue, 8th Floor New York, NY 1002 2 Tel : (212) 935-7400 Fax: (212) 753-3630
42011 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF Harvey Matcovsky Jules Brody Stull, Stull & Brody 6 East 45th Street New York, NY 1001 7 Tel: (212) 687-723 0 Fax: (212) 490-2022
Joseph H. Weiss Weiss & Yourman 551 Fifth Avenue Suite 1600 New York, NY 10176 Tel: (212) 682-3025 Fax: (212) 682-301 0 Howard Rosengarten Jill A. Abrams Gianna M. McCarthy Abbey Gardy, LL P 2121 East 39 Street New York, NY 1001 6 Tel: (212) 889-3700 Fax: (212) 684-5191
Curt V. Trinko Law Offices of Curt V. Trinko 16 West 46th Street New York, NY 1003 6 Tel: (212) 490-9550 Fax: (21 2) 986-0158 Alan Russo Mel E. Lifshitz Gregory M. Egleston Bernstein Liebhard & Lifshitz, LLP 10 East 40th Street New York, NY 1001 6 Tel: (212) 779-1414 Fax: (212) 779-321 8 Barbara Dietel Frederic S . Fox Kaplan, Kilsheimer & Fox, LLP 805 Third Avenue New York, NY 10022 Tel: (212) 687-1980 Fax: (212) 687-771 4
42011 PLAINTIFF INDIVIDUAL COUNSEL FOR PLAINTIFF Earl Benne tt Aaron L. Brody Stull, Stull & Brod y 6 East 45th Street New York, NY Tel : (212) 687-7230 Fax : (212) 490-2022 Jack L. McBride Thomas H. Burt Wolf Haldenstein Adler Freeman & Herz LLC 270 Madison Avenue New York, NY 1001 6 Tel: (212) 545-4600 Fax: (212) 545-4653 Vardan Sarkisov Ira M. Press Kirby, McInerney & Squire, LLP 830 Third Avenue, 10th Floor New York, NY 10022 Tel : (212) 317-2300 Fax: (212) 751-2540
Lionel Z. Glancy Michael Goldberg Glancy & Binkow LLP 1801 Avenue of the Stars, Suite 31 1 Los Angeles, CA 9006 7 Tel : (310) 201-9150 Fax: (310) 201-9160 Sherry Weindorf James V. Bashian Law Offices of James V. Bashian, P .C. 500 Fifth Avenue Suite 2700 New York, NY 1011 0 Tel : (212) 921-4110 Fax (212) 921-4249
Mark C. Gardy Nancy Kaboolian Abbey Gard y, LL P 2121 East 39 Stree t New York, NY 1001 6 Tel: (212) 889-3700 Fax: (212) 684-519 1
42011 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF Earl Mikolitch Patrick A. Klingman Schatz & Nobel, P.C. 330 Main Street 2"d Floor Hartford, CT 0610 6 Tel: (860) 493-629 2 Fax: (860) 493-6290 John Pleggenkuhle Fred T. Isquith Thomas H. Burt Wolf Haldenstein Adler Freeman & Herz LLC 270 Madison Avenue New York, NY 1001 6 Tel : (212) 545-4600 Fax: (212) 545-465 3
Martin D. Chitwood Craig G. Harley Chitwood & Harley 1230 Peachtree Street 2900 Promenade II Atlanta, GA 3030 9 Tel: (404) 873-3900 Fax: (404) 876-4476 Prena Smajlaj Nadeem Farugi Antonion Vozzol o Faruqi & Faruqi LLP 320 East 39th Street New York, NY 1001 6 Tel: (212) 983-933 0 Fax: (212) 983-933 1 R. Gregory Warren Stephen M. Sohmer The Sohmer Law Firm, LLC I Passaic Avenue Fairfield, NJ 0700 4 Tel: (973) 227-7080 Fax: (973) 227-5775
