AOL Time Warner, Inc. Securities & ERISA Litigation 02-CV-5575-Second Amended Consolidated

298 Pages·2005·11.82 MB·English

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
02 MDL Do cket No. 1500 (SWIG)
) 02 CIV. 5575 (SWK)
IN RE AOLTIME WARNER, INC. )
SECURITIES & "ERISA" LITIGATION )
SECOND AMENDED CONSOLIDATED CLASS AC ION COMPLAINT OF LEAD
PLAINTIFF MINNESOTA STATE BOARD OF INVESTMENT
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MEREDTflI COHEN GREENFO GEL HENS MILLS & OLSON, P.L.C.
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Attorneys for Lead Plaintiff Minnesota Attorneys for Lead Plaintiff-Minnesota:
State Board of Investment and Local State Board of Investment and Lead
Counsel for the Class Counsel for the Class
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TABLE OF CONTENTS
1. INTRODUCTION _
......................1
U. NATURE OF THE ACTION.............................................................................................11
III. JURISDICTION AND VENUE........................................................................................13
IV. PARTIES.......................................................................................................... .............14
A. Plaintiffs .................................................................................................................14
1. Lead Plaintiff.............................................................................................14
2. Additional Plaintiffs...................................................................................15
B. Defendants..............................................................................................................15
1 . AOL Time Warner, Inc..............................................................................15
2. America Online, Inc...................................................................................16
3. Time Warner, Inc.......................................................................................16
4. The Individual Defendants.........................................................................17
a. Stephen M. Case............................................................................17
b. Robert W. Pittman.........................................................................18
c. J. Michael Kelly................................................................ 18
d. David M. Colburn..........................................................................19
C. Eric Keller.....................................................................................19-
f Joseph A. Ripp...............................................................................19
g- Steven Rinder ................................................................................20
h. Gerald M. Levin ............................................................................20
k. Wayne H. Pace ..............................................................................20
5. Additional Individual Defendants........................................................ ...23
a. Paul T. Cappucio ...........................................................................23
b. Kenneth J. Novack.........................................................................23
6. Ernst & Young LLP................................................................ ........ ...23
V. CLASS ALLEGATIONS ..... ... ... ... ............... ... ... .. . . . . . . .. ... ... ........... .. . . . . .24
VI. SUBSTANTIVE ALLEGATIONS .............................................................. ..........27
A. The Growth of AOL and Its Emphasis on Increasing Advertising Revenue.........27
B. The Constant and Increasing Pressure to Falsify Advertising Revenue ................32
I
C. The Creation of AOL Time Warner and the Additional Pressure
to Report Growing Advertising Revenue ..............................................................36
D. AOL's Pattern and History of Accounting Improprieties ......................................37
E. Fraudulent Transactions and Improper Accounting Used to
Artificially Inflate AOL and AOL Time Warner Advertising Revenue ................40
I . Use of Sham Transactions and Improper Accounting
Practices Regarding Round-Tripping, Back-to-Back,
and Boomerang Deals................................................................................47
2. Barter Transactions ....................................................................................48
a. Exchange of Advertising for Goods and/or Services .....................50
b. Warrants or Stock (equity) Received in Barter o r
Partial Barter Transactions .............................................................52
c. Exchange of Advertising - "In Kind" Advertising ........................54
(i) Homestore, Inc. ..................................................................56
(ii) Sun Microsystems, Inc. ......................................................60
(iii) Veritas Software Corporation ............................................62
(iv) BertelsmannAG.................................................................64
(v) Gateway Inc. RoundtripfFree Internet Service ..................66
(vi) WorldCom Inc ...................................................................67
