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AOL Named in Expanded Homestore Lawsuit

America Online and 15 other Internet-related companies have been named in an expanded lawsuit by the California State Teachers' Retirement fund that charges they contributed to the financial collapse of online real estate company Homestore.com .

The $92 billion pension fund, the third largest in the nation, says as the result of Homestore.com's $192 million restatement of its financial results covering 2000 and 2001, its stockholders suffered massive losses in the fund's holdings. By some estimates, the retirement fund lost about $9 million as a result of the financial restatement.

At issue in the 251-page complaint are so-called "round-trip" transactions, "in which Homestore entered into agreements with various firms for the circular flow of money from Homestore to those firms and then back to Homestore." The complaint said the round-trip transactions, in the tens of millions of dollars, enabled Homestore to illegally recognize revenue to meet its Wall Street targets and keep its stock prices climbing.

The fund had already filed suit against Homestore but until now, hadn't named AOL specificially in the complaint.

The complaint charged that Homestore's restatement was the result of the named companies' executives' actions in which they allegedly acted "to falsify revenues to maintain the myth of Homestore's inflated success story on Wall Street."

The other companies named in the amended complaint are Cendant Corp., L90 (which has since become MaxWorldwide), Dorado Corporation, Adonis Systems, Internet Pictures, City.com, Classmates Online, Corner.com, Glob, Private, Promise, Revco, Smart, Wiz.com and Top Producer Systems.

The complaint names David Colburn, a former executive vice president of business affairs and development for AOL who was fired in August. Also named in the complaint is Eric Keller, a former executive vice president of business affairs and development at the ISP.

Colburn was in charge of structuring many of AOL's advertising and commerce deals during the dot-com heyday. AOL's past barter transactions related to Homestore and software company PurchasePro have been subjects of investigations by the Department of Justice and the Securities and Exchange Commission.

The retirement fund's complaint said that Keller, while acting as senior vice president at AOL under Colburn in early 2001, worked with Homestore executive Peter Taken and "concocted a triangular scheme whereby Homestore would purchase goods or services from certain third party companies, AOL would pay Homestore cash for advertising, and these third party companies (using money round tripped by Homestore) would purchase advertising from AOL."

Keller is also reportedly being investigated by the SEC regarding the nature of the transactions among Homestore, AOL and PurchasePro. Since last summer, a host of AOL's own barter arrangements have been under scrutiny by regulators after The Washington Post in July raised questions in a series of articles about AOL's accounting on advertising deals during the late 1990s and early 2000.

AOL Time Warner also recently announced it would restate about $190 million worth of revenue and $97 million worth of cash earnings after conducting an internal review of how some of its ad deals were structured.

"Round-tripping" deals are often described as bartered exchange between companies that started out innocently enough, such as offering advertising space in return for goods or services, but were then stretched beyond their legitimate means and used to inflate revenue.

One example of a straightforward barter deal described in the complaint involved a 1998 transaction in which Homestore paid AOL $20 million in cash and gave AOL 1.5 million in warrants at various guaranteed prices in return for Homestore's right to be the exclusive online realtor for AOL. "Homestore was able to recognize the revenue and AOL became an important partner in Homestore's scheme to generate revenue."

But after government regulators and the accounting industry raised red flags about the practice, which was becoming pervasive among start-up Internet-related companies, the Financial Accounting Standards Board issued new guidelines about the use of barter. The guidelines prohibited companies from booking gross revenue from a barter transaction and required such deals to be recognized as expenses.

The complaint charged that Homestore, even after the new accounting standards went into effect, knowingly entered into "fraudulent" barter transactions with other Internet companies such as CityRealty.com, Classmates Online and PromiseMark.

"In the first component or 'leg' of each transaction, Homestore paid cash at an inflated price to each company in exchange for advertising and other services. In the second leg, each company recycled the cash received from Homestore back to Homestore as payment for Homestore's advertising and/or services also at inflated prices. The amount of the first leg of each transaction was almost identical to the amount of the second leg of the same transaction. Homestore then improperly recognized the inflated value as revenue on its financial statements."

An AOL Time Warner spokesperson was not immediately available to comment. Efforts to reach other companies named in the complaint were not successful by presstime.

The complaint is seeking unspecified compensatory damages.