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

UNITED STATES DISTRICT COURTSOUTHERN DISTRICT OF NEW YORK

)IN RE AOL TIME WARNER, INC. )SECURITIES & "ERISA" LITIGATION )

02 MDL Do cket No . 1500 (SWIG)02 CIV . 5575 (SWK)

SECOND AMENDED CONSOLIDATED CLASS AC ION COMPLAINT OF LEADPLAINTIFF MINNESOTA STATE BOARD OF INVESTMENT

tLL EUAUG

MEREDTflI COHEN GREENFO GEL HENS MILLS & OLSON, P .L.C.& SEÌRN1CI , -P.C. 3554 IDS Center - .Oane Liberty Plaza, 35th Floor - 80 South Eighth Street

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Attorneys for Lead Plain tiff Minnesota Attorneys for Lead Plaintiff-Minnesota :State Board of Investment and Local State Board of Investment and LeadCounsel for the Class Counsel for the Class

48184

TABLE OF CONTENT S

1. INTRODUCTION _.. . . . . . . . . . . . . . . . . . . . .1

U. NATURE OF THE ACTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . .11

III. JURISDICTION AND VENUE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

IV. PARTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

A. Plaintiffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .14

1 . Lead Plaintiff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .142. Addi tional Plaintiffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 5

B. Defendants. . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

1 . AOL Time Warner, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .152 . America Online, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163. Time Warner, Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . .. . . . . . . . . . . . . . . . . .164. The Individual Defendants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . .1 7

a. Stephen M. Case. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17b. Robert W. Pittman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18c. J. Michael Kelly . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18d. David M . Colburn . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19C. Eric Keller . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19-f Joseph A. Ripp. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19g- Steven Rinder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20h. Gerald M. Levin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20k. Wayne H. Pace .. . . . . . . . . . . . . . . .. . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

5 . Additional Individual Defendants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23

a. Paul T. Cappucio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . .23b. 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.

D .

E.

The Creation of AOL Time Warner and the Additional Pressureto Report Growing Adve rtising Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 6

AOL's Pattern and History of Accounting Improprieties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37

Fraudulent Transactions and Improper Accounting Used toArtificially Inflate AOL and AOL Time Warner Advertising Revenue . . . . . . . . . . . . . . . .40

I . Use of Sham Transactions and Improper AccountingPractices 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 rPartial 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) Bertelsmann AG . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64(v) Gateway Inc. RoundtripfFree Internet Service . . . . . . . . . . . . . . . . . .66(vi) WorldCom Inc . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67(vii) Qwest Communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69ìii) 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 oRecord Advertising Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79

(i) Catalina Marketing Corporation . . . . . . . . . . . . . . . . . . . . . . . . .. . . .. . . . . . . . . . .80(ii) Telefonica SA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . .8 1

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 Basisto Inflate Advertising Revenue . . . . . . . .. . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85

eBay. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86

6. Counting Repricing of Equity Stock Rights as Advertisin gRevenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . .. . . .. . . . . . . . . . . . . . . . . .89

PurchasePro . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . .89

7. Converting Contract Termination Fees into Advertisin gRevenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .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 Adver tisingRevenue and Violations of the Securities Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97

G. The Materially False and Misleading Statements, Omissions ofMaterial Fact and Devices, Schemes or Artifices to Defraud RegardingArtificially Inflated Advertising Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .99

a . The Fiscal Quarter Ended December 31, 1998 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100b . The Fiscal Quarter Ended March 31, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102c. The Fiscal Quarter and Year Ended June 30, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105d . The Fiscal Quarter Ended September 30, 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109C . The Fiscal Quarter Ended December 31, 1999 . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112f. The Fiscal Quarter Ended March 31, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 6g. The Fiscal Quarter and Year Ended June 30, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12 1h . The Fiscal Quarter Ended September 30, 2000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126i . The Fiscal Quarter and Year Ended December 31, 2000 . . . . . . . . . . . . . . . . . . .. . . . . 132j . The Fiscal Quarter Ended March 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . .. . . 142k. The Fiscal Quarter Ended June 30, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 11 . The Fiscal Quarter Ended September 30, 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156M. The Fiscal Quarter and Year Ended December 31, 2001 . . . . . . . . . . . . . . . . . . . . . . . . 158n. The Fiscal Quarter Ended March 31, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 1a . The Fiscal Quarter Ended June 30, 2002 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162

H. The Materially False and Misleading Statements, Omissions ofMaterial Fact and Devices, Schemes or Artifices to Defrau d

ill

Regarding AOL Time Warner 's Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166

1 . Defendants' Course of Conduct is Revealed . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 1

J. Scienter of the Individual Defendants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187

The Individual Defendants Knew, or Recklessly Disregarded,that AOL and AOL Time Warner Were Engaged in Fraudand Were Motivated to Use and Cover Up the Useof Improper Accounting and Sham Transactions toArtificially Inflate Advertising Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .187

a. The Individual Defendants Were Actively Engage din the Company's Daily Activities Such That They WereAware Of, Recklessly Disregarded, Controlled and/orCulpably Participated in the Fraudulent Activities of th eBusiness Affairs Division . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .188

b. The Nature of the Accounting Improprieties an dSham Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .193

c. Whistleblowers Provide Further Evidence of IndividualDefendants' Knowledge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .195

d. The Prior Pattern of Improper Accountin gPractices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . .197

e. Defendants ' Restatement of AOL's Advertising Revenu eand GAAP Violations Provide Evidence of Scienter . . . . . . . . . . . . . . . . . . . 198

f. The Individual Defendants ' Awareness of Improper Dealsand Continued Denial of Any Wrongdoing After theTruth is Revealed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .199

2 . Motive and Opportunity of the Individual Defendants to Engagein Improper Accounting, Sham Transactions and Reporting ofInflated Advertising Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .200

a. Salaries, Bonuses, Stock Sales - The Culture ofGreed Begins . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .200

b. The Shift to Flat Rate Pricing and the Increased Importanc eof Advertising Revenue to AOL's Bottom Line . . . . . . . . . . . .. . . .. . . . . . . .. . 201

c. A Culture of Recklessness and Greed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .202

iv

d. The Importance of Ini tiating , Consummating an dSuccessfully Implementi ng the Merger . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . .. . . . . . . . . 206

e. Defendants' Financial Incentives Related to the Merger . . . . . . . . . . . . .209

f. The Individual Defendants Deny and Cover Up Problem sAssociated with Shrinking Advertising Revenue . . . . . . . . . . . . . . . . . . . . . . . . .21 0

3. Individual Defendants' Compensa tion Incentives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .213

4. Additional Allegations and Discussions Regarding Scienter and § 10(b )Violations of Stephen M . Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 7

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 Warne rand AOL Time Warner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .232

2. Ernst & Young 's Close Relationship with AOL Time Warner . . . . . . . . . . . . . . .233

3 . Ernst & Young's Auditing Expertise and Indust ry Knowledge . . . . . . . . . . . . . .234

4. Ernst & Young's Actual Knowledge of Specific Transactionsand Accoun ting Thereof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .235

5 . TheRestatement of AOL's and AOL Time Warner'sFinancial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .237

6. Ernst & Young's Past Involvement with Previou sAccounting Frauds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238

7. Ernst & Young's Responsibilities as AOL's and AOL TimeWarner's Independent Auditor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .239

8. Ernst & Young's Violations of Accounting and AuditingStandards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .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 thatthe Financial Statements Were Presented inAccordance with GAAP When They Were Not . . . . . . . . . . . . . . . . . . . . . . . . . .250

d. Ernst & Young Failed to Obtain Sufficient andCompetent Evidential Matter .. . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . .251