42011 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIF F Wayne Rome Stephen V. Saia Law Offices of Stephen V . Saia 70 Old Cart Path Lane Pembroke, MA 0235 9 Tel: (781 ) 826-840 1 Fax:
Dennis J. Johnson Jacob B. Perkinson Johnson & Perkinson 1690 Williston Road South Burlington, VT 05403 Tel: (802) 862-0030 Fax: (802) 862-0060 David Anderson Jack L. Chestnut Karl L. Cambronne Chestnut & Cambronne, PA 222 South Ninth Street Suite 3700 Minneapolis, MN 55402 Tel : (612) 339-7300 Fax: (612) 336-2940
42011 PLAINTIFF INDIVIDUAL COUNSEL FOR PLAINTIFF Kenneth McClure George L. McWilliams Frances McClure Richard A. Adams Sean F . Rommel Patton, Haltom, Roberts, McWilliams & Greer LLP 2900 St. Michael Dr. Century Plaza, Suite 400 Texarkana, TX 75505 Tel : (903) 334-700 0 Fax: (903) 334-7007
Cary Patterson Bradley E. Beckworth Nix, Patterson & Roach , L.L.P. 205 Linda Drive P.O. Box. 679 Daingerfield, TX 75638 Tel: (903) 645-7333 Fax: (903) 645-2172 Michael A . Johnson George L . McWilliams Richard A. Adams Sean F . Rommel Patton, Haltom, Roberts, McWilliams & Greer LLP 2900 St. Michael Dr. Century Plaza, Suite 400 Texarkana, TX 75505 Tel: (903) 334-7000 Fax: (903) 334-7007
Cary Patterso n Bradley E. Beckworth Nix, Patterson & Roach, L.L.P. 205 Linda Driv e P.O. Box. 679 Daingerfield, TX 7563 8 Tel : (903) 645-7333 Fax: (903) 645-2172
42011 PLAINTIFF INDIVIDUAL COUNSEL FOR PLAINTIFF Lisa G. Johnson George L. McWilliams Richard A. Adams Sean F. Rommel Patton, Haltom, Roberts, McWilliams & Greer LLP 2900 St. Michael Dr . Century Plaza, Suite 400 Texarkana, TX 75505 Tel: (903) 334-7000 Fax : (903) 334-7007
Cary Patterson Bradley E. Beckworth Nix, Patterson & Roach, L.L.P. 205 Linda Drive P.O. Box. 679 Daingerfield, TX 7563 8 Tel: (903) 645-7333 Fax: (903) 645-2172 Howard J. Sevel Steven J. Toll Daniel S . Sommers Cohen Milstein Hausfeld & Toll, P.L.L.C. 1100 New York Avenue N .W. West Tower, Suite 500 Washington, D .C. 20005 Tel: (202) 408-4600 Fax: (202) 408-4699 Philip J. Goodman Conor R. Crowley Finkelstein, Thompson & Loughran 1050 30`t' Street, N.W. Washington, D .C. 20007 Tel: (202) 337-8000 Fax: (202) 337-8090
42011 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF Stuart Wollman Steven J. Toll Daniel S . Sommers Cohen Milstein Hausfeld & Toll, P.L.L.C. 1100 New York Avenue N .W. West Tower, Suite 500 Washington, D .C . 20005 Tel : (202) 408-4600 Fax: (202) 408-4699
Klari Neuwelt Law Office of Klari Neuwelt 110 East 59th Street, 29th Floor New York, NY 10022 Tel : (212) 593-8800 Fax: (212) 593-913 1 Rodney W. Narbesky Steven J. Toll Daniel S. Sommers Cohen Milstein Hausfeld & Toll, P.L.L.C. 1100 New York Avenue N.W. West Tower, Suite 500 Washington, D .C. 20005 Tel: (202) 408-4600 Fax: (202) 408-4699
Thomas Shapiro Shapiro Haber & Urmy, L.L.P. 75 State Street Boston, MA 0210 9 Tel: (617) 439-393 9 Fax: (617) 439-0134
