SEC PREPARING TO CHARGE
TIME WARNER

There’s insecurity at Time Warner as press reports swirl that the Securities and Exchange Commission is preparing to formally notify TW that it has evidence of wrongdoing in advertising revenue accounting. The largest single pact under the microscope is a $400 million ad deal with Bertelsmann. The SEC will most likely send the notification through the mail, though if anyone at TW gets an instant message from SECguy43, they have been asked to contact Dick Parsons immediately.

The Bertie investigation is part of a larger inquiry by the SEC as to whether Time Warner and America Online misled its shareholders about AOL’s financial health by overstating both advertising revenue and the number of subscribers. The Commission is planning to send notice to Time Warner by early summer, which means investigators believe they have enough evidence to support their accusations and they want to get the paperwork off their desks before hitting the Hamptons.

Here come the sexy details: That $400 million in Bertelsmann ad revenue is linked to Time Warner's $6.75 billion purchase of AOL Europe from Bertie in 2002. Time Warner agreed to reduce the purchase price by $400 million as Bertelsmann to pay for $400 million Bertie ads on AOL in 2001 and 2002. Bertelsmann officials told the SEC that they didn’t consider the $400 million an advertising deal. In depositions, Bertie peeps said they reduced the price by $400 million because AOL was going to pay cash for its AOL Europe stake, rather than in stock. Bertelsmann also ran AOL ads that Time Warner valued at $400 million.

Bertelsmann execs told the SEC that because the price had been reduced by $400 million, it was as if the AOL ads were free, according to the Washington Post. While Time Warner recorded $400 million in ad revenue, Bertelsmann recorded no advertising expense. Instead, Bertelsmann accounted for the entire $400 million as a reduction in the price it received for its stake in AOL Europe. Accounting controversies are wacky, huh?

According to depositions in the case, AOL could buy the Bertelsmann’s 49 percent share of AOL Europe for cash or stock. Parsons and its chief financial officer, Wayne Pace, told the SEC that they intended to pay for AOL Europe in cash all along.

In the Post story, Federal officials said Bertelsmann execs’ testimony backs up the case that the SEC is putting together against Time Warner. The SEC enforcement staff is trying to determine the value of Bertelsmann ads that appeared on AOL, which is apparently much less than the stated value. Bertelsmann former CEO Thomas Middlehoff and other Bertelsmann officials have been questioned about the value of the ads.

Bertie spokeswoman Liz Young told the paper, "There were never allegations of wrongdoing against Bertelsmann. We were never under investigation. This was always an AOL-Time Warner issue, and Bertelsmann cooperated fully with the SEC."

The additional questionable advertising revenue on the books followed Time Warner’s merger with America Online in Jan. 2001. Once TW gets its notice, called a “Wells notice,” the company has a period of weeks to review, respond in writing and meet with the SEC in person. The SEC and TW could then work out a settlement or not. Following that, the SEC staff would submit recommendations for enforcement action against TW to SEC commissioners for approval.

Both the Justice Department and the SEC started looking in 2002 at the way AOL booked advertising revenue. That fall, TW restated $190 million in AOL advertising revenue from deals within the 2000-2003 period. The Post quotes a government official close to the probe as saying, “There were a lot of deals that were not kosher.”

Time Warner officials have laid the blame for questionable practices at the feet of AOL, saying that TW is cleaning up and cooperating with the investigations. However, the biggest dollar item is the Bertie deal, which came after the merger, and was supported by Parsons, other execs and the company’s outside accountants.

The SEC is reportedly also considering seeking financial sanctions against TW for not adequately cooperating with the inquiry. The SEC won’t approve any new stock offerings by Time Warner or any of its divisions while the Bertelsmann issue is unresolved.