C . Ernst & Young Fa iled to Exercise Due Professiona lCare and Professional Skepticism . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .253

f. Ernst & Young Failed to Properly Plan and Supervise . . . . . . . . . . . . . . . .253

g. Ernst & Young Failed to Properly Evaluate Audi tFindings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . .. . . .. . . .. . . . . . . . . .255

h. Ernst & Young Failed to Properly Consider AOL andAOL Time Warner's Lack of Internal Control . . . . . . . . . . . . . . . . . . . . . . . . . .. .256

L. The Materially False and Misleading Statements and Omissions ofMaterial Facts In the Merger Registration Statemen tand 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 eSecurities Act in Connection With the Merger Registration Statement . . . . . . . . . . . . . . . . . . . . . . . :. .266

COUNT TWO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .268

Against Defendants Case, Levin, Kelly, Cappuccio, Novack and Pittmanfor Violation of Section 1 I of the Securities Act in Connectionwith the Merger Registration Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .268

COUNT THREE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .269

Against Ernst & Young for Violations of § 11 of theSecurities Act in Connection With the Merger Regis tra tion 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 Securi ties Act . . . . . .. . . .. . . .. . . .. . . .. . . .. .272

COUNT FIVE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . .. . . . . . . .. . . . . . . . . .274

Against AOL, Time Warner, and AOL Time Warner For Violationsof § 14 (a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunde rIn Connection With the Joint Proxy Statement-Prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .274

COUNT SIX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .275

Against Defendants Case, Levin, Kelly, Cappuccio, Novack and PittmanFor Violations of § 14(a) of the Exchange Act, and Rule 14a-9Promulgated Thereunder In Connec tion With theJoint Proxy Statement-Prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . .275. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

COUNT SEVEN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .277

Against Ernst & Young For Violations of § 14(a) of the ExchangeAct, and Rule 14a-9 Promulgated Thereunder In Connec tion With theJoint Proxy Statement-Prospectus . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .277

COUNT EIGHT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .278

Violations Of Section 10(b) OfThe Exchange Act And Rule lOb-5Promulgated 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 theExchange Act and Rule I Ob-5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .282

COUNT TEN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .286

Against Defendants Case, Kelly, Pittman, Colburn, Ripp, Levin and Pace for LiabilityUnder § 20(a) Of The Exchange Act For Violations Of § I0(b) Of The Exchang eAct 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 . ActualAdvertising 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 op tions 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/o r

bought or sold options on AOL Time Warner stock during the period January 12, 2001 throug h

and including July 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 viola tion 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, Defendant AOL, and other Defendant s

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 of AOL and AOL Time Warner stock . To that end, during the Clas s

Period , Defendants overstated AOL's reported adver tising revenue by at least a staggering $1 .7

billion through the use of sham transactions and improper accounting practices. This illegal

48184

conduct was designed to capitalize on the "dot-corn" stock market phenomenon and ensure th e

consumma tion of the merger between AOL and Time Warner, Inc. (` Time Warner"), announced

in January 2000 .

3. In 1985, AOL began as a small start-up company called Quantum Computer

Services . After going public in 1992, AOL grew rapidly and was one of "the nation ' s fastest-

growing commercial computer networks" by the end of 1993 . The AOL business consists

principally of interactive services , web properties, internet technologies and electronic commerce

services . As of September 34, 2002, AOL had 26.7 million subscribers to its domestic AOI-

branded internet services, and 6 .1 million subscribers to its European internet services . Time

Warner was created by multiple mergers over 75 years, including the combination in .1996 of

Time Warner Companies, Inc. and Turner Broadcasting System, Inc. Time Warner's principal

business is to create and distribute branded information and entertainment throughout the world .

Its business interests include cable networks , publishing, music, filmed entertainment, cable and

digital media .

4. Investor expectations of the future prospects of publicly traded companies had

historically been based largely on reported corporate earnings and cash flows . However, during

the 1990s "Internet boom", many Internet companies had significant losses and negative cash

flow, and were not expected to generate earnings or positive cash flow for some time. As a

result, investors principally based their expectations for the probable future prospects of Interne t

companies, like AOL, on multiples of reported revenue. These revenue multiples were

extraordinarily high by historical standards due to the perceived potential of businesses in this

new industry .

48184 2

5. AOL's stock price experienced a meteoric rise during the Internet boom of the

1990s, with a resulting beneficial impact on the value of Individual Defendants' substantia l

personal holdings of AOL stock and stock options and their AOL employee compensation. Due

in large part to huge increases in reported AOL revenue, in 1998 alone, the value of AOL stock

jumped 552%. From 1993 to 1998 the stock price increased by an annual compounded rate o f

135% . However, early in the Class Period , a key source of AOL' s recurring advertising revenu e

- Internet companies -- were facing significant concerns with, and eventually a fatal downturn in ,

their business condition . In turn , AOL's advertising revenue from these sources was leveling off ,

with future advertising revenue from Internet companies looking increasingly bleak for AOL. In

a deliberate attempt to hide that fact and continue its previous extraordinary gains in stock price ,

and thereby create even greater wealth for themselves, the Individual Defendants devised a n

illegal scheme to report materially inflated advertising revenue, a number which had becom e

increasingly important to the market in the late 1990s as AOL' s subscription revenue waned .

6. AOL and Time Warner announced with much fanfare on Janua ry 10, 2000 their

agreement to merge the two companies (the "Merger"), valuing the deal at $200 billion.

However, the value placed on AOL's stock for purposes of the Merger was based p rimarily on

AOL's purported advertising revenue, and the tremendous growth AOL touted as to this revenue

source. Indeed , Salomon Smith Barney Inc., the investment banking firm advising AOL on the

Merger, valued the "advertising and e-commerce" segment ofAOL's business at a multiple of

between 44 and 171 - times the repo rted es timates for fiscal year 2000 revenue, far greater than

the multiples attached to the other parts of AOL's business . In other words, it was AOL's

historical and projected advertising revenue and e-commerce which were driving its value .

48]84

7. Consummation of the Merger, which the media described as "the deal of the

century," was delayed until January 11, 2001 (one year) due to its complexity and a review of th e

transaction by the Department of Justice ("DOJ") for an titrust purposes . During that time, the

advertising market was continuing to soften and the dot-corn bubble burst for many Interne t

companies . Analysts questioned whether AOL' s advertising revenue was immune from this

development. In response, the AOL Individual Defendants assured the market that, unlike th e

rest of the industry, AOL was unaffected . At the same time, however, internal AOL documents

and discussions between Defendants during the pendency of the Merger apprised Individua l

Defendants to the contrary : AOL was at ri sk to lose at least $140 million in adve rtising revenu e

for calendar year 2001 alone !

To avoid the fate of a rising number of other Internet companies, Individual

Defendants were intent on making sure the merger went through . As one AOL Senior Manager

was quoted by The Washington Post on July 18, 2002, in an article entitled "Unconventional

Transactions Boosted Sales, Amid Big Merger, Company Resisted Dot-Corn Collapse:"

The bubble had clearly burst, but senior management was under enormouspressure to hit the- [financial] numbers and close the Time Warner transaction,which would diversify the revenue base and lower the risk profile of the Company .

Accordingly, during the one year period before the Merger was finalized , AOL's publicly

reported advertising revenue was artificially inflated not only to boost the value of AOL stock ,

but also to ensure the Merger . After the Merger, Individual Defendants continued to overstat e

AOL Time Warner' s advertising revenue to bolster the Company's stock price and make it

appear that both the Merger and the value of AOL stock exchanged in the Merger were jus tified .

Even when the advertising market eventually became so weak that the Company was forced t o

report decreases in advertising revenue, it nonetheless continued to artificially inflate it s

48184 4

advertising revenue to soften the stock market's reaction to the reported revenue numbers .

