The University of California yesterday accused AOL Time Warner Inc. Chairman Steve Case, Vice Chairman Kenneth J. Novack, former AOL president Robert W. Pittman and other top executives of reaping $936 million in illegal insider-trading profits by using "tricks, contrivances and bogus transactions" to manipulate AOL's stock price before and after its merger with Time Warner in January 2001.
In a 184-page complaint filed in California state court, the giant university system, which has lost more than $450 million on AOL Time Warner shares, accused Case and others of concealing the deterioration in America Online's business so they could complete the merger and trigger lucrative stock options. The executives also used corporate cash to prop up AOL Time Warner shares after the merger, enabling them to sell stock while hiding weaknesses in AOL's advertising, the lawsuit alleged.
Although federal probes into America Online have focused primarily on financial reporting issues, the scope of those investigations may include a careful review of these fresh insider-trading allegations, sources said. The lawsuit follows the filing of dozens of other federal shareholder actions against AOL Time Warner. The university recently withdrew from a class-action shareholder suit to file its own action in its home state. It was joined in the lawsuit by a bank that manages money for union pension funds. "Under the law, a company issuing new stock, as the merged AOL Time Warner did, is liable to the purchasers of that stock for material misstatements that inflate the stock's value," said James E. Holst, general counsel of California's university system. "We believe that AOL Time Warner and its investment advisers must be held responsible for the admitted misstatement of AOL's financial condition."
AOL Time Warner spokeswoman Tricia Primrose declined to comment yesterday on behalf of the corporation and the individual defendants in the lawsuit, including AOL Time Warner's board of directors and former chairman Gerald M. Levin.
The company, which is seeking to cooperate with ongoing criminal and Securities and Exchange Commission probes, has restated $190 million in inflated ad revenue booked by AOL. In addition, AOL Time Warner recently disclosed that the SEC has indicated it may need to restate a portion of $400 million in ad revenue tied to a questionable deal. In addition to making sweeping accusations and including small photos of key defendants in the lawsuit, the papers filed yesterday state that senior executives of America Online received detailed descriptions of the steep decline in AOL's business prior to the merger. Lawyer William S. Lerach, who is representing the university system, said the accusations against Case and others are based on interviews with former America Online officials.
"During the months preceding the closing of the Merger, AOL's senior executives were frequently secretly briefed on the decline in advertising revenue, and held weekly meetings to discuss the increasingly devastating effect on AOL of the troubles suffered by the company's dot-com base," the lawsuit said. "Rather than disclose this adverse trend and risk derailing the Merger, AOL concealed it. The company did not take non-paying dot-coms to court for fear that public filings would disclose this growing weakness in AOL's business. Instead, it charged failing dot-com customers a fee for shortening the term of their contracts and improperly recorded the fee as advertising revenue."
The lawsuit said AOL's business affairs unit -- then headed by David M. Colburn, a defendant in the lawsuit who is under investigation by federal authorities and was ousted from America Online -- structured increasing numbers of unconventional deals, known as "BA Specials," to artificially inflate revenue. Without being specific, the lawsuit alleged that AOL recorded "bogus" deals with Qwest Communications International Inc., WorldCom Inc., Veritas Software Corp., Homestore.com and other companies.
Lerach is a senior partner of the law firm Milberg Weiss Bershad Hynes & Lerach, which has filed a $25 billion class-action lawsuit against Enron Corp., and has lead roles in shareholder litigation against WorldCom, AT&T Corp., Honeywell and Sprint. Yesterday, Lerach said the decision by the University of California to go after AOL Time Warner and its management, rather than joining in the class-action suit, is part of a growing trend.
"It is a clear statement that large institutional investors are not only extremely upset over the level of executive misconduct in the past few years but they are becoming more self assertive in taking steps to recover those losses and hold the executives accountable," Lerach said. "The bottom line is they believe they can obtain superior recovery by pursuing individual actions."
In addition to the AOL executives, others named as defendants in the lawsuit include the investment banking and accounting firms involved in the AOL Time Warner merger. AOL stock rose 21 cents yesterday to close at $12.51.