42011 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF Amy C . Vasquez Nadeem Faruq i Antonion Vozzolo Faruqi & Faruqi LLP 320 East 39th Street New York, NY 1001 6 Tel : (212) 983-933 0 Fax: (212) 983-933 1
Corey D . Holzer Michael I. Fistel, Jr. Holzer Holzer & Cannon Loc 1117 Perimeter Center Wes t Suite E-107 Atlanta, GA 3033 8 Tel : (770) 392-0090 Fax: (770) 392-0029 Jason Walsh Timothy D . Baffin Straus & Boies , L.L.P. 10513 Braddock Road Fairfax, VA 22032 Tel : (703) 764-8700 Fax: (703) 764-8704 Charles Miller Anthony Bolognese Bolognese & Associates, LLC One Penn Center 1617 JFK Boulevard, Suite 650 Philadelphia, PA 1910 3 Tel : (215) 814-675 0 Fax: (215) 814-6764
42011 10 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF Municipal Police Employees Retirement John P. Connolly System of Louisiana Ford C. Ladd 211 North Union Street Suite 100 Alexandria, VA 2231 4 Tel : (703) 684-4865 Fax: (703) 683-4707
Stanley M. Grossmann Marc I . Gross Robert J. Axelrod Gregory B. Linkh Pomerantz Haudek Block Grossmann & Gross LLP 100 Park Avenue, 26th Floor New York, NY 1001 7 Tel : (212) 661-1100 Fax: (212) 661-8665
Patrick V. Dahlstrom Leigh R. Handelman Pomerantz Haudek Block Grossmann & Gross LLP One La Salle Street, Suite 2225 Chicago, IL 60602 Tel: (312) 377-118 1 Fax: (312) 377-1184
42011 11 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF Louisiana School Employees Retirement John P. Connolly System Ford C. Ladd 211 North Union Street Suite 100 Alexandria, VA 2231 4 Tel: (703) 684-4865 Fax: (703) 683-4707
Stanley M. Grossmann Marc I. Gross Robert J. Axelrod Gregory B . Linkh Pomerantz Haudek Block Grossmann & Gross LLP 100 Park Avenue, 26th Floor New York, NY 1001 7 Tel: (212) 661-1100 Fax : (212) 661-8665
Patrick V. Dahlstrom Leigh R. Handelman Pomerantz Haudek Block Grossmann & Gross LLP One La Salle Street, Suite 2225 Chicago, IL 60602 Tel: (312) 377-118 1 Fax: (312) 377-1184 StoneRidge Investment Partners LLC and John Deborah R . Gross Turner Law Offices Bernard M. Gross 1515 Locust Street, Second Floor Philadelphia, PA 19102 Tel: (215) 561-3600 Fax: (215) 561-3000 Ontario Teachers' Pension Plan Board Javier Bleichmar Eitan Misulovi n Bernstein Litowitz Berger & Grossmann LLP 1285 Avenue of the Americas New York, NY 1001 9 Tel: (212) 554-1400 Fax: (212) 554-1444
42011 12 PLAINTIFF INDIVIDUAL COUNSEL FOR PLAINTIFF Policemen & Firemen Retirement System of Javier Bleichmar the City of Detroit Eitan Misulovin Bernstein Litowitz Berger & Grossmann LLP 1285 Avenue of the Americas New York, NY 1001 9 Tel : (212) 554-1400 Fax: (212) 554-1444 Bruce Sobel Robert C. Susser Robert C. Susser, P.C. 6 East 43rd Street, Suite 190 0 New York, NY 10017-4609 Tel: (212) 808-0298 Fax: (212) 949-0966