Largely as a result of declining advertising revenue figures, AOL has been forced to write-down

over $100 billion in goodwill -- the largest write-down in corporate history .

9. On July 18 and 19, 2002, The Washington Post published a two-part article

reporting allegations that AOL before the Merger, and AOL Time Warner after the Merger, had

substantially overstated publicly reported advertising revenue. Within hours after The

Washington Post first reported the story, Defendant Robert Pittman, AOL Time Warner's Chie f

Operating Officer, a member of the Company's Board, the head of operations for the AOL

division of the Company, and formerly the President and Chief Operating Officer of AOL prior

to the Merger, abruptly resigned from the Company . At the same time, the Company and

Defendant Ernst & Young, AOL's and AOL Time Warner's independent auditing firm,

emphatically denied any wrongdoing and reaffirmed the accuracy of AOL's and AOL Time

Warner's financial statements .

10. Soon thereafter, the Company began to trickle out information confirming its

illegal conduct . After the close of the stock market on July 24, 2002, the Company

acknowledged that the Securities and Exchange Commission ("SEC") was investigating AOL

and the Company's accounting practices, driving AOL Time Warner's stock price down by

almost 15.4% overnight . On July 31, 2002, the Company confirmed that the DOJ had

commenced a criminal investigation of AOL and the Company's accounting practices .

11 . Two weeks later, in an August 14, 2002 press release and in its SEC Form 1 O-Q

filing, the Company acknowledged that advertising revenue "may" have been overstated for

AOL in the amount of $49 million with respect to three transactions covering a period of six

48184

quarters . The Company also stated that it was "continuing its review of these and othe r

transactions at the AOL division."

12. On October 23, 2002 , after the fi ling of the initial complaint in this matter, the

Company restated the financial statements of AOL and AOL Time Warner for eight consecutive

quarters (July 1, 2000 to June 30, 2002) during the Class Period, a clear admission of repeated

violations of the securi ties laws. In fact, in its October 23, 2002 Form 8-K filing with the SEC ,

AOL Time Warner not only restated the companies ' advertising revenue by reducing it in the

amount of $190 million, it also stated :

As a result of the restatement announced on October 23, 2002 by AOL and AOL

Time Wa rner Inc . (the "Company "), the Company' s financial statements for the

affected periods should no longer be relied upon, including the audited financialstatements for 2000 and 2001 contained in the Company's annual repo rt on Form

I O-K for the year ended December 31, 2001 .

(Emphasis added .) The largest quarterly restatement of AOL 's advertising revenue, a reductio n

of $66 million, was for the last publicly reported fiscal quarter prior to the consummation of the

Merger that Individual Defendants wanted to be effectuated at all costs .

13. On March 28, 2003, just prior to the filing of the amended Complaint, th e

Company reported in its SEC Form 10-K filing that it may further restate AOL advertising

revenue by reducing it in an additional amount of up to $400 million for the years 2001 and 2002 .

According to the Company, this possible restatement is attributable to two transactions with

Bertelsmann AG, which are a subject of the SEC's investigation . The Company also stated that,

in addition to the Bertelsmann transactions, "it is possible that further restatement of the

Company's financial statements may be necessary," with respect to "the range of other

transactions" being investigated by both the SEC and the DOJ.

48184 6

14. In the aggregate , the Company has thus far restated or acknowledged th e

possibility of restating advertising revenue for the Class Period by reducing the revenue in the

amount of at least $477 million, with essentially all of the reduction attributable to AOL

advertising revenue. However, this figure does not come close, either in magnitude or timeframe ,

to all of the advertising revenue that was previously overstated by AOL and AOL Time Warner

during the Class Period . By Plaintiff's calculation set forth in detail in this Complaint ,

Defendants have overstated ADL's advertising revenue during the Class Period by at least $1 .7

billion. A chart reflecting the significant difference between the artificially inflated AO L

advertising revenue reported during the Class Period and the actual amounts ofAOL advertising

revenue is set forth below . (A full-size chart is attached hereto as Exhibit A . )

Boo

700

600

500

400

300

200

100

0

AOL Advortialnp and Commorco Revenue(Ovarsta ta d ( as Or1 Inalty Reported) vs.

Actual Advertlaing and Commerce Revenue)

Quarters ende d

These numbers may decrease as knowledge aboutAOL's Improper oceounting praetFces Increases with formaldiscovery.

48184 7

The Company claims that it continues to review the propriety of previously reported financia l

statements . The SEC and DOJ investigations, which according to the Company, "have focuse d

on transactions involving the Company's America Online unit that were entered into after July 1 ,

1999," are continuing and include numerous transactions referenced in this Complaint an d

people named as Defendants in this action .

15. Examples of Defendants' illegal conduct during the Class Period include, but are

not limited to, the following:

Sixteen separate sham transactions involving AOL and then AOLTime Warner, Homestore, Inc . and various third parties, wherebyAOL Time Warner improperly reported significant advertisingrevenue. At least four Homestore executives have already pleadguilty to criminal charges in connection with such transactions andAOL Time Warner executives are targets of the ongoing criminalinvestigation. In a related civil proceeding brought by Homestoreshareholders, the court characterized the sham transactions as "amassive conspiracy driven by pure avarice ;"

b. Various other sham transactions, including one withPurchasePro.com, Inc ., which was referred to in the July 19, 2002,Washington Post article as "science fiction ." This sham dealinvolved a purported revision of the terms of AOL's equity interestin PurchasePro, and AOL and the Company fraudulentlyaccounted for the transaction by reporting $27 .5 million inadvertising revenue;

c. So-called "round-trip" deals with various companies such asBertelsmann AG, Veritas Software Corporation, WorldCom, Inc.,Qwest Communications , Hughes Electronics Corporation,Gateway, Inc., Homestore, Inc., PurchasePro .com, Inc., SunMicrosystems, Inc., Monster.com and Oxygen Media Inc., withrespect to which AOL or AOL Time Warner improperly reportedat least $1 .4 billion dollars in advertising revenue during the ClassPeriod;

d. So called "jackpotting" where AOL and the Companyimpermissibly "squeezed" multiple on -line advertising bannerspurchased by the same customer onto the same screen and did sorepeatedly during a short period of time at the end of a reporting

48184 8

period in order to record the revenue in that particular reportingperiod;

C . Converting an arbitration award against MovieFone, Inc . and thesettlement of litigation with Ticketmaster into $36 .7 million ofadvertising revenue;

f Booking gross, rather than net, revenue for advertising which AOLand AOL Time Warner sold on behalf of eBay as a broker, therebyallowing AOL and AOL Time Warner falsely to reportsubstantially more advertising revenue than permitted byapplicable accounting rules ;

g. Improperly converting contract termination fees from failing "dot-com" companies into advertising revenue ;

h. Improperly accounting for cross-platform adver tising deals(advertising services provided by more than one AOL TimeWarner division), including the double-booking of advertisingrevenue;

i. Reporting materially overstated AOL advertising revenue innumerous AOL and Company press releases and financialstatements ;

j . Failing to disclose the true current and anticipated condi tion ofAOL's advertising revenue and business, both before and after theMerger;

k. Misrepresenting as part of the Merger, AOL's advertising revenueand the value of "goodwill" ;

1 . Failing to properly account for the vastly inflated goodwillassociated with the AOL and Time Warner Merger ; and

m. Falsely representing that AOL and AOL Time Warner 's financialstatements were prepared in conformance with Generally AcceptedAccounting Principles ("GAAP") and fairly represented thefinancial operation of the companies, and that certain of thosefinancial statements were audited in compliance with GenerallyAccepted Auditing Standards ("GAAS") .

