Federal prosecutors, during opening statements Thursday in a criminal trial against former Homestore CEO Stuart H. Wolff, charged that Wolff was driven by “his ego and his greed” to artificially inflate the company’s revenue numbers and deceive investors.
Wolff’s lawyers, meanwhile, portrayed him as a “smart guy from Oklahoma,” an electrical engineer with great ideas about the Internet but “not one lick of managerial experience” before his role at the company. Wolff, according to his legal defense team, “left the accounting to the accountants.”
The jury will have to sort out whether Wolff is guilty of participating in a criminal conspiracy with other Homestore executives to commit securities fraud, filing false financial reports, falsifying the company’s financial records and misleading accountants about the company’s finances and engaging in illegal insider trading.
Financial accounting problems led the company to restate its earnings and caused its stock to drop to pennies per share, nearly being de-listed, amidst the scandal. Homestore, soon to be re-branded as Move Inc., has since rebounded from the financial problems.
In September 2005, Homestore announced a settlement agreement through which the company will pay for up to $11 million related to Wolff’s legal defense costs.
The U.S. Securities and Exchange Commission and U.S. Justice Department in April 2005 announced criminal and civil cases against Wolff and Peter Tafeen, the company’s former executive vice president of business development. Wolff served as Homestore’s CEO and chairman of the board from 1997 to January 2002, when he resigned during an internal investigation. Tafeen served at Homestore from 1997 to November 2001.
Tafeen pleaded guilty in early March to one count of securities fraud for his participation in a scheme to artificially inflate company revenues, the U.S. Attorney’s Office for the Central District of California announced. As a part of this plea agreement, Tafeen will testify against Wolff. Tafeen faces a maximum sentence of 10 years in federal prison.
Ten former Homestore employees have also pleaded guilty to criminal charges related to so-called “round-trip” fraudulent transactions that created a circular flow of money and appeared to inflate the company’s revenues.
Michael Wilner, an assistant U.S. Attorney, said in court Thursday that Homestore participated in multimillion-dollar deals with AOL, for example, in which Homestore essentially paid itself by routing money through other companies and disguising the transactions, according to court transcripts.
The deals involving AOL “were large, and they will be a significant part of this trial,” Wilner stated in court. Homestore paid about $55 million of its corporate funds to various vendors, he said, and those vendors in turn paid $47 million to AOL. “And the last leg of the transaction was that AOL, after it took its cut, paid $36 million to Homestore for the online advertising. That’s the money that Homestore recorded as revenue in its financial records.”
Wilner also said, “You’ll learn during this trial that paying yourself, routing money through other companies, disguising the transactions, is a form of fraud,” alleging that, “Wolff and his co-conspirators knew that this revenue, that these sales were fraudulent at the time that they implemented this scheme.”
Wilner said that there were nicknames for the so-called “round-trip” transactions. “They called them home runs, they called them sketchy deals, they called them end-of-quarter deals … and in one case an executive simply called the deal ‘shamco.'”
Wolff had a very large stake in the company, Wilner also said – and in April 2001, Wolff’s personal holdings in Homestore stock were worth an estimated $100 million. Wilner said the government would present evidence that Wolff lied when he told investors in April 2001 that Homestore was in excellent financial condition. “At the time Homestore was engaged in a massive financial fraud,” Wilner said.
The crimes at Homestore, Wilner alleged, occurred with Wolff’s “knowledge, with his approval, and with his involvement. He made the most money as a result of these crimes, and he also had the most to lose if the crimes didn’t occur.”
Lawrence Barcella, a lawyer who is leading Wolff’s legal defense team, said that Wolff “didn’t start out as a manager” and “didn’t start out as somebody who wanted to be a CEO or thought that he would be a CEO. He’s not a guy that got an MBA, a business degree at Princeton. He was an electrical engineer. But he had ideas. He was smart.”
He was hired to lead Homestore, a company that operates property-search Web sites, because “he had great ideas roaming around that brain of his on how to use the Internet,” Barcella said.
Barcella encouraged jurors to keep an open mind in considering the case. He noted that Wolff “kept virtually all of his stock … keeps some of the stock today. The others cashed out.” Prosecutors, meanwhile, charged that Wolff “sold stock in Homestore and profited over $8 million” during the time period that is the focus of the criminal lawsuit.
Barcella also said that Wolff began the internal investigation at Homestore. “Filter that through your common sense for a man who is supposedly a conspirator,” Barcella said in his opening statement, according to court transcripts.
He also called AOL the “8,000-pound gorilla of the Internet,” and he said that AOL was important “because at the time it had the most number of subscribers; that is, it could bring the most number of eyeballs, the most number on the Internet looking at your product.” The Internet was still relatively new in 2001, and Internet companies were “still trying to grapple” with how to do business and account for business transactions, he said.
“A lot the Internet companies … they didn’t have a lot of money. They had great ideas, but a lot of them didn’t have a lot of money so they engaged in transactions based on something else they had. ‘I give you something I have if you give me something you have.’ Barter transactions, they’re called,” he said.
Because of the newness of the Internet, Barcella said, there wasn’t “a bright white line, where on one side of it you knew exactly what was going on, and on the other side you didn’t know what was going on. What you had was a big range of gray trying to figure out,” according to court transcripts.
Wilner, though, alleged that Wolff participated in a “conspiracy to engage in fraud, to cook the books, and to inflate the company’s numbers.”
Barcella countered in his opening statement, “Who cooked the books? The finance department. And you’re going to find out, ladies and gentlemen, a lot about the finance department. You’re going to find out a lot about the people in the finance department, and you’re going to find out a lot about the interrelationships of the people in the finance department.”
Barcella added, “To the extent … that the Government wants you to take a look at Stuart Wolff – and you must – you have to also look at the people in the finance department. They will come, and they will testify about the deals that they made, about what they did in the finance department, who they talked to and who they didn’t talk to. They did things sometimes on their own to line their own pockets, having nothing to do with Mr. Wolff, in fact, having nothing to do with Homestore, except to the extent that they could line their pockets. They made Homestore a victim of their greed. They didn’t even deal with Mr. Wolff. Nobody knew about some of the stuff that was going on.”
Homestore officials in several cases “bought products they didn’t use or they didn’t need,” Wilner said in his opening statement, such as the purchase of 300 million phone minutes for $4.5 million or the purchase of 330,000 first-aid kits. “They tried to sell (the kits) for scrap, because Homestore wasn’t in the first-aid kit business. You’ll learn that Homestore paid tens of millions of dollars for computer software … (that) was put into a desk drawer and not used because it wasn’t needed. These transactions were valueless.”
Barcella said that the calling cards were a good idea, and “something that should and could have made a profit. Sometimes … shocking as this may sound, good ideas don’t end up being good business.”
He concluded that Wolff did not authorize all of the wire transfers that Homestore engaged in, noting that Wolff’s signature was absent from a particular deal valued at $19 million.
The federal government also called its first witness to trial this week – Mark Rowen, an employee at Prudential Equity Group, a division of Prudential Financial. Rowen is a research analyst who helps customers to make decisions about whether to buy, sell or hold a stock. He testified about the surfacing of accounting problems at Homestore, and his evaluations of the company during that period.
The trial will continue Tuesday in U.S. District Court in Los Angeles.
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