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Time Warner settles fraud charges over online ads

Company agrees to pay $300 million and to restate financial results. Three execs also settle.

Time Warner has agreed to pay a $300 million civil penalty to settle charges from the U.S. Securities and Exchange Commission that the company "materially" overstated online ad revenue and the number of its Internet subscribers.

Time Warner, which was also charged with aiding and abetting securities fraud, will pay the penalty without admitting or denying the charges.

The media giant also restated about $500 million in advertising revenue it reported during the fourth quarter of 2000 through 2002 due to alleged inflated numbers. That is in addition to the $190 million in revenue the company restated in 2002, due to accounting irregularities.

Time Warner will hire an independent investigator to determine whether its historical accounting for certain transactions adhered to standard accounting principles. The media giant said further restatements may be necessary, depending on the independent examiner's conclusions, which are expected 180 days after beginning the review.

These latest actions by the SEC stem from an investigation that began several years ago into the accounting practices of the company's America Online unit.

"Our complaint against AOL Time Warner details a wide array of wrongdoing, including fraudulent round-trip transactions to inflate online advertising revenues, fraudulent inflation of AOL subscriber numbers, misapplication of accounting principles relating to AOL Europe, and participation in frauds against the shareholders of three other companies," Stephen Cutler, director of the SEC's enforcement division, said in a statement. "Some of the misconduct occurred while the ink on a prior commission cease-and-desist order was barely dry. Such an institutional failure calls for strong sanctions."

Among the allegations, the SEC claimed that AOL essentially paid some of its customers' advertising bills to boost revenue; inflated the number of its subscribers by counting bulk subscriptions to corporate customers, even though it knew a number of them would not likely pan out; failed to consolidate its financial results with those of its AOL Europe joint venture, in a move to improve its financial picture; and violated its cease-and-desist order of May 2000.

AOL, nonetheless, said it was pleased to resolve that aspect of the SEC's investigation.

"We're committed to cooperating with the independent examiner as well as fulfilling all of our other obligations under the settlement," Dick Parsons, AOL chief executive, said in a statement.

In detailing its allegations, the SEC claimed that AOL funded its own online ad revenue by providing certain customers with the means to pay for advertising on its site that they would not otherwise have purchased. The SEC further alleged that AOL tried to conceal these transactions by booking them as two or more separate agreements, "conducted at arm's length."

Homestore and PurchasePro.com were some of the publicly traded companies that allegedly engaged in these transactions.

Securities regulators also claim that AOL did not consolidate its financial results with AOL Europe, a joint venture it owned with European media giant Bertelsmann AG. When AOL received direct control of AOL Europe's operations and assets, it should have bundled the financial results of both entities together, according to the SEC.

As a result of keeping the books separate, AOL misstated its own net income in 2000 and understated its net losses the following year, according to the SEC. The company also overstated its operating income during 2000 and 2001, the SEC maintained.

In addition to these issues with AOL Europe, AOL allegedly inflated its revenue by $400 million when it restructured its purchase agreement for AOL Europe with Bertelsmann. Rather than take $400 million in cash and book it as a restructuring for the agreement, AOL allegedly asked Bertelsmann to pay that amount as advertising to the online giant - thereby boosting its advertising revenues.

Separately, the SEC has settled charges with company Chief Financial Officer Wayne Pace, Controller James W. Barge and Deputy Controller Pascal Desroches. The three were charged with "causing violations of the reporting provisions of the federal securities laws."

According to the SEC, they have consented, without admitting or denying the allegations, to a cease-and-desist order stating that they caused reporting violations by the company "based on their roles in accounting for $400 million paid to the company by Bertelsmann AG in two sets of transactions."

Despite the settlement with its finance executives, Parsons said in a statement: "We have confidence in our top financial officers, and we're pleased that they will continue to serve our company in their current positions."

The SEC said it will continue its investigation into Time Warner's financial practices.