16. Defendants' illegal actions during the Class Period artificially propped up th e

price ofAOL and AOL Time Warner stock when they were purchased , exchanged or otherwise

48184 9

acquired by the MSBI and other Class members, causing the MSBI and the Class to lose billion s

of dollars .

17. While AOL and AOL Time Warner investors lost huge amounts of money due t o

Defendants' fraudulent scheme, Individual Defendants reaped billions of dollars in proceed s

selling their own AOL and AOL Time Warner stock at artificially inflated prices . For instance,

Defendant Pittman sold at least $262 million of AOL and Company stock during the Class

Period, and in the year preceding consummation of the Merger was awarded options for 4

million shares of stock . Defendant Case, the Company's Chairman of the Board, who

announced his resignation in January 2003, sold at least $555 million of AOL and AOL Time

Warner stock during the Class Period and, in the year prior to completion of the Merger, wa s

awarded options for about 5 million shares of stock. Moreover, a large portion of the insider

selling by Defendants was conducted during a four-month period just after consummation of the

Merger, during which time the Company was engaged in a $5 billion repurchase of its own stock ,

serving to further inflate the stock while these Defendants sold millions of their own AOL Time

Warner shares . For instance, Defendants Pittman and Case sold 1 .5 and 2 million AOL Time

Warner shares, respectively, in early 2001, while the Company was mid-flight in its massive

stock buy-back program .

18. Even prior to the wrongful acts complained of here, which cover approximately a

31/2-year period beginning Janua ry 27, 1999, AOL's accounting practices had come under SE C

scrutiny. At least as early as 1997 , the SEC determined that AOL had improperly inflated

advertising revenue of the company . The SEC action resulted in AOL 's restatement of the

financial reporting for its 1997 fiscal year third quarter, transforming an alleged p rofit into a loss .

In response to the SEC action , Defendant Case promised the inves ting public that AOL would

48184 10

adopt "new gold-standard accounting policies ." However, in the very next fiscal quarter,

through improper accounting, AOL reported a $10.9 million profit. The SEC again require d

AOL to restate that quarter 's results to reflect proper accounting standards, turning the reported

profit into an $11 .8 million loss. In the fall of 1998, the SEC identified further accounting

improprieties of AOL and required AOL to revise its accounting for $316 million in acquisition

costs related to internet companies .

19. On May 15, 2000, the SEC issued an Order against AOL finding that it had

improperly accounted for $385 million in costs associated with AOL revenue production for the

period spanning July 1, 1994-June 30, 1997 and required AOL to cease and desist from further

improper accounting practices and viola tions of the securities laws . As part of the SEC Cease

and Desist Order, AOL paid a $3 .5 million fine and restated its earnings for the company 's fiscal

year 1995, 1996 and 1997 financial reports, again converting previously reported profits into

losses .

20. Instead of complying with the SEC's Order, the Individual Defendants and Ernst

& Young chose to continue the illegal conduct to ensure consummation of the Merger and fo r

their own sho rt-term personal gain to maximize the value of their AOL or AOL Time Warner

securities holdings, options, bonuses, etc ., or fees to be made from the companies . As one

Company employee described the corporate mentality in the July 19, 2002 Washington Post

article, "The sheer arrogance, the feeling of being untouchable, was amazing . "

II. NATURE OF THE ACTION

21 . The schemes alleged herein entailed , inter alia the dissemination of materially

false and misleading information, and omissions of material facts, in AOL and AOL Time

Warner financial statements, press releases , and filings with the SEC; the AOL Time Warner, Inc.

49184 11

Registration Statement, filed with the SEC in connec tion with the Merger of AOL and Time

Warner consummated on January 11, 2001 ("Merger Registration Statement"); the Joint Proxy

Statement-Prospectus filed with the SEC by AOL and Time Warner, distributed to thei r

respective shareholders and incorporated into the Merger Registration Statement ("Joint Proxy

Statement-Prospectus") ; and in statements of individual Defendants .

22. The material misrepresentations and omissions were designed to and did, inter

alb inflate artificially AOL's and AOL Time Warner's publicly reported advertising revenue.

In turn, this created the illusion during the Class Period that such revenue -- the most significant

qualita tive measure by which the market evaluated the current and future financial health and

prospects of AOL and its touted synergies with Time Warner - was, as desc ribed by one stock

market analyst, the Company's "fastest growing revenue stream and a key element of growth

going forward." The material misrepresentations and omissions were also designed to and di d

hide from the public the schemes used to falsely inflate advertising revenue, including th e

creation of sham transactions and use of improper accounting practices .

23. Defendants were well aware that advertising revenue was material to th e

marketplace . During the Class Period , it became increasingly important for AOL and AOL Time

Warner to set themselves apart from the rest of an industry experiencing growing concerns ove r

declining advertising revenue and difficulties in meeting analysts' expectations . Motivated by

the desire to ensure consummation of the Merger and enhance their own wealth through personal

AOL and AOL Time Warner securities holdings, salaries , bonuses and stock options, or fees t o

be earned from the companies, Defendants violated repeatedly the federal securities laws durin g

the Class Period . Indeed , the recent restatement of AOL's and AOL Time Warner 's financial

statements constitutes admissions of numerous violations of the securities laws.

48194 12

24. Defendants' schemes were intended to, and in fact did , artificially inflate the

prices of AOL and AOL Time Warner stock purchased or acquired by the MSBI and the Class

causing them to suffer billions of dollars in losses .

25. The financial fraud described herein could not have been accomplished withou t

the knowing participation of Ernst & Young, the supposed "independent" auditor of AOL and

Time Warner and later, of AOL Time Warner . Ernst & Young received millions of do llars in

auditing, consulting and other fees from the companies.

26. As the longstanding auditor of AOL and Time Warner, and after the Merger ,

AOL Time Warner, Ernst & Young had knowledge of, or recklessly disregarded, the fraudulen t

accounting practices and schemes engaged in by AOL and AOL Time Warner during the Class

Period, and lent its considerable reputation and credibility to AOL and AOL Time Warner' s

financial statements. Those financial statements were materially misstated starting in 199 8

through and including 2002, as a direct result of false advertising revenue which Ernst & Youn g

allowed AOL and AOL Time Warner to recognize.

M. JURISDICTION AND VENUE

27. Certain claims asserted herein arise under Sections 10(b), 14(a) and 20(a) of th e

Securities Exchange Act, 15 U.S.C. §§ 78j(b), 78n(a) and 78t(a), and the rules and regulations

promulgated thereunder, including SEC Rule 1Ob-5, 17 C .F.R. § 240.1Ob-5. Certain other claims

asserted herein arise under Sections 11, 12 and 15 of the Securities Act, 15 U.S.C. §§ 77k ,

771(a)(2) and 77o. Claims asserted against any Defendant under Sections 11, 12 and 15 of the

Securities Act and Sections 14 and 20 of the Exchange Act are not based in fraud, and should no t

be construed to be based in fraud .

481 84 13

28. The Court has jurisdiction over this action pursuant to Sec tion 27 of the Exchange

Act, 15 U.S.C. § 78aa, and 28 U . S.C. § 1331 and Sec tion 22 of the Securi ties Act, 15 U .S.C. §

77v.

29. Venue is proper in this District pursuant to Section 27 of the Exchange Act, an d

28 U.S.C. § 1391(b) and'Section 22 of the Secu rities Act, 15 U .S.C. § 77v. Defendant AOL

Time Warner is a corporation with its principal place of business in this District and many of th e

acts, practices and transactions complained of herein, including the preparation, issuance an d

dissemination of materially false and misleading statements , occurred in substantial part in this

District .

30. In connection with the acts alleged in this Complaint, Defendants, directly o r

indirectly, used the means and instrumentalities of interstate commerce, including, but no t

limited to, the United States mails, interstate telephone communications and the facilities of th e

national securities markets .