Brian Barry Law Offices of Brian Barry 1801 Avenue of the Stars , Suite 307 Los Angeles, CA 9006 7 Tel: (301) 788-083 1 Fax: (301 ) 788-084 1 Mary Kueser Ann D. White Mager White & Goldstein, LLP One Pitcairn Place, Suite 2400 165 Township Line Road Jenkintown, PA 19046 Tel : (215) 481-0273 Fax: (215) 481-027 1 Jerry D. Simms Ann D. White Mager White & Goldstein, LLP One Pitcairn Place, Suite 2400 165 Township Line Road Jenkintown, PA 19046 Tel: (215) 481-0273 Fax : (215) 481-0271 Jules R. Cattie, III Paul J. Scarlato Brian D. Penny Weinstein, Kitchenoff Scarlato & Goldman Ltd. 1845 Walnut Street, Suite 1100 Philadelphia , PA 19103 Tel : (215) 545-7200 Fax: (215) 545-653 5
42011 13 PLAINTIFF INDIVIDUAL COUNSEL FO R PLAINTIFF George Crone, Jr. Steven N. Berk Mehri & Skale t 1300 19`h Street NW, Suite 400 Washington, DC 20036 Tel : (202) 822-510 0 Fax: (202) 822-4997 Amy K. Hoffman Marc H. Edelson Hoffman & Edelson, LL C 45 W. Court Street Doylestown, PA 1890 1 Tel: (215) 230-8043 Fax: (215) 230-8735 Peter Fisher Todd S. Collins Law Offices of Berger & Montague, P.C. 1622 Locust Street Philadelphia, PA 1910 3 Tel : (215) 875-3000 Fax: (215) (215) 875-4604
42011 14 SERVED VIA FEDERAL EXPRESS Holly K. Kulka Robert D. Joffe Heller, Ehrman, White & McAuliffe LLP Peter T. Barbur 120 West 45`h Stree t Jeff E. Butler New York, NY 10036 Cravath, Swaine & Moore Tel: (212) 832-8300 Worldwide Plaza, 825 Eighth Avenue Fax: (212) 763-7600 New York, NY 1001 9 Tel: (212) 474-1000 Attorney for Defendant Ernst & Young Fax: (212) 474-3700 LLP
Attorney for Defendants AOL Time Warner, Inc., America Online, Inc., Stephen M. Case, J. Michael Kelly, Wayne H. Pace, Robert W. Pittman, Daniel F. Ackerson, James L. Barksdale, Stephen F. Bollenbach, Frank J. Caufield, Miles R. Gilburne, Carla A. Hills, Gerald M. Levin, Reuben Mark, Michael A . Miles, Kenneth J. Novack, Richard D. Parsons, Franklin D. Raines, R. E. Turner and Francis T. Vincent, Jr.
Roger C. Spaeder Zuckerman Spaeder LL P 1201 Connecticut Avenue, N .W. Suite 1200 Washington, DC 20036 Tel: (202) 778-1800 Fax: (202) 822-8106
Attorney for Defendant David S . Colburn
Michael L . Rugen Heller, Ehrman, White & McAuliffe LLP 333 Bush Street San Francisco, CA 94104 Tel : (415) 772-6000 Fax: (415) 772-6268
38465 8 CERTIFICATE OF SERVIC E
I, Samuel D. Heins, Esq., hereby certify that on the 15`h day of April, 2003, I caused to be served, in the manner indicated, on each of the parties listed on the attached service list by either First Class Mail or Federal Express true and correct copies of the foregoing Amended Consolidated Class Action Complaint of Lead Plaintiff Minnesota State Board of Investment on Behalf of Purchasers and Acquirers of America Online, Inc. and AOL Time Warner, Inc . Publicly Traded Securities.