(vii) Qwest Communications.....................................................69
`iii) Hughes Electronics Corporation ........................................70
(ix) Homestore-The 2000 House and Home Deal ...................72
(x) Gateway Inc Stock Purchase..............................................74
(xi) Oxygen Media Inc. Stock Purchase...................................75
(xii) PurchasePro.com, Inc. Advertising Swap.......................... 77
(xiii) Monster.com ......................................................................78
3. "Front Loading" or "Jackpotting" t o
Record Advertising Revenue.....................................................................79
(i) Catalina Marketing Corporation ........................................80
(ii) Telefonica SA ....................................................................81
4. Converting Legal Disputes into Advertising Revenue ..............................82
(i) 24dogs.com Arbitration Award .........................................82
(ii) Ticketrnaster Legal Action.................................................84
ii
5. Booking Sales on a Gross Rather Than Net Basis
to Inflate Advertising Revenue..................................................................85
eBay................................................................................................86
6. Counting Repricing of Equity Stock Rights as Advertising
Revenue......................................................................................................89
PurchasePro ....................................................................................89
7. Converting Contract Termination Fees into Advertisin g
Revenue......................................................................................................90
Dr.Koop.com..................................................................................92
8. "Cross-Platform" Deals to Inflate Advertising Revenue ...........................93
(i) The Golf Channel...............................................................94
(ii) Oxygen Media-Carriage Deal ............................................95
F. The Company's Admissions of Materially Overstated Advertising
Revenue and Violations of the Securities Laws ....................................................97
G. The Materially False and Misleading Statements, Omissions of
Material Fact and Devices, Schemes or Artifices to Defraud Regarding
Artificially Inflated Advertising Revenue .............................................................99
a. The Fiscal Quarter Ended December 31, 1998 ........................................100
b. The Fiscal Quarter Ended March 31, 1999 ..............................................102
c. The Fiscal Quarter and Year Ended June 30, 1999 .................................105
d. The Fiscal Quarter Ended September 30, 1999 .......................................109
C. The Fiscal Quarter Ended December 31, 1999 ........................................112
f. The Fiscal Quarter Ended March 31, 2000 ..............................................116
g. The Fiscal Quarter and Year Ended June 30, 2000 .................................121
h. The Fiscal Quarter Ended September 30, 2000 .......................................126
i. The Fiscal Quarter and Year Ended December 31, 2000 ........................132
j. The Fiscal Quarter Ended March 31, 2001 ..............................................142
k. The Fiscal Quarter Ended June 30, 2001 .................................................151
1. The Fiscal Quarter Ended September 30, 2001 .......................................156
M. The Fiscal Quarter and Year Ended December 31, 2001 ........................158
n. The Fiscal Quarter Ended March 31, 2002 ..............................................161
a. The Fiscal Quarter Ended June 30, 2002 .................................................162
H. The Materially False and Misleading Statements, Omissions of
Material Fact and Devices, Schemes or Artifices to Defrau d
ill
Regarding AOL Time Warner's Goodwill ..........................................................166
1. Defendants' Course of Conduct is Revealed .......................................................181
J. Scienter of the Individual Defendants..................................................................187
The Individual Defendants Knew, or Recklessly Disregarded,
that AOL and AOL Time Warner Were Engaged in Fraud
and Were Motivated to Use and Cover Up the Use
of Improper Accounting and Sham Transactions to
Artificially Inflate Advertising Revenue .................................................187
a. The Individual Defendants Were Actively Engage d
in the Company's Daily Activities Such That They Were
Aware Of, Recklessly Disregarded, Controlled and/or
Culpably Participated in the Fraudulent Activities of th e
Business Affairs Division.............................................................188
b. The Nature of the Accounting Improprieties and
Sham Transactions .......................................................................193
c. Whistleblowers Provide Further Evidence of Individual
Defendants' Knowledge ...............................................................195
d. The Prior Pattern of Improper Accounting
Practices........................................................................................197