A. Plaintiffs

1 . Lead Plaintiff

IV. PARTIES

31 . Plaintiff MSBI purchased, exchanged or otherwise acquired stock ofAOL, and

AOL Time Warner during the Class Period and has suffered damages caused by Defendants '

violations of the federal securi ties laws. The MSBI is an agency established by Article XI of the

Minnesota Constitution and laws of the State of Minnesota for the purpose of administering and

directing investment of all state funds and pension funds . The funds managed by the MSB I

include: the Basic Retirement Funds, the Post Retirement Fund, the Supplemental Investmen t

Fund, the Permanent School Fund, the Environmental Trust Fund, the Assigned Risk Plan, and

48184 14

the State Cash Accounts . As of June 2002, the MSBI had approximately $44 .6 billion in funds

under management . The MSBI purchased or otherwise acquired approximately 3,073,050 share s

of AOL stock during the Class Period, exchanged approximately 2,610,780 shares of Time

Warner stock for AOL Time Warner stock pursuant to the Merger, and purchased approximately

5,769,839 shares of AOL Time Warner stock during the Class Period . On January 8, 2003, the

Honorable Shirley Wohl Kram, United States District Court Judge for the Southern District of

New York, appointed the MSBI as Lead Plaintiff for this litigation and directed the MSBI to file

an Amended Consolidated Complaint .

2 . Additional Plaintiffs

32. The persons and entities listed on Exhibit B attached hereto are addi tional

Plaintiffs in this consolidated action. During the Class Period , each purchased, exch anged or

otherwise acquired stock of AOL and/or AOL Time Warner, and/or bought or sold op tions on

AOL and/or AOL Time Warner stock , and suffered damages as a result of Defendants '

violations of law.

B. Defendant s

1. AOL Time Warner. Inc.

33. Defendant AOL Time Warner is a Delaware corpora tion with its headquarters in

New York, New York. AOL Time Warner claims to be the world's first fully integrated,

Internet-powered media and communications company . The Company was formed in

connection with the Merger of AOL and Time Warner, Inc . As a result of the Merger, AOL and

Time Warner each became wholly owned subsidiaries of AOL Time Warner . AOL Time

Warner is named as a Defendant in its own right for all liabilities of AOL Time Warner arising in

conjunction with or after the Merger and for all liabilities of AOL and Time Warner arising in

48184 15

conjunction or after the Merger. AOL Time Warner is also named as a successor-in-interest for

all liabilities of AOL and Time Warner arising prior to or in conjunction with the Merger. On

October 16, 2003, AOL Time Warner officially changed its name to Time Warner, Inc. in an

effort to "better reflect the portfolio of our investors ." To avoid confusion in this Complaint ,

Plaintiff will refer to the merged entity as AOL Time Warner or the Company.

2. America Online. Inc.

34. Defendant AOL is a Delaware corpora tion with its principal place of business i n

Dulles, Virginia . It is a who lly owned subsidiary of AOL Time Warner. AOL began its

existence on May 24, 1985 as a small company called Quantum Computer Services . AOL went

public on March 19, 1992 and, by the end of 1993, was one of "the nation's fastest-growin g

commercial computer networks ." The AOL business, based both before and after the Merger in

Dulles, Virginia, consists principally of interactive services, web properties, internet technologies

and electronic commerce services . Before the Merger, AOL operated on a fiscal year ended Jun e

30. Following the Merger, AOL has operated on AOL Time Warner' s fiscal year , which ends on

December 31 . Currently, AOL operates two worldwide internet services . As of September 30,

2002, AOL had 26.7 million subscribers to its domestic AOL-branded internet services,

including America Online, CompuServe, AOL MovieFone, Net Center, AOL .com, ICQ an d

Digital City . As of the same date, there were 6.1 million subscribers to its European internet

services . AOL is responsible for its liabilities resulting from this lawsuit, whether arising before,

in conjunction with, or after the Merger.

3. Time Warner Inc.

35 . Defendant Time Warner , Inc. (now known as Histo ric TW, Inc.) is a Delaware

corporation with its headquarters in New York, New York . Time Warner is a wholly owned

48194 16

subsidiary of AOL Time Warner. Time Warner was created in 1996 as a result of the acquisitio n

of Time Warner Companies, Inc . and Turner Broadcasting System, Inc. by TW, Inc., renamed

Time Warner Inc. Time Warner's principal business is to create and distribute branded

information and entertainment throughout the world . Its business interests include cable

networks, publishing, music, filmed entertainment, cable and digital media. Prior to the Merger,

Time Warner functioned as a holding company deriving its operating income and cash flow from

its investments in its subsidiaries, includ ing Time Warner Entertainment Company, L.P., or

"TWE," a Delaware limited partnership formed in 1992 that owns a majority of Time Warner' s

interests in filmed entertainment and cable television systems and a portion of its interests i n

cable networks. Before the Merger, Time Warner operated on a fiscal year ended December 31 .

Following the Merger, Time Warner operates on AOL Time Warner's fiscal year, which als o

ends on December 31. Time Warner is responsible for its liabilities resulting from this lawsuit ,

whether arising before, in conjunction with, or after the Merger. On October 15, 2043, Time

Warner, Inc., the then subsidiary of AOL Time Warner, Inc., officially changed its name to

Historic TW, Inc . For purposes of this Complaint, Plaintiff will refer to this Defendant as Time

Warner.

4. The Individual Defendants

36. The following Defendants were Officers and/or Directors of AOL prior to the

Merger with Time Warner :

a. Stephen M. Case. Defendant Stephen M . Case {"Case") co-founded AOL

in 1985 and served as its Execu tive Vice President from September 1987 to January 1991 and

Vice President of Marketing from 1985 to September 1987 . He became a Director of AOL when

it first became a public company in September 1992, Chief Executive Officer in Ap ri l 1993 and

48194 17

Chairman of the Board in October 1995, holding all of these positions until the Merger wa s

consummated on January 11, 2001 . Case was a signatory to the Joint Proxy Statement-

Prospectus incorporated into the Merger Registration Statement . Upon the Merger, Case becam e

an Affiliated Director and Chairman of the Board of AOL Time Warner. Case is also a member

of the Board of Representatives of Time Warner Entertainment Company, L.P. On January 12 ,

2003, Case announced his resignation from the Company effective May 2003, noting that ,

among other things, the Merger had been a "disappointment, "

b. Robert W . Pittman . Before joining AOL, from 1990 to September 1995 ,

Defendant Robert W . Pittman ("Pittman") was President and Chief Executive Officer of Time

Warner Enterprises, a division of Time Warner Entertainment Company . Pittman moved to

AOL in November 1996, where he was President and Chief Executive Officer of AOL Networks ,

a division of AOL, until February 1998 . From February 1998 until the Merger, Pittman wa s

President and Chief Operating Officer of AOL. He was a Director of AOL from 1995 until th e

Merger . Upon the Merger, January 11, 2001, Pittman became Co-Chief Operating Officer o f

AOL Time Warner and an Affiliated Director of the AOL Time Warner Board of Directors . On

April 19, 2001, Pittman also resumed his previous responsibilities for operations of the AOL

subsidiary of AOL Time Warner. In May 2002, Pittman became the sole Chief Operating

Officer of AOL Time Warner. On July 18, 2002, the day The Washington Post reported on

various accounting improprieties regarding AOL advertising revenue, Pittman abruptly resigned

his position as Chief Operating Officer with AOL Time Warner and announced his intent t o

resign as acting head of AOL " after a new CEO is in place." He resigned from his AOL position

shortly thereafter in July 2002 .

