Homestore to Settle Suit by Investors

Homestore Inc. said Wednesday that it would pay $13 million in cash and hand over 20 million shares to settle a stockholders’ lawsuit over a scam that puffed up the Internet real estate firm’s revenue in 2000 and 2001 as the dot-com balloon began to deflate.

The settlement, valued at $71 million based on Homestore’s Wednesday closing price of $2.90, was negotiated with the California State Teachers’ Retirement System, the lead plaintiff.

CalSTRS said it would continue to press its case against other defendants, including former Homestore auditor PricewaterhouseCoopers and several former Homestore executives. The suit claims they engineered phony business deals with advertisers and others to inflate revenue.

As part of the settlement, CalSTRS won an overhaul of corporate governance procedures that would give it and other shareholders powerful influence on the board of directors at Westlake Village-based Homestore.

The settlement must be approved by a federal court judge, a process expected to take four or five months.

“This was a dark cloud over the company,” Homestore Chief Executive Michael Long said Wednesday. “We can now focus on running our business. We start looking like a normal company again.”

The settlement money would be less than 10% of the estimated $1 billion in stock-market losses claimed by the plaintiffs.

But the plaintiffs stand the chance to recover additional damages from the remaining defendants.

They include Homestore founder and former CEO Stuart Wolff and Wolff’s chief deal-maker, Peter Tafeen.

Recovering a small fraction of losses is typical in such fraud cases against public companies, noted Henry Hu, a corporate and securities law professor at the University of Texas in Austin.

“Typically, you don’t get to retire to the south of France in securities settlements,” he said.

Issuing stock to settle accusations of corporate wrongdoing has become more common but has been controversialbecause it dilutes the value of existing shares, said Stanford University securities law expert Joseph Grundfest.

But CalSTRS executives and their attorneys defended their decision to take most of the settlement in stock, contending that shares of Homestore probably would become far more valuable now that the threat of being driven into bankruptcy by the shareholder litigation has been removed.

The settlement “is a powerful combination,” said Bruce L. Simon, a San Francisco-area attorney for CalSTRS. “It takes cash from the company as a penalty for something it did that was wrong, gives shares to people who were hurt, and allows them to benefit if the company has what we hope will be gains in its value.”

CalSTRS, on behalf of all the shareholders who bought artificially inflated shares of Home- store stock, “never intended to try to put the company out of business,” Simon said.

The changes in corporate governance in the settlement include gradually eliminating staggered terms for directors, banning the use of stock options to reward directors and allowing shareholders to directly appoint a director to the board.

It is part of a trend among big California pension funds to insist on such measures as part of settlements, said Columbia University securities law professor John Coffee.

Coffee praised the way in which Simon’s law firm would be compensated -- in the same mix of stock and cash as the plaintiffs.

Homestore said it would take a charge of $75.8 million to account for the settlement of the shareholder litigation and other disputes.

As a result, it reported a second-quarter net loss Wednesday of $97.1 million, or 78 cents a share, compared with a net loss of $52.3 million, or 44 cents a share, in the same quarter last year.

Shares of Homestore rose 37 cents to $2.90 on Nasdaq. The settlement was announced after the market closed.

Homestore acknowledged that its founding managers had improperly recorded nearly $200 million in revenue in 2000 and 2001 -- a period when they were exercising stock options for millions of dollars -- and won praise from federal officials last fall for its cooperation with the government’s investigation of the company.

Four former Homestore executives pleaded guilty to fraud and conspiracy charges, and a criminal investigation continues into the role played by former executives at Homestore and some of its business partners.

Homestore recently settled legal disputes with its two biggest business partners, AOL Time Warner Inc. unit America Online and real estate franchiser Cendant Corp. Cendant and AOL Time Warner were dismissed as defendants in the CalSTRS lawsuit, but Simon said he would try to have them reinstated on appeal after the rest of the case is settled.

Those who are entitled to share in the settlement are investors that purchased Home- store shares between Jan. 1, 2000, and Dec. 21, 2001.

If they choose, investors can opt out of the settlement and seek damages separately, Simon said.

The settlement would leave the company with more than $35 million in cash -- enough to propel it toward its goal of becoming profitable in 2004, Long said.

Long said the company had been unsuccessful in attempting to get its officers and directors insurance to pay for its liability in the case.

Homestore is the No. 1 Internet real estate firm, attracting consumers to Web sites including home-listings leader Realtor.com and selling ads to providers of housing-related goods and services.