Samuel D. Heins
42025 AOL Time Warner File # 4363 Service List
SERVED VIA FEDERAL EXPRESS
Robert A. Skirnick Todd S. Collins Meredith Cohen Greenfogel & Skirnick, Michael T. Fantini P.C. Berger & Montague, P.C. One Liberty Plaza, 35th Floor 1622 Locust Street New York, NY 10006 Philadelphia, PA 19103 Tel : (212) 240-0020 Tel: (215) 875-3000 Fax: (212) 240-0021 Fax: (215) 875-4604
Plaintiffs ' Local Counsel Kurt Olsen The Olsen Law Firm SERVED VIA FIRST CLASS MAI L 2121 K. Street, N.W. Suite 800 Washington, D .C . 2003 7 Christopher Lovell Tel : (703) 351-6565 Victor E. Stewart Fax: (703) 351-591 1 Christopher J. Gray Lovell Stewart Halebian LLP Attorneys for Plaintiff Mark Bluestein 500 Fifth Avenu e New York, NY 10110 Mel E. Lifshitz Tel: (212) 608-1900 Gregory M. Egleston Fax: (212) 719-4677 Bernstein Liebhard & Lifshitz, LLP 10 East 401h Street Attorney For Plaintiff Jennifer J. Fadem New York, NY 10016 Tel: (212) 779-1414 Marian P. Rosner Fax: (212) 779-321 8 Wolf Popper LLP 845 Third Avenue Attorney for Plaintiffs Malka Birnbaum New York, NY 10022 and Alan Russo Tel : (212) 759-4600 Fax: (212) 486-2093 Robert I . Harwood Mathew M. Houston Attorney for Plaintiff Marian Anti n Jeffrey M. Norton Wechsler Harwood LLP Brian Murray 488 Madison Avenue, 8th Floor Eric J. Belfi New York, NY 10022 Rabin & Peckel LLP Tel : (212) 935-7400 275 Madison Avenue Fax : (212) 753-3630 New York, NY 10016 Tel: (212) 682-1818 Attorney for Plaintiff Ernest Hack Fax: (212) 682-1892 SERVED VIA FIRST CLASS MAI L
Jules Brody Aaron L. Brody Stull, Stull & Brody Stull, Stull & Brody 6 East 45`h Street 6 East 45th Street New York, NY 10017 New York, NY Tel: (212) 687-7230 Tel : (212) 687-7230 Fax: (212) 490-2022 Fax: (212) 490-2022
Joseph H. Weiss Attorney for Plaintiff Earl Bennett Weiss & Yourman 551 Fifth Avenue Thomas H. Burt Suite 1600 Wolf Haldenstein Adler Freeman & Herz New York, NY 10176 LLC Tel: (212) 682-3025 270 Madison Avenue Fax : (212) 682-301 0 New York, NY 10016 Tel: (212) 545-4600 Attorney for Plaintiff Harvey Matcovsky Fax: (212) 545-4653
Jill A. Abrams Attorney for Plaintiff Jack L. McBride Gianna M. McCarthy Abbey Gardy, LLP Ira M . Press 2121 East 39th Street Kirby, McInerney & Squire, LLP New York, NY 10016 830 Third Avenue, 10th Floo r Tel: (212) 889-3700 New York, NY 10022 Fax: (212) 684-519 1 Tel: (212) 317-2300 Fax: (212) 751-2540 Curt V. Trinko Law Offices of Curt V . Trinko Lionel Z. Glancy 16 West 46`h Street Michael Goldberg New York, NY 10036 Glancy & Binkow LLP Tel: (212) 490-9550 1801 Avenue of the Stars, Suite 311 Fax: (212) 986-0158 Los Angeles, CA 9006 7 Tel: (310) 201-9150 Attorneys for Plaintiff Howard Fax: (310) 201-9160 Rosengarten Attorneys for Plaintiff Vardan Sarkisov Frederic S . Fox Kaplan, Kilsheimer & Fox, LLP Conor R. Crowley 805 Third Avenue Finkelstein, Thompson & Loughran New York, NY 10022 1050 30th Street, N .W. Tel: (212) 687-1980 Washington, D .C. 20007 Fax: (212) 687-7714 Tel: (202) 337-8000 Fax: (202) 337-8090 Attorney for Plaintiff Barbara Dietel Attorney for Plaintiff Philip J. Goodman