J. Michael Kelly. From June 1998 until the Merger, Defendant J . Michael

48184 18

Kelly ("Kelly") was Senior Vice President, Chief Financial Officer and Assistant Secretary of

AOL. Kelly was a signatory to the Merger Registra tion Statement . Upon the Merger, Kelly

became Chief Financial Officer and Execu tive Vice President of AOL Time Warner. On or

about November 1, 2001, Kelly was appointed Chief Operating Officer of the AOL subsidiary of

AOL Time Warner. Kelly is now Chairman and Chief Execu tive Officer of AOL International

and Web Services.

d . David M. Colburn. From 1995 until the Merger, Defendant David M.

Colbum ("Colbum") was Senior Vice President of Business Affairs for AOL, who reported

directly to Defendant Pittman. Following the Merger, Colburn became Executive Vice-Presiden t

and President of Business Affairs and Development for AOL Time Warner and continued t o

report directly to Pittman . Colburn was AOL's, and then AOL Time Warner's chief deal-maker.

Colbum was terminated in August 2002 after he was identi fied as a subject of the SEC and DOJ

investigations .

e . Eric Keller. Defendant Eric Keller ("Keller") was Senior Executive Vice

President of Business Affairs and Development under, and reported directly to, Defendan t

Colburn at AOL. After the Merger, Keller remained Senior Executive Vice President of

Business Affairs and Development and continued to work under, and report directly to, Colbwrn .

Keller was the number two deal-maker at AOL and AOL Time Warner. Various media reports

have identified Keller as a subject of the SEC and DO ] investigations .

f. Jos h A. Ri . Defendant Joseph A. Ripp ("Ripp") was Executive Vice

President, Chief Financial Officer and Treasurer of Time Inc . until 1999. He then became the

Executive Vice President and Chief Financial Officer of Time Warner from 1999 until th e

Merger. On October 16, 2000, Ripp was named Executive Vice President, Chief Financia l

48184 19

Officer and Treasurer of AOL subsidiary, effective upon the Merger. In September 2002, Ripp

became Vice Chairman of AOL, a position he currently maintains.

g. Steven Rindner. Defendant Steven Rindner ("Rindner") was Senior Vic e

President of Business Affairs & Development in 2001 for the Company .

37. Defendants Case, Kelly, Pittman, Colburn, Keller, Ripp, Rindner and Novack ar e

sometimes collectively referred to herein as the "AOL Individual Defendants ."

38. The following Defendants were Officers and/or Directors of Time Warner prior t o

the Merger with AOL :

h. Gerald M. Levin. From 1983 until January 1987 and from 1988 unti l

the Merger, Defendant Gerald M. Levin ("Levin") was a Director of Time Warner . From

January 1993 until the Merger, Levin was Chairman and Chief Executive Officer of Tim e

Warner. He served in multiple executive positions with Time Warner prior to 1993 . Upon the

Company's incorporation in February 2000, Levin was appointed Chief Executive Officer o f

AOL Time Warner. Levin also became an Affiliated Director of AOL Time Warner's Board of

Directors . Levin was a signatory to the Merger Registration Statement and the Joint Proxy

Statement-Prospectus incorporated therein . He is also a member of the Board of Representative s

of Time Warner Entertainment. Levin retired from the Company in

May 2002 .

Wayne H. Pace. From July 1993 to March 2001, Defendant Wayne H .

Pace {"Pace"} held multiple executive posi tions with Time Warner, including that of Chief

Financial Officer. Following the Merger, in March 2001, Pace became Vice Chairman and Chie f

Financial and Administrative Officer of Turner Broadcasting System, Inc . In November 2001 ,

48184 20

Pace became the Company's principal financial officer as the Executive Vice President an d

Chief Financial Officer of the Company, a position he maintains at the present time.

39. Defendants Case, Kelly, Pittman, Colburn, Keller, Ripp, Rindner, Levin, an d

Pace, are sometimes collectively referred to herein as the "Individual Defendants ."

40. Due to the Individual Defendants' positions with AOL and/or AOL Time Warner,

they directly participated in management, and the day-to-day operations, of one or both of th e

companies during the Class Period . In addition, they had access to and/or were provided the

adverse undisclosed information, including the adverse information detailed herein, about th e

business, opera tions, products, operational trends, financial statements, markets and present and

future business prospects of AOL and AOL Time Warner. They had such access via internal

corporate documents (including the Company's and AOL' s operating plans, budgets and

forecasts and repo rts of actual operations compared thereto), conversations with other AOL and

AOL Time Warner corporate officers and employees , attendance at management and Board of

Directors meetings and commi ttees thereof, and reports and other information provided to them

in connection therewith .

41 . The Individual Defendants, because of their positions of control and authority a s

officers and/or Directors of the Company and/or AOL, were able to and did control the conten t

of the various SEC filings, press releases and other public statements pertaining to the Company

and AOL during the Class Period . Each Individual Defendant was provided with copies o f

documents alleged herein to be misleading prior to or shortly after their issuance and/or had th e

ability and/or opportunity to prevent their issuance or cause them to be corrected . Accordingly,

each of the Individual Defendants is responsible for the accuracy of such public reports an d

releases detailed herein and is therefore primarily liable for the representations contained therein.

48184 21

42. As Officers and controlling persons ofpublicly-held companies whose common

stock was, and is, registered with the SEC pursuant to the Securities Exchange Act, and traded

on the New York Stock Exchange, and governed by the provisions of the federal securities laws,

the Individual Defendants had a duty to disseminate promptly, accurate and truthful information

with respect to the Company's and AOL's financial condi tion and performance, growth,

operations, financial statements, business, products, markets, management , revenues , earnings

and present and future business prospects, and to correct any previously-issued statements tha t

had become materially misleading or untrue, so that the market price of the Company's an d

AOL's publicly-traded stock would be based upon truthful and accurate information . The

Individual Defendants' misrepresentations and omissions during the Class Period violated thes e

specific requirements and obligations .

43 . The Individual Defendants par ticipated in the drafting, preparation, and/or

approval of the public statements, press releases, shareholder repo rts and other communications

complained of herein, and were aware of, or recklessly disregarded, the misstatements containe d

therein and omissions therefrom, and were aware of their materia lly false and misleading nature.

Because of their board membership and/or executive and managerial posi tions with AOL Time

Warner and/or AOL each of the Individual Defendants had access to the adverse undisclosed

information about AOL Time Wa rner 's and/or AOL's business prospects and fin ancial condi tion

and performance as particularized herein and knew (or recklessly disregarded) that these advers e

facts rendered the representations made by or about AOL, AOL Time Warner and their business

materially false and misleading.

44. It is appropriate to treat the Individual Defendants, and the AOL Individua l

Defendants, respectively, as groups for pleading purposes and to presume that the false ,

48184 22

misleading and incomplete information conveyed in the Company's and AOL's SEC filings ,

press releases and other publications and communications alleged herein, are the collective

actions of the narrowly defined group ofDefendants identified above.

45. Each of the above-referenced Individual Defendants is liable as a participant in a

fraudulent scheme and course of business that operated as a fraud or deceit on the Class b y

disseminating materially false and misleading statements and/or concealing material adverse

facts .

5. Additional Individual Defendants

46. The following are additional Individual Defendants :

a . Paul T. Cappucio . Defendant Paul T . Cappuccio ("Cappuccio") was an

Associate Deputy Attorney General at the U .S. Department of Justice from 1991 to 1993 . He

was Senior Vice President and General Counsel of AOL from August 1999 unti l the Merger.

