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SEC sets example with AOL

In correcting the industry leader's accounting practices, regulators set the standards for an emerging industry.

America Online (AOL) is the biggest, and now it is paying for it.

The Securities and Exchange Commission has once again targeted the online services giant's aggressive accounting practices, using AOL to set the standards for an emerging industry.

What was expected to be a clean fourth quarter for the giant online service provider was mottled last week with changes and restatements of previous quarterly results, made at the request of the SEC.

AOL's "aggressive" accounting is nothing new; the practice aims to make the company's results look as good as possible. After numerous complaints from investors and Wall Street about the way the company expensed the cost of securing new members, AOL in the first quarter switched to a more conservative measure and bit the bullet for its earlier practice by taking a $385 million charge. The company started to account for the expenses in the quarter they occurred, rather than spread them out over a period of time.

And analysts say that in a new industry without a lot of precedent, there is going to be a learning curve, and the leader is likely to bear the brunt while regulators set an example.

"[The SEC] could be picking on AOL because AOL is the leader," said CS First Boston analyst Alan Braverman, saying that a close look at AOL accounting does effectively put the SEC's imprint on the industry. "Whenever there is a pioneer, they are going to get arrows in their back."

After its talks with SEC regulators, AOL restated its third-quarter profit of $2.6 million as a loss of $4.7 million. It had booked $12 million in revenues from a long distance provider contract, rather than spreading out those revenues over the length of the 40-month agreement.

"AOL has been aggressive, but it is a bit of trial and error" as companies in the growing industry try to fit into accounting standards, Braverman said. He suspects that the SEC is using the giant to set the industry on track for what will be "the norm."

Les Zuke, a spokesman for Earnst & Young, AOL's accountant, said "guidelines prevent us from making any comment on client matters."

A spokesman for the SEC said the commission does not comment on its decisions.

Len Leader, AOL's chief finanical officer, told CNET's NEWS.COM last week that it stands by its accountants. Len Leader, AOL's chief finanical officer, defended his company's practice against critics who may suggest the company is trying to cook the books, something that has been hinted at in the past.

"We believe our accounting is in accordance with [General Accounting Practices] and I would underscore [that the rules] are very general and open for interpretation," he said.

Henry Blodget, an analyst with Oppenheimer & Company, said that it was unusual that the SEC stepped in so late in the year to question previous quarter's result. "[Accounting] is an art, not a science," Blodget said. "You can choose to be conservative or aggressive, and analysts like the conservative side."

He added that AOL should not have as many problems going forward. By restating certain deals, AOL has been given the example of how to properly account for similar transactions going forward.

"This is a service industry, and this is the nature of the emerging beast," said Braverman, and AOL is the guinea pig.