Justice probing AOL accounting practices

Criminal investigation targets Internet division


AOL Time Warner Inc. said yesterday that the Justice Department had begun a criminal investigation into accounting practices at its America Online division, after the initiation of an inquiry by the Securities and Exchange Commission.

The company reiterated yesterday that its outside auditors, Ernst & Young, had repeatedly certified its books. But the new investigation steps up the pressure and scrutiny on the AOL division, which is seeking a chief executive who can help stanch a steep decline in its advertising revenue.

Several executives close to the search said yesterday that the leading candidate for the job is Jonathan F. Miller, who resigned in June as chief executive of the Internet unit of USA Interactive, the shopping and online travel company. However, no offer has been made, and a final decision is not expected until next week.

For now, investors remained focused on reports of the Justice investigation, and they sent the stock price down more than 7 percent yesterday, to $11.50. Wall Street lawyers said the latest investigation could hassle executives and embarrass the company regardless of the outcome. An SEC investigation typically culminates in nothing worse than a settlement agreement and the payment of a fine by the company. But the Justice investigation raises the threat of criminal charges, a grand jury and potential jail sentences.

"In this environment, once the case goes criminal, the level of anxiety increases by an order of magnitude," said John Coffee, a professor of law at Columbia University. "The Justice Department has its crosshairs fixed on corporate America."

The scrutiny from the Justice Department increases the likelihood that AOL Time Warner executives will retain their own lawyers, and they will probably advise their clients to invoke their Fifth Amendment right not to testify. It is potentially sound legal advice regardless of their culpability, legal experts say, but poor public relations.

"Generally speaking, I would urge a client not to testify until I knew the full picture," said Martin R. Pollner, a lawyer at Loeb & Loeb. "But the company's counsel might find that hard to swallow because of the impression it makes on the mind of the public."

In a statement yesterday, AOL Time Warner said, "We are cooperating 100 percent with the SEC, and we will cooperate with the Department of Justice."

The statement added, "As we have consistently said, our accounting is appropriate and in accordance with generally accepted accounting principles, and our outside auditors, Ernst & Young, have repeatedly confirmed that."

USA Today reported the Justice inquiry yesterday. Both investigations were prompted by articles in The Washington Post last month that outlined how in the two years preceding March, AOL classified a variety of one-time fees - such as payments to settle advertising contracts - as continuing advertising revenue.

AOL Time Warner says that all of the transactions at issue amounted to less than 2 percent of AOL's revenue. But the timing of the transactions is significant because they took place when the company was under pressure to show that its revenue was holding up even though many of its dot-com advertising clients were collapsing.

Around the same time, AOL used its soaring stock price to acquire Time Warner, a company with four times its revenue. Since that time, AOL's advertising revenue has plummeted with the collapse of many Internet companies, and, to the chagrin of shareholders, its poor performance has become the biggest drag on the combined company's stock.

Accounting experts said the transactions described by the Post resembled some routine practices at Internet firms, but there was no way to know what the SEC or the Justice Department might produce in their investigations.

AOL Time Warner executives said yesterday that the investigation was being handled by the U.S. attorney's office in Alexandria, Va., the jurisdiction where the AOL division is located.

People involved in the search for a chief executive at AOL said that Miller, the leading candidate, had met at the beginning of last month with Richard D. Parsons, AOL Time Warner's chief executive, and other company executives, including Logan. The interview took place before the resignation of AOL's interim chief executive, AOL Time Warner's chief operating officer, Robert W. Pittman.

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