Upon the Merger, Cappuccio became Executive Vice President, General Counsel and Secretary

of the Company. Cappucaio was a signatory to the Merger Registration Statement .

b . Kenneth J . Novack . Defendant Kenneth J. Novack ("Novack") was Vice

Chairman of AOL from May 1998 until the Merger . He was a Director of AOL from January

2000 until the Merger. Upon the Merger, Novack was appointed an Affiliated Director of the

Company and became its Vice Chairman . He is also a member of the Board of Representatives

of Time Warner-Entertainment .

6. Ernst & Young LLP

47. Defendant Ernst & Young is a firm of certified public accountants that maintain s

its headqua rters in the Southern District of New York . At all times relevant to this action, Erns t

& Young provided auditing and accounting services to AOL and AOL Time Warner, including

48194 23

but not limited to, conducting audits of AOL and AOL Time Warner 's year-end financia l

statements and, beginning no later than the quarter ended March 31, 2000, reviewing AOL's and

the Company's quarterly financial statements . In connection therewith, Ernst & Young issued

unqualified audit repo rts related to AOL and AOL Time Warner's financial statements, for

inclusion in each of AOL's annual reports for the fiscal years 1999 and 2000 and transi tion

period ended December 31, 2000 on SEC Forms 10-K, in the Merger Registration Statement .

Ernst & Young also issued an unqualified audit repo rt for inclusion in AOL Time Warner's

annual report for the years 2000 and 2001 on SEC Forms 10-K .

V. CLASS ALLEGATION S

48. Plaintiff brings this action on its own behalf and as a class action pursuant to

Rules 23 (a) and (b)(3) of the Federal Rules of Civil Procedure on behalf of a Class of all person s

and en tities who purchased, exchanged, or otherwise acquired publicly traded stock of AOL or

bought or sold options on AOL stock during the period January 27, 1999 through January 11 ,

2001, and all persons or entities who purchased, exchanged or otherwise acquired publicly trade d

stock of AOL Time Warner or bought or sold options on AOL Time Warner stock during the

period January 12, 2001 through and including July 24, 2002, and were damaged thereby .

Excluded from the Class are Defendants, Defendants' immediate families, and the lega l

representatives, heirs, successors or assigns of any Defendant, and any entity in which an y

Defendant has or had a controlling interest, and the senior Officers and Directors of AOL and th e

Company. Also excluded from the Class are Homestore, Inc., PurchasePro .com, Inc., and

Veritas Software Corporation, their successors or assigns and any entity in which Homestore ,

PurchasePro or Veritas has a controlling interest ; and the senior executives of Homestore ,

48184 24

PurchasePro, and Veritas, their legal representatives and heirs, successors or assigns, and th e

immediate families of the senior executives of Homestore, PurchasePro and Veritas .

49. The members of the Class are so numerous that joinder of all members is

impracticable. Throughout the Class Period, AOL and AOL Time Warner common shares were

actively traded on the New York Stock Exchange (AOL through January 11, 2001, and AO L

Time Warner starting January 12, 2001), which was an efficient market . Currently, AOL Time

Warner has over 4 billion shares of common stock issued and outstanding and is reported to be

the third most widely held stock in the United States . While the exact number of Class members

is unknown to Plaintiff at this time and can only be ascertained through appropriate discovery ,

there are many thousands of members in the proposed Class . Record owners and other members

of the Class may be identified from records maintained by AOL Time Warner or its transfer

agent and may be notified of the pendency of this action by mail, using the form of notice simila r

to that customarily used in securities class actions .

50. Plaintiffs claims are typical of the claims of the members of the Class as all

members of the Class are similarly affected by Defendants' wrongful conduct in violation of

federal law complained of herein-

51 . Plaintiff will fairly and adequately protect the interests of the members of th e

Class and has retained counsel competent and experienced in class and securities litigation .

52. Common questions of law and fact exist as to all members of the Class and

predominate over any questions solely affecting individual members of the Class . Among the

questions of law and fact common to the Class are :

a. whether the federal securities laws were violated by Defendants' acts as

alleged herein ;

48184 25

b. whether statements made by Defendants to the investing public during th e

Class Period misrepresented, or omitted, material facts about the business, operations an d

prospects of the Company and AOL;

c. whether AOL and AOL Time Warner's reported financial results during

the Class Period were materia lly misstated ;

d. whether AOL and AOL Time Warner's reported financial results during

the Class Period were in accordance with GAAP;

e. whether the Merger Registration Statement contained material

misstatements or omitted to state material information ;

f. whether the Joint Proxy Statement-Prospectus contained material

misstatements or omitted to state material information ;

g. whether Defendants acted with the requisite state of mind in

misrepresenting or omitting material facts ;

h. whether the market price of AOL and AOL Time Warner publicly traded

stock was artificially inflated due to the material omissions and misrepresentation s

complained of herein;

i . whether Defendant Ernst & Young's unqualified reports issued on AO L

and AOL Time Warner's financial statements during the Class Period materially

misstated that Ernst & Young's audits thereon were conducted in accordance with GAAS;

and

whether members of the Class have sustained damages and, if so, the

appropriate measure thereof.

48184 26

53 . A class action is superior to all other available methods for the fair and efficien t

adjudication of this controversy since joinder of all members is impracticable . Furthermore, a s

the damages suffered by individual Class members may be relatively small, the expense and

burden of individual litigation make it impossible for members of the Class to individually

redress the wrongs done to them . There will be no difficulty in the management of this action as

a class action .

VI. SUBSTANTIVE ALLEGATIONS

A. The Growth of AOL and Its Emphasis on Increasing Advertising Revenu e

54. AOL, since its inception, has been a revenue-driven company . The stock market

historically valued companies based on earnings and free cash flows . Beginning in the 1990s,

however, there was an explosion of start-up Internet companies which reported net losses an d

negative cash flows . Traditional valuation methods were not applied to determine the value o f

these companies . Rather, due to the potential presented by the Internet, the market began t o

value high-tech companies based upon revenues . As a result, there was an increasing pressur e

on Internet companies , like AOL, to report substantial growth in revenue each reporting pe riod to

maintain or increase stock market value.

55. Companies reporting revenue that disappointed the market's expectations, eve n

narrowly, saw their share prices plummet . Given these circumstances , AOL and later AOL Time

Warner, and the Individual Defendants, have continually looked for ways to increase AO L

revenue in order to increase its market valuation, and the value of the Individual Defendants '

substantial personal holdings of AOL and AOL Time Warner stock and/or options . The focus on

revenue growth became even more acute when concern over the viability of dot-corn companie s

surfaced in late 1999 and early 2400.

48184 27

56. During the dot-com boom AOL's stock price skyrocketed due to its reported

revenue growth. For example, a $100 investment in AOL stock in 1993 was worth $16,972 by

the end of 1998, a 135% compounded annual return . In turn, AOL employees became

fantastically wealthy. As reported by The Washington Post on July 19, 2002, in an ar ticle titled

"Creative Transactions Earned Team Rewards": "Everyone [at AOL], it seemed was becoming

an instant mil lionaire at the Company's Dulles headquarters . There were a lot of Ferraris and

twenty somethings and secretaries retiring with seven-figure bank accounts after a few years o n

the job, thanks to the incredible windfall from stock options . "

57. However, for AOL stock to continue its extraordina ry increase in value, it was

imperative that company revenue continue to show impressive growth. Any weakness in AOL

revenue growth would mean that the company's phenomenal ri se in its stock price could not

continue. Accordingly, the Individual Defendants, first at AOL , and later at AOL Time Warner,

devised various fraudulent schemes to artificially enhance advertising revenue to fraudulently

induce continued substantial increases in the companies' stock prices .

58. Histo rically, AOL has reported three main types of revenue: (1) subscription

services revenues; (2) advertising and e-commerce revenues ; and (3) enterprise solution revenues .