38465 2 SERVED VIA FIRST CLASS MAIL
James V. Bashian Fred T. Isquith Law Offices of James V. Bashian, P.C. Thomas H. Burt 500 Fifth Avenue Wolf Haldenstein Adler Freeman & Herz Suite 2700 LLC New York, NY 10110 270 Madison Avenue Tel: (212) 921-4110 New York, NY 10016 Fax (212) 921-424 9 Tel : (212) 545-4600 Fax: (212) 545-4653 Mark C. Gardy Nancy Kaboolian Martin D. Chitwood Abbey Gardyz, LLP Craig G. Harley 2121 East 39' Street Chitwood & Harley New York, NY 10016 1230 Peachtree Street Tel: (212) 889-3700 2900 Promenade II Fax: (212) 684-519 1 Atlanta, GA 30309 Tel : (404) 873-3900 Attorneys for Plaintiff Sherry Weindorf Fax: (404) 876-4476
George L. McWilliams Attorney for Plaintiff John Pleggenkuhle Richard A. Adams Sean F. Rommel Nadeem Faruqi Patton, Haltom, Roberts, Antonion Vozzolo McWilliams & Greer LLP Faruqi & Faruqi LLP 2900 St. Michael Dr. 320 East 39th Street Century Plaza, Suite 400 New York, NY 10016 Texarkana, TX 75505 Tel: (212) 983-9330 Tel : (903) 334-7000 Fax: (212) 983-933 1 Fax: (903) 334-7007 Attorney for Plaintiffs Prena Smajlaj and Cary Patterson Amy C. Vasuaz Bradley E. Beckworth Nix, Patterson & Roach, L.L.P. Steven J. Toll 205 Linda Drive Daniel S. Sommers P.O. Box. 679 Cohen Milstein Hausfeld & Toll , P.L.L.C. Daingerfield , TX 75638 1100 New York Avenue N .W. Tel: (903) 645-7333 West Tower, Suite 500 Fax : (903) 645-2172 Washington, D.C. 20005 Tel: (202) 408-4600 Attorney for Plaintiffs Kenneth and Fax: (202) 408-4699 Frances McClure, Michael A. and Lisa G. Johnson
38465 SERVED VIA FIRST CLASS MAI L
Klari Neuwel t Jeffrey C. Block Law Office of Klari Neuwelt Berman DeValerio Pease Tabacco Burt & 110 East 59`h Street, 29th Floor Pucillo New York, NY 10022 One Liberty Square Tel : (212) 593-8800 Boston, MA 02109 Fax: (212) 593-913 1 Tel: (617) 542-8300 Fax: (617) 542-1194 Attorneys for Plaintiff Stuart Wollman Michael J. Pucillo Thomas Shapir o Berman DeValerio Pease Tabacco Burt & Shapiro Haber & Urmy, L.L.P. Pucillo 75 State Street Northridge Centre Boston, MA 02109 Suite 170 1 Tel : (617) 439-3939 515 North Flagler Drive Fax: (617) 439-0134 West Palm Beach, FL 33401 Tel: (561) 835-9400 Attorney for Plaintiff Rodney W. Fax: (561) 835-0322 Narbesky Attorneys for Plaintiff Universities Steven J. Toll Retirement System of Illinois Daniel S. Sommers Cohen Milstein Hausfeld & Toll, P.L.L.C. John P. Connolly 1100 New York Avenue N .W. Ford C . Ladd West Tower, Suite 500 211 North Union Street Washington, D .C. 20005 Suite 100 Tel : (202) 408-4600 Alexandria, VA 22314 Fax: (202) 408-4699 Tel : (703) 684-4865 Fax: (703) 683-4707 Attorney for Plaintiff Howard J. Sevel and Rodney W. Narbesky Stanley M. Grossmann Marc I. Gross Corey D. Holzer Robert J. Axelrod Michael I . Fistel, Jr. Gregory B . Linkh Holzer Holzer & Cannon LLc Pomerantz Haudek Block Grossmann & 1117 Perimeter Center Wes t Gross LLP Suite E-107 100 Park Avenue , 26th Floor Atlanta, GA 30338 New York, NY 1001 7 Tel: (770) 392-0090 Tel: (212) 661-1100 Fax: (770) 392-0029 Fax : (212) 661-8665
Attorneys for Plaintiff Amy C. Vasquez
38465 4 SERVED VIA FIRST CLASS MAIL
