The government’s plans to retry former Homestore CEO Stuart Wolff for his alleged involvement in circular advertising deals that led the company to restate millions in earnings could be complicated by charges that AOL executives who testified in Wolff’s first trial were involved in other, bigger schemes.
Wolff’s 2006 fraud conviction and 15-year prison sentence were overturned last year, when an appeals court ruled that the judge presiding over the case should have disqualified himself because he owned stock in America Online (see story).
AOL allegedly served as the intermediary for 17 of 23 "roundtrip" advertising deals with Homestore vendors, which Homestore later said artificially inflated 2001 earnings by $67 million.
Homestore — the Realtor.com operator that rebranded as Move Inc. — allegedly overpaid vendors for products. The vendors would take the excess profits and buy something from a third-party intermediary like AOL, which would then advertise on Homestore’s Web sites. Homestore was essentially buying its own revenue, prosecutors said, and Wolff was accused of concealing the circular transactions from auditors and investors.
Several former Homestore executives who have already served prison time in the case are expected to testify in the new trial. From the government’s perspective, it’s "as if the original trial had never happened," Assistant U.S. Attorney Michael R. Wilner recently told Inman News (see story).
But since Wolff’s conviction was overturned, the U.S. Securities and Exchange Commission has brought civil charges against four former AOL executives — including two who testified in Wolff’s original trial — over $1.26 billion in restated earnings.
The SEC’s May 19 complaint against the former AOL executives involves restatements of earnings covering a period from October 2000 through the end of 2003 — the same time frame AOL was allegedly serving as an intermediary for Homestore’s circular transactions.
Although AOL’s dealings with Homestore are not specifically mentioned in the SEC’s complaint, several other transactions the commission claims were fraudulent are described as "roundtrip" ad deals.
The SEC alleges that AOL negotiated deals with companies and vendors including Ticketmaster Corp., WorldCom Inc. and Sun Microsystems Inc. that inflated the company’s advertising revenue.
In June 2000, for example, AOL allegedly agreed to give up a negotiated discount on the purchase of $250 million in equipment from Sun, in exchange for Sun’s commitment to buy $37.5 million in online advertising from AOL. Sun didn’t pay cash for the ads, and AOL improperly reported the foregone discount as ad revenue, the SEC alleges. Defendants in the civil suit deny wrongdoing.
Government prosecutors in Wolff’s criminal case say he shouldn’t be allowed to raise the SEC’s civil complaint against the former AOL executives in his new trial. The government maintains that AOL’s past practices with other companies are irrelevant, and have no bearing in the Homestore case.
But Wolff’s attorney, Richard Sauber, argues the government is attempting to create a double standard.
In Wolff’s original trial, prosecutors attempted to establish that other Homestore executives hadn’t participated in "roundtrip" ad deals in their previous positions at other companies. During the trial, one Homestore executive agreed with the prosecution that the practice was not something taught "at Harvard Business School." Now, Sauber said, the government doesn’t want allegations that AOL engaged in other, similar transactions, around the same time raised at Wolff’s trial.
"The defense has no objection to an order prohibiting both parties from comparing these deals to the broader marketplace unless such knowledge is directly tied to (Wolff’s) state of mind, but the government cannot have it both ways," Sauber said in a filing opposing the government’s motion on the matter.
Sauber also argued that three former AOL executives who may be called to testify at Wolff’s new trial are among the four defendants in the SEC civil complaint, and may have an "enormous incentive to try to please the government with their performance in these criminal proceedings."
Even if the Department of Justice has made no promises to intervene with the SEC on their behalf, the three might reasonably hope "that such intervention might occur if their testimony is sufficiently helpful," Sauber said.
Two were called to the stand during Wolff’s first trial — Steven Rinder, formerly a vice president in business affairs group, and Mark Wovsankiker, a senior vice president of accounting policy. The third defendant in the SEC civil suit who could be called to the stand during Wolff’s retrial is former AOL CFO Joseph Ripp, who Sauber said was personally involved in AOL’s deals with Homestore.
"One of the major thrusts of the AOL executives’ testimony at the first trial was that they, unlike the Homestore executives, wanted transactions to be above-board and properly documented," Sauber said. "The pending SEC action gives the defendants strong reason to deny any wrongdoing, as any admission of error on their part could potentially be used against them in the civil proceedings."
In the legal maneuverings before Wolff’s new trial, Sauber is also seeking to frame the debate by blocking Homestore’s restated earnings from being introduced as evidence at trial, and to bar prosecutors from referring to the defendant as "Dr. Wolff."
Homestore restated its earnings after Wolff left the company. Under federal rules of evidence, such after-the-fact remedial actions can’t be used to establish guilt, Wolff’s attorney argues.
But the government says it wants to introduce the earnings restatements as evidence not to establish Wolff’s guilt, but to prove that the $67 million in revenue represented a material misstatement that had to be disclosed to investors under the rules governing publicly traded companies. Much of the government’s case rests on proving not only misconduct by Wolff, but that such misconduct had a significant, or "material," impact on the company’s bottom line, prosecutors said.
"In the original trial, defendant Wolff bitterly disputed that the revenue from the roundtrip deals was material to Homestore, even though that money represented a large percentage of Homestore’s advertising revenue and overall revenue in 2001," prosecutors said in arguing that the earnings restatements be allowed as evidence.
Sauber also wants to bar prosecutors from referring to Wolff as "Dr. Wolff" or the "smartest guy in the room" — an allusion to the book and documentary film about Enron — as they did during Wolff’s first trial.
The government says it wants to protect its right to use such terms and point out the defendant’s "superb academic credentials," because "Wolff, like many other corporate fraud defendants, seeks to portray himself as unsophisticated or unable to understand matters of finance and accounting."
Prosecutors say they are "entitled to present evidence that (the) defendant was indeed bright enough to understand events around him, particularly the wrongful nature of the roundtrip deals."
While a jury might be swayed by such details, Wolff and the government have both agreed to waive their rights to a jury trial, leaving Judge Gary Allen Feess of the U.S. District Court for the Central District of California free to weigh the importance of such matters.
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