e. Defendants' Restatement of AOL's Advertising Revenue
and GAAP Violations Provide Evidence of Scienter...................198
f. The Individual Defendants' Awareness of Improper Deals
and Continued Denial of AnyWrongdoing After the
Truth is Revealed..........................................................................199
2. Motive and Opportunity of the Individual Defendants to Engage
in Improper Accounting, Sham Transactions and Reporting of
Inflated Advertising Revenue ..................................................................200
a. Salaries, Bonuses, Stock Sales - The Culture of
Greed Begins ................................................................................200
b. The Shift to Flat Rate Pricing and the Increased Importance
of Advertising Revenue to AOL's Bottom Line..........................201
c. A Culture of Recklessness and Greed ..........................................202
iv
d. The Importance of Initiating, Consummating and
Successfully Implementing the Merger........................................206
e. Defendants' Financial Incentives Related to the Merger .............209
f. The Individual Defendants Deny and Cover Up Problems
Associated with Shrinking Advertising Revenue.........................210
3. Individual Defendants' Compensation Incentives...................................213
4. Additional Allegations and Discussions Regarding Scienter and § 10(b )
Violations of Stephen M. Case................................................................217
5. Additional Allegations and Discussions Regarding Scienter and § 10(b)
Violations of Gerald M. Levin.................................................................224
6. Additional Allegations and Discussions Regarding Scienter and § 10(b)
Violations of Joseph A. Ripp and Steven E. Rindner..............................228
K. Scienter of Ernst & Young. .................................................................................232
I. Ernst & Young's Work for AOL, Time Warner
and AOL Time Warner............................................................................232
2. Ernst & Young's Close Relationship with AOL Time Warner...............233
3. Ernst & Young's Auditing Expertise and Industry Knowledge ..............234
4. Ernst & Young's Actual Knowledge of Specific Transactions
and Accounting Thereof..........................................................................235
5. TheRestatement of AOL's and AOL Time Warner's
Financial Statements ................................................................................237
6. Ernst & Young's Past Involvement with Previous
Accounting Frauds...................................................................................238
7. Ernst & Young's Responsibilities as AOL's and AOL Time
Warner's Independent Auditor ................................................................239
8. Ernst & Young's Violations of Accounting and Auditing
Standards..................................................................................................240
a. Ernst & Young Failed to Properly Consider Fraud ......................242
b. Ernst & Young Failed to Maintain Independence........................249
v
c. Ernst & Young Violated GAAS by Reporting that
the Financial Statements Were Presented in
Accordance with GAAP When They Were Not ..........................250
d. Ernst & Young Failed to Obtain Sufficient and
Competent Evidential Matter .......................................................251
C. Ernst & Young Failed to Exercise Due Professional
Care and Professional Skepticism................................................253
f. Ernst & Young Failed to Properly Plan and Supervise ................253
g. Ernst & Young Failed to Properly Evaluate Audit
Findings........................................................................................255
h. Ernst & Young Failed to Properly Consider AOL and
AOL Time Warner's Lack of Internal Control ............................256
L. The MateriallyFalse and Misleading Statements and Omissions of
Material Facts In the Merger Registration Statement
and Joint Proxy Statement-Prospectus.................................................................257
VII. APPLICABILITY OF PRESUMPTION OF RELIANCE:
FRAUD-ON-THE-MARKET DOCTRINE....................................................................264
VIII. NO SAFE HARBOR .......................................................................................................265
IX. COUNTS .........................................................................................................................266
COUNT ONE...................................................................................................................266
Against AOL Time Warner for Violations of § I 1 of th e
Securities Act in Connection With the Merger Registration Statement .......................:..266
COUNT TWO..................................................................................................................268
Against Defendants Case, Levin, Kelly, Cappuccio, Novack and Pittman
for Violation of Section 1 I of the Securities Act in Connection
with the Merger Registration Statement ..........................................................................268
