SEC Sues 8 Former AOL Officials
Regulator Alleges Inflation of Online Ad Revenue

By Cecilia Kang
Washington Post Staff Writer
Tuesday, May 20, 2008

The Securities and Exchange Commission yesterday filed civil lawsuits against eight former America Online executives, accusing them of participating in illegal accounting practices that inflated the online giant's reported revenue by more than $1 billion.

Former chief financial officers John Michael Kelly and Joseph A. Ripp, as well as several leaders of the company's dealmaking business affairs unit, were among those charged. Four of the executives agreed to settle with the agency for about $8 million, including David M. Colburn, former head of business affairs, who agreed to pay $4 million.

All four who settled agreed to do so without admitting or denying the allegations against them.

In the complaints filed in a federal court in Manhattan, the SEC contended that the former AOL executives "knowingly or recklessly engineered, oversaw and executed a scheme to artificially and materially inflate the company's reported online advertising revenue."

The lawsuits were the result of a drawn-out investigation by the SEC that began in 2002 after a Washington Post report on a series of unconventional deals involving the online giant. In 2005, AOL's parent company, Time Warner, reached its own settlement with the SEC, agreeing to pay $300 million.

"From our perspective, this is one of most egregious accounting frauds in recent memory," said Scott W. Friestad, associate director of the SEC's enforcement division.

At the center of the charges is what the SEC described as an elaborate accounting scheme designed by the business affairs unit of AOL from 2000 to 2002, around the time of AOL's merger with Time Warner. At the time, the online firm was under intense pressure to prove to investors that its advertising business was healthy, despite the fact that many firms had begun to falter with the bursting of the technology bubble.

To bolster their earnings statements for investors and Time Warner, AOL executives allegedly worked up illegal marketing arrangements with companies such as WorldCom, Hewlett-Packard, Sun Microsystems and Veritas Software, according to the lawsuits. In those agreements, AOL allegedly paid the companies to buy online advertising space from AOL, booking the proceeds as revenue in a practice known as "roundtrip" transactions.

The SEC contended that all eight executives participated in the alleged shams and that the four who declined to settle -- Kelly, Ripp, Steven E. Rindner, former senior executive of business affairs, and Mark Wovsaniker, former head of accounting policy -- took part in at least one of three types of accounting maneuvers.

In one alleged scheme, AOL is said to have offered to pay higher prices for goods and services from vendors, who in exchange promised to buy online ads on the Web site. Another tactic involved business mergers, in which AOL allegedly agreed to increase the price it paid to buy a company as long as the firm in turn agreed to buy ads on AOL's site. AOL also allegedly took proceeds from legal settlements and counted them as advertising revenue, according to the government.

Attorneys for defendants Kelly, Ripp, Rindner and Wovsaniker said the men did not settle with the SEC because they were not involved in the wrongdoing.

Ripp and Wovsaniker served as witnesses in separate federal cases against former AOL employees engaged in illegal accounting, which showed that the defendants tried to expose the malfeasance of other executives, their attorneys said.

Ripp "exposed fraud that led to two federal prosecutions," said his attorney, David Geneson. "In one of those cases, the federal prosecutor in open court called him a 'white hat' at AOL, who was fixing problems, not creating problems. There is no question this lawsuit is just plain wrong."

The executives, whose careers have been beleaguered by the six-year investigation, hope a trial would bring an end to their ordeal, their attorneys said.

"Steven Rindner is a decent and honorable young man who conducted himself appropriately during his three years at AOL. While he is disappointed that the SEC has decided to pursue this unjustified course of action, he looks forward to the opportunity to clear his name," said his attorney, Mark J. Hulkower.

The SEC said it has e-mails and other evidence to back up its allegations.

For instance, the agency cited a deal involving WorldCom, a telecommunications giant that allegedly agreed to an illegal advertising arrangement with AOL even though, according to one of the e-mails in question, it didn't need to place ads on AOL Web sites. "This has turned into a money changing scheme and it can't continue," a WorldCom official said in an e-mail to AOL, the SEC said.

Kelly and other executives touted the advertising revenue to analysts and the financial press, according to the suit. Those public comments were made despite evidence that Kelly was aware of the false advertising practices as acknowledged in a May 3, 2000, e-mail to Wovsaniker, in which he allegedly stated, "[w]hat other round trips do you have coming down the line?"

The roundtrip tactics became known among executives as "BA Specials," a reference to the business affairs group run by Colburn, an eccentric star lawyer who was the company's chief dealmaker. Colburn's attorney did not respond to requests for an interview.

In addition to Colburn, those who agreed to settle were a former senior manager of business affairs, Eric L. Keller; former controller James F. MacGuidwin; and Jay B. Rappaport, another former senior manager of business affairs. Colburn and MacGuidwin promised not to serve as officers or directors of a public company for 10 years and seven years, respectively.

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