Subscription services revenue is generated from customers subscribing to AOL 's internet

services . Advertising and c-commerce revenue are non-subscription based and are, generated

from the company's base of subscribers and users as well as businesses who advertise on AO L

internet sites . Enterprise solu tion revenues consist principally of product licensing fees and fees

from technical support, consulting and training services . Of the three revenue sources, AOL

initially depended primarily on its subscription service revenue for the bulk of its revenue an d

revenue growth.

48184 28

59. . As a result of increased competi tion, the increased use of the World Wide Web

and increased popularity of browser software, AOL was forced to continually reduce prices for

its online services and in December 1996 dropped its pay-by-the-hour method of chargin g

subscribers and adopted a "flat-rate" pricing plan .

60. Following the introduction of the flat rate plan for the AOL subscriber service in

December 1996, the company experienced a significant increase in both (1) subscriber usage ,

which was mainly due to the growth of the subscriber base, and (2) the average monthly usage

per subscriber as subscribers spent more and more time online. As the average usage level s

increased, the company faced further pressures on its operating margins due to increased networ k

costs on both an absolute dollar basis, as well as a percentage of revenue basis . The increase in

cost of revenues was primarily attributable to increase in data network costs, as well as personne l

and related costs associated with operating the data centers, data network and providing custome r

support, consulting, technical supportltraining and bi lling. According to AOL' s SEC Form 1O-Q

for the quarter ended March 31, 1997, the company reported that overall average monthly onlin e

service revenue per AOL subscriber in fiscal 1997 was expected to be lower than in fiscal 1996,

primarily due to the adoption of the flat-rate pricing plan in fiscal 1997 . As AOL began seeing

its subscription revenue for the online service drop, the company looked for ways to increas e

advertising revenue.

61 . The growth of higher margin advertising revenue became increasingly important

to AOL's business objectives . Advertising revenue grew in importance as the compan y

continued to leverage its large, active and growing user base . This user base not only included

the paying subscribers of the AOL and CompuServe services, it also included users of the

48194 29

company's other branded services such as AOL MovieFone, Net Center, ACL.com, ICQ and

Digital City .

62. AOL 's SEC Form 10-K for the fiscal year ended June 30, 1997, described th e

importance of advertising revenue to AOL's success :

An important component of the company 's business s trategy is to increasenonsubscrip tion based revenues, including from advertising sales and transactionfees associated with electronic commerce , and the sale of merchandise , which thecompany believes are increasingly im ortant to its growth and success . Thecompany continues to estab lish a wide variety ofrelationships with advertisinand elec tronic commerce partners in order to grow its non-subscription basedrevenues and to provide AOL subscribers with access to a broad selection ofcompe titively priced, easy to order products and services .

(Emphasis added.)

63 . Many ofAOL's advertising deals involved various forms of partnerships o r

alliances . According to AOL's SEC Form 10-K for the fiscal year ended June 30, 1999 :

The company offers its advertising and commerce partners a variety ofcustomized programs, which may include premiere placement or selectsponsorship of particular online areas or web pages for designated time periods .As merchants recognized the value in reaching the company's large, growing andactive subscriber base and users of its web-based properties, the company hasbeen able to earn additional revenues by offering selected merchants exclusiverights to market particular goods or services within one or more of the company'sonline services and properties . In those transactions, the company provides itscommerce partners certain marketing and promotional opportunities and in returnreceives cash payments, the opportunity for revenue sharing, cross promotionsand competitive pricing and online conveniences for subscribers. Certain of thetransactions with partners also include an equity component for the company .The company may receive a warrant to purchase stock or may purchase oracquire a direct equity interest in the partner . These equity investments areaccounted for in accordance with company accounting policies . In addition,these equity investments can also represent an additional potential source ofincome or loss to the company upon their disposition .

(Emphasis added.)

64. Beginning at least as early as May 1998, many of these alliances and partnership s

enabled AOL, and later AOL Time Warner, to artificially inflate revenue through , among other

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means, the use of improper accounting practices regarding "round-trip" and barter transactions .

This was accomplished , in large part, through the emergence of AOL "portal" deals. A "portal"

can be viewed as a website playing the role of a "gate" that welcomes the user onto the interne t

and guides the user towards the information he or she is seeking .

65 . As reported in an October 30, 2000 article in the Industry Standard entitled

"AOL's Rough Riders :"

Never was [AOL's Senior Vice President of Business Affairs David] Colburnmore valuable to AOL than when the portal deal was born, the offspring ofnecessity and opportunity. In December 1996, AOL, following the lead of itscompetitors, dropped its pay-by-the-hour method of charging customers in favorof a flat monthly fee, precipitating one of the many crises that AOL has faced inits relatively short life as a publicly traded company . The price change may havebeen great news for the company's millions of subscribers, but it meant a hugehit for AOL's bottom line and also its stock price . Deals with the company'smany content providers, which had been based on AOL's per hour fees, neededto be renegotiated, and alternative revenues had to be found. Back then there wasplenty of talk about a wondrous new business model dubbed the "portal," buthow a company might cash in on all those eyeballs they had attracted remained tobe seen .

That's what David was responsible for doing," says a former Colburn lieutenant ."It largely fell on him to restructure all the existing deals and figure out, moreimportantly, how the company could make money as a portal ." The plan fordealing with content providers was a radical departure from the old model ; mostwould now have to pay for the privilege of providing news and information toAOL users. "It's not like an edict was handed down one Thursday and that wasthat," says David Ellington, CEO of NetNoir, an AOL stalwart since 1995 . "Buton the other hand, it's not like they left us much room to negotiate." Yetfinessing relations with a few pissed-off content providers was hardly AOL'smain concern .

Terms such as "anchor tenancy" had been invented, or reinvented for the Web,and a new paradigm adopted : AOL was no longer a diverse community of usersbut an enormous online shopping mall visited by tens of millions of consumers .

(Emphasis added .)

66 . In addition to acquiring an equity stake in its advertisers, other alliance partner s

agreed to share revenue realized from deals, and online brokerages like E-Trade agreed to shar e

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commissions from every trade initiated by all AOL secured customers . The need to strike deals

with AOL was particularly apparent with regard to sta rt-up Internet companies, many of whom,

believing their companies' survival depended on an AOL deal , made enormous upfront

payments to AOL and gave up large por tions of their companies . According to a former AOL

Vice President , fledgling companies that had just gone public or were on the verge of going

public and were in need of financing, were finding that in order to get the financing, investors

were asking "What sort of deal do you have with AOL?" If a company did not have a deal wit h

AOL, the investors refused to take the company seriously, saying they could not invest un ti l the

company had an AOL -deal .

67 . According to a former AOL Chief Technology Officer, Product Manager and

Senior Business Manager, as AOL became a portal with an increasing number of millions of

subscribers, the company had more power to demand what it wanted . It insisted that some of its

advertisers and content providers give AOL performance warrants or shares of their companies

for as little as a penny a share . According to this source, "[i]nternally, the thinking at AOL was

that when we sign a deal with a company, the stock will go up, so we would try to capture th e

full value of our deal ."

68. According to the same source , AOL used creative accounting when the company

began charging other companies for exposure to its subscribers .

B . The Constant and Increasing Pressure to Falsify Advertising Revenue

69. Within AOL, and later AOL Time Warner, there was enormous pressure to show

increasing revenue each quarter and meet or exceed revenue targets . This was especia lly true

with respect to advertising revenue following AOL's shift in its business model to emphasize thi s

revenue source. A former AOL dealmaker in the October 30, 2000 Industry Standard article

48184 32

entitled, "AOL's Rough Riders," confirmed that no matter how many advertising deals AOL was

generating, it was never enough "Working there you were under pressure all of the time to make

your quota, especially at the end of the quarter