COUNT THREE..............................................................................................................269
Against Ernst & Young for Violations of § 11 of the
Securities Act in Connection With theMerger Registration Statement..........................269
N
COUNT FOUR ................................................................................................................272
Against Defendants Case, Pittman, Kelly, Colburn, Ripp and Levinfor Liability Under §
15 of the Securities Act For Violations of § 11 of the Securities Act ............................272
COUNT FIVE..................................................................................................................274
Against AOL, Time Warner, and AOL Time Warner For Violations
of § 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunde r
In Connection With the Joint Proxy Statement-Prospectus.............................................274
COUNT SIX.....................................................................................................................275
Against Defendants Case, Levin, Kelly, Cappuccio, Novack and Pittman
For Violations of § 14(a) of the Exchange Act, and Rule 14a-9
PromulgatedThereunderIn Connection With the
Joint Proxy Statement-Prospectus....................................................................................275
COUNT SEVEN .............................................................................................................277
Against Ernst & Young For Violations of § 14(a) of the Exchange
Act, and Rule 14a-9 Promulgated Thereunder In Connection With the
Joint Proxy Statement-Prospectus ...................................................................................277
COUNT EIGHT ..............................................................................................................278
Violations Of Section 10(b) OfThe Exchange Act And Rule lOb-5
Promulgated Thereunder Against Defendants AOL Time Warner,
AOL and Case, Pittman, Kelly, Colburn, Keller, Ripp,
Binder, Levin and Pace....................................................................................................278
COUNT N NE.................................................................................................................282
Against Ernst & Young for Violations of § 10(b) of the
Exchange Act and Rule I Ob-5 ..........................................................................................282
COUNT TEN...................................................................................................................286
Against Defendants Case, Kelly, Pittman, Colburn, Ripp, Levin and Pace for Liability
Under § 20(a) Of The Exchange Act For Violations Of§ I0(b) Of The Exchange
Act And Rule IOb-5 Promulgated Thereunder.................................................................286
X. PRAYER FOR RELIEF..................................................................................................288
XI. JURY TRIAL DEMANDED ..........................................................................................289
vii
EXHIBIT A - AOL Advertising and Commerce Revenue
(overstated (as originally reported) vs . Actual
Advertising and Commerce Revenue)
EXHIBIT B - Additional Plaintiffs and Their Respective Counsel
viii
I. INTRODUCTION
This action is brought on behalf of Lead Plaintiff Minnesota State Board o f
Investment ("Plaintiff' or "MSBI") and all other persons and entities who purchased, exchange d
or otherwise acquired publicly traded stock of America Online, Inc . ("America Online" or
"AOL") and/or bought or sold options on AOL stock during the period January 27, 1999 through
January 11, 2001, and persons or entities who purchased, exchanged or otherwise acquire d
publicly traded stock of AOL Time Warner, Inc. {"AOL Time Warner" or "Company") and/or
bought or sold options on AOL Time Warner stock during the period January 12, 2001 throug h
and includingJuly 24, 2002. The "Class Period" therefore runs from January 27, 1999 through
and including July 24, 2002, and the "Class" is comprised of all persons and entities who
purchased, exchanged or otherwise acquired the stock referenced above or bought or sold option s
on such stock during the Class Period, and were damaged thereby . The illegal conduct detailed
in this Second Amended Consolidated Class Action Complaint ("Complaint") was committed by,
among others, senior officers and directors of AOL and AOL Time Warner and their outside
auditor, Ernst &Young, LLP ("Ernst & Young"), in violation of the Securities Act of 1933 (the
"Securities Act") and the Securities and Exchange Act of 1934 (the "Exchange Act") .
2. The MSBI brings this securities class action to redress numerous violations of th e
federal securities laws. Defendant AOL Time Warner, DefendantAOL, and other Defendants
named herein, have engaged in, inter alia, a systematic and fraudulent scheme to materially
inflate advertising revenue reported in the companies' publicly disclosed financial statement s
and, in turn, the value ofAOL and AOL TimeWarner stock. To that end, during the Class
Period, Defendants overstated AOL's reported advertising revenue by at least a staggering $1.7
billionthrough the use of sham transactions and improper accounting practices. This illegal
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