Patrick V . Dahlstrom Stephen V. Saia Leigh R. Handelman Law Offices of Stephen V. Saia Pomerantz Haudek Block Grossmann & 70 Old Cart Path Lane Gross LLP Pembroke, MA 0235 9 One La Salle Street, Suite 2225 Tel : (781) 826-8401 Chicago, IL 60602 Fax: Tel: (312) 377-1181 Fax: (312) 377-1184 Dennis J. Johnson Jacob B. Perkinson Attorneys for Plaintiffs Municipal Police Johnson & Perkinson Employees Retirement System of 1690 Williston Road Louisiana and Louisiana School South Burlington, VT 05403 Employees Retirement System Tel: (802) 862-003 0 Fax: (802) 862-0060 Deborah R. Gross Law Offices Bernard M. Gross Attorneys for Plaintiff Wayne Rom e 1515 Locust Street, Second Floor Philadelphia, PA 19102 Robert C. Susser Tel: (215) 561-3600 Robert C. Susser, P.C. Fax: (215) 561-3000 6 East 43`d Street, Suite 1900 New York, NY 10017-4609 Attorneys for Plaintiffs StoneRidge Tel: (212) 808-0298 Investment Partners LLC and John Fax: (212) 949-0966 Turner Brian Barry Javier Bleichmar Law Offices of Brian Barry Eitan Misulovin 1801 Avenue of the Stars, Suite 307 Bernstein Litowitz Berger & Grossmann Los Angeles, CA 9006 7 LLP Tel: (301) 788-0831 1285 Avenue of the Americas Fax: (301) 788-084 1 New York, NY 1001 9 Tel: (212) 554-1400 Attorneys for Plaintiff Bruce Sobe l Fax: (212) 554-1444 Ann D. White Attorneys for Plaintiffs Ontario Teachers' Mager White & Goldstein, LLP Pension Plan Board and the Policemen & One Pitcairn Place, Suite 2400 Firemen Retirement System of the City of 165 Township Line Road Detroit Jenkintown, PA 19046 Tel : (215) 481-0273 Fax: (215) 481-027 1
Attorney for Plaintiffs Mary Kueser and Jerry D. Simms
38465 5 SERVED VIA FIRST CLASS MAI L
Jack L. Chestnut Marc H. Edelson Karl L . Cambronne Hoffman & Edelson, LLC Chestnut & Cambronne, PA 45 W. Court Street 222 South Ninth Street Doylestown, PA 18901 Suite 3700 Tel : (215) 230-8043 Minneapolis, MN 55402 Fax : (215) 230-873 5 Tel: (612) 339-7300 Fax: (612) 336-2940 Attorney for Plaintiff Amy K. Hoffman
Attorney for Plaintiff David Anderson Anthony Bolognese Bolognese & Associates, LLC Timothy D. Baffin One Penn Center Straus & Boies, L.L.P. 1617 JFK Boulevard, Suite 650 10513 Braddock Road Philadelphia, PA 1910 3 Fairfax, VA 22032 Tel : (215) 814-6750 Tel : (703) 764-8700 Fax: (215) 814-6764 Fax: (703) 764-8704 Attorney for Charles F . Miller Attorney for Plaintiff Jason Walsh Todd S . Collins Paul J. Scarlato Law Offices of Berger & Montague, P.C. Brian D. Penny 1622 Locust Street Weinstein, Kitchenoff Scarlato & Philadelphia, PA 19103 Goldman Ltd. Tel : (215) 875-3000 1845 Walnut Street, Suite 1100 Fax: (215) (215) 875-460 4 Philadelphia, PA 19103 Tel: (215) 545-7200 Attorney for Peter Fisher Fax: (215) 545-6535 Stephen M. Sohmer Attorneys for Plaintiff Jules R. Cattie, III The Sohmer Law Firm, LLC 1 Passaic Avenue Steven N. Berk Fairfield, NJ 07004 Mehri & Skalet Tel: (973) 227-7080 1300 19th Street NW, Suite 400 Fax: (973) 227-5775 Washington, DC 20036 Attorney for Plaintiff R. Gregory Warren Tel: (202) 822-5100 Fax: (202) 822-4997
Attorney for Plaintiff George Crone, Jr.
