SEC Advancing Time Warner Case

The Securities and Exchange Commission is preparing documents alleging that Time Warner Inc. booked more than $400 million in questionable advertising revenue after the company’s January 2001 merger with America Online Inc., according to people familiar with the investigation.

The SEC plans to send a formal letter of notification to Time Warner by early summer, signaling that investigators believe they have assembled enough evidence to support their conclusions about wrongdoing. The most prominent single item in the Time Warner matter is a suspicious $400-million ad deal with German media giant Bertelsmann, federal sources said.

Bertelsmann is part of a broader case that SEC officials are putting together, alleging that Time Warner and America Online misled investors about the true financial health of the online unit by pumping up ad revenue in numerous deals and by inflating AOL subscriber numbers, sources said.

After the company receives formal notification of allegations through a letter known as a Wells notice, Time Warner would have a period of weeks to review it, respond in writing and meet in person. Afterward, the SEC and the company could negotiate a settlement or remain at odds over all or some issues. Then the SEC staff would submit its recommendations for enforcement action against Time Warner to the agency’s commissioners for approval.

In 2002, the SEC and the Justice Department began looking into the way AOL booked its advertising revenue. In the fall of that year, Time Warner restated $190 million in revenue from a handful of AOL advertising deals affecting the 2000-2002 period. But people familiar with the case said the SEC had identified numerous other transactions that its staff had concluded require additional restatements.

Time Warner executives have blamed the questionable practices largely on AOL, saying that Time Warner had begun cleaning up the online firm and was cooperating with the probe. But the biggest dollar item in the case pertains to decisions about Bertelsmann that were made after the merger and were supported by Richard D. Parsons, Time Warner’s chairman and chief executive, other executives and the company’s outside accountants, according to lawyers involved in the case.

The SEC also is considering seeking financial sanctions against the company for allegedly failing to cooperate sufficiently with the investigation, according to people familiar with the probe.

Time Warner executives declined to comment on the investigations. The company said in regulatory filings that it intended to continue to cooperate with the SEC and the Justice Department.

The $400 million in questionable ad revenue is linked to Time Warner’s $6.75-billion purchase of a large stake in AOL’s European operations from Bertelsmann in 2002. Time Warner has said that it agreed to reduce the purchase price by $400 million as a way for Bertelsmann to pay for $400 million of advertising on America Online in 2001 and 2002. AOL booked $400 million in advertising during those two years, making Bertelsmann the company’s single biggest advertiser and helping AOL meet promises to Wall Street about its financial performance.

Current and former Bertelsmann executives have told the SEC that from their perspective, the $400 million was not really an ad deal. They told the SEC in depositions that they agreed to reduce the price by $400 million in exchange for a promise by Time Warner to pay for its AOL Europe stake in cash rather than stock. Bertelsmann also agreed to run advertising on AOL that Time Warner valued at $400 million.

But Bertelsmann executives have told the SEC that since the $400-million price reduction had already been agreed upon, it was as if they were given the AOL ads for free, sources familiar with their testimony said.