AOL Shares Fall as New Accounting Questions Surface

Shares of AOL Time Warner Inc. slipped into single digits again Monday as a California lawsuit alleged that the media giant participated in an accounting sham with troubled real estate Web site Homestore Inc.

The suit comes as New York-based AOL Time Warner faces an investigation by the Securities and Exchange Commission and a related criminal probe by the Justice Department into reports that the company used aggressive accounting practices to inflate revenue and mask financial problems.

In a revised class-action lawsuit filed July 31 in U.S. District Court in Los Angeles, the California State Teachers’ Retirement System alleges that AOL and Homestore engaged in bogus advertising transactions that appear to have been designed to help Homestore pad its revenue.

The suit, first reported Monday in the Wall Street Journal, is the consolidation of several shareholder lawsuits that have been filed against Homestore, which admitted this year to improperly using barter deals to boost ad revenue. The Westlake Village-based company restated its revenue for 2000 and 2001, spurring an SEC investigation.

AOL Time Warner is not named in the lawsuit, but an attorney for the teachers retirement system--which claims to have lost $9 million from its Homestore shares--said AOL may be added to the suit if it is determined that company officials knew how the transactions were being used.

“We’ll continue to investigate the AOL link,” said Bruce Simon of Cotchett, Pitre, Simon & McCarthy, lead counsel in the shareholder lawsuit. “What we are hearing about the [federal] investigation of AOL for its own accounting issues feels an awful lot like the Homestore transaction.”

The suit seeks as much as $2 billion in lost equity for Homestore investors, he said.

An AOL Time Warner spokesman defended the company’s practices and stressed that it has not been named in the suit.

“AOL’s accounting for all transactions with Homestore.com were appropriate and signed off on by our outside auditors, Ernst & Young,” said AOL spokesman John Buckley.

A spokeswoman for Homestore did not return a phone call seeking comment.

SEC investigators interviewed AOL officials in the spring as part of the probe into Homestore, but additional questions now are likely to be raised in light of the lawsuit, according to a source familiar with the investigation.

Shares of both companies fell Monday. AOL Time Warner’s stock lost 35 cents to close at $9.95 in New York Stock Exchange trading. Homestore fell 4 cents to close at 75 cents in Nasdaq trading.

According to the lawsuit, Homestore.com used third-party companies such as SFX Technology and L90, now known as MaxWorldwide Inc., to funnel money first to AOL and then back to Homestore, where it could be counted as new revenue.

In one transaction, the suit claims, Homestore.com paid about $2 million to SFX Technology for an asset that had no real value. SFX kept about $30,000 for itself and used the rest to buy $2 million worth of ads on AOL’s House and Home Channel.

Because AOL and Homestore had signed a revenue-sharing deal in May 2000 to jointly promote the feature, AOL gave about $1 million back to Homestore, the suit alleges. AOL and Homestore announced an exclusive advertising partnership, valuing the five-year deal at about $200 million.

Now that partnership is the subject of arbitration, with each side accusing the other of failing to live up to the terms of the agreement. Homestore has set aside a reserve of $90 million to cover potential costs.

Homestore remains the premier partner on AOL’s real estate site.