38465 6 SERVED VIA FIRST CLASS MAI L
Patrick A. Klingman Richard Schiffrin Schatz & Nobel, P.C. Schiffrin & Barroway, LLP 330 Main Stree t Three Bala Plaza East, Suite 400 2nd Floor Bala Cynwyd, PA 19004 Hartford, CT 06106 Tel : (610) 667-7706 Tel: (860) 493--6292 Fax: (610) 667-705 6 Fax: (860) 493-6290 Attorney for Steven Winfield (ERISA Attorney for Plaintiff Earl Mikolitch Case)
Lee S . Shalov Marc S. Henzel Shalov, Stone & Bonner Law Office of Marc S. Henzel 485 Seventh Avenue 237 Montgomery Avenue, Suite 202 Suite 1000 Bala Cynwyd, PA 1900 4 New York, NY 10018 Tel: (610) 660-8000 Tel: (212) Fax: (610) 660-8080 Fax: (212) Carol V. Gilden Attorney for Chuck Hall (Derivative case ) Much Shelist Freed Denenberg Ament & Rubenstein, P .C. Edwin J. Mills 191 North Wacker Drive, Suite 1800 Stull, Stull & Brody Chicago, IL 60606 6 East 45th Street Tel: (312) 521-2000 New York, NY 10017 Fax: (312) 521-2100 Tel: (212) 687-7230 Fax: (212) 490-2022
Attorney for Rita Roberts (ERISA Case )
Robert A. Izard Schatz & Nobel, P.C. 330 Main Street Hartford CT 06106-1851 Tel: (860) 493-6292 Fax: (860) 493-6290
Attorney for Barbara Grant (ERISA Case)
38465 7 SERVED VIA FEDERAL EXPRESS Holly K. Kulka Robert D. Joffe Heller, Ehrman, White & McAuliffe LLP Peter T. Barbur 120 West 45th Street Jeff E. Butler New York, NY 10036 Cravath, Swaine & Moore Tel : (212) 832-8300 Worldwide Plaza, 825 Eighth Avenue Fax : (212) 763-7600 New York, NY 1001 9 Tel : (212) 474-1000 Attorney for Defendant Ernst & Young Fax: (212) 474-3700 LLP
Attorney for Defendants AOL Time Warner, Inc ., America Online, Inc., Stephen M. Case, J. Michael Kelly, Wayne H. Pace, Robert W. Pittman, Daniel F. Ackerson, James L. Barksdale, Stephen F. Bollenbach, Frank J . Canfield, Miles R. Gilburne, Carla A. Hills, Gerald M. Levin, Reuben Mark, Michael A. Miles, Kenneth J. Novack, Richard D . Parsons, Franklin D . Raines, R. E. Turner and Francis T . Vincent, Jr.
Roger C. Spaeder Zuckerman Spaeder LLP 1201 Connecticut Avenue, N .W. Suite 1200 Washington, DC 20036 Tel : (202) 778-1800 Fax: (202) 822-8106
Attorney for Defendant David S . Colburn
Michael L. Rugen Heller, Ehrman, White & McAuliffe LLP 333 Bush Street San Francisco, CA 94104 Tel: (415) 772-6000 Fax: (415) 772-6268
38465 8