Immediately before and after AOL's merger with Time Warner in
January 2001, executives at the internet company artificially
inflated the value of AOL stock while liquidating their own shares
in a selling frenzy to enrich themselves to the tune of $936
million, according to a lawsuit filed on Monday in a California
court.
The lawsuit, filed by the University of California and
Amalgamated Bank's LongView Collective Investment Fund, alleges
that former AOL chairman Steve Case and other senior figures were
primary beneficiaries of illegal insider trading. The complaint
also names as defendants a number of other past and present
officers and directors at AOL Time Warner Inc., along with the
company itself and its auditor, Ernst & Young LLP.
Case and two of his AOL colleagues, Vice Chairman Kenneth Novack
and President/COO Robert Pittman, are accused of carrying out a
scheme to overstate the number of the company's internet
subscribers and inflate its e-commerce advertising revenues,
profits and backlog of future business to help secure a merger with
Time Warner.
While the stock was still at an artificially high level, AOL and
Time Warner executives used the closing of the merger in January
2001 to take advantage of a "change of control" proviso to cash in
millions of stock options on an accelerated basis.
The merger triggered early vesting of 35 million shares valued
at $1.7 billion for the five top AOL executives alone. In the
subsequent five months, company executives sold off 10.7 million
shares from personal portfolios. During the same period, however,
they spent $1.3 billion of the company's cash reserves to
repurchase 30.2 million shares on the open market – in effect,
using corporate money to prop up the stock's value so they could
benefit personally and shield themselves from a stock collapse,
according to the suit. The lawsuit reports that repurchasing began
on 1st February, 2001, and the personal stock sales began the very
next day.
AOL executives Case and Pittman received the highest gain from
vesting their shares, selling off $157 million and $94 million,
respectively, between July 2000 and November 2002. AOL Time
Warner's stock price ultimately plummeted from a high of $58.51 per
share to a low of $8.60 per share, resulting in a combined loss of
more than $500 million for the two parties bringing the action.
"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
Holst, a lawyer for the University of California. "We believe that
AOL Time Warner and its investment advisers must be held
responsible for the admitted misstatement of AOL's financial
condition."
The scheme began in the period leading up to the merger when AOL
executives engaged in "falsifications" to create a "grossly
distorted" e-commerce advertising business that pumped up AOL stock
prices, according to the complaint. It adds that the advertising
deals included swaps with other internet companies that AOL
misleadingly counted as revenues or transactions involving AOL's
own funds that were provided to purported customers. Many of the
deals were also made with companies "that lacked the financial
wherewithal to honor them."
Even as other internet competitors were reporting a slowdown in
advertising, AOL continued to insist it was bucking the trend. Six
months after the merger, former AOL chief executive officer Gerald
Levin, who is also named a defendant, claimed ad revenues were
"stabilizing" and that "we have several high growth areas." Levin
left the company a few months later with a $625 million retirement
package.
The lawsuit alleges that AOL revenues from 2000 - 2001 were
overstated by almost $1 billion. AOL Time Warner has admitted that
AOL may have overstated revenues by as much as $600 million, but
the lawsuit argues that even this number is too conservative.
"The public may becoming numb to the stream of reports about
accounting scandals and corporate fraud, but this case should fuel
renewed concern about how America's big corporations do business
and earn the trust of investors," said William Lerach, a partner at
Milberg Weiss, the US law firm acting for the investors. "In this
instance, had AOL truthfully reported its actual ad revenue at the
time, the merger could never have taken place."
The merger has been called "a terrible deal" by Dow Jones, the
"worst deal of the century" by Time and "one of the great train
wrecks in corporate history" by Fortune. The New York Times has
said that Case "pulled off one of the sweetest deals in business
history...by managing to acquire Time Warner with AOL's inflated
stock." Richard Parsons, AOL Time Warner's current CEO has called
the merger "silly" and a "mistake" based on "overly ambitious"
forecasts that were "not real." Due to overvalued assets, the
merged company took a $100 billion loss in 2002, the largest in
history.
Ernst & Young, the accounting firm that oversaw the auditing
throughout the merger, has retained the account and is paid $52
million in annual fees. "The merger itself turns out to have been a
contrivance intended to benefit an unscrupulous few at the top of
the corporate hierarchy," said Bruce Raynor, Amalgamated Bank vice
chairman.
"The University of California made a sound investment in a solid
company when it invested heavily in Time Warner prior to its merger
with AOL," said the University's treasurer, David Russ. "The value
of that investment was significantly impaired as a result of the
merger."
In addition to this lawsuit, a class action is being brought
against the company, lead by the Minnesota State Board of
Investments. It is also facing a class action securities suit and
investigations by the Securities and Exchange Commission and US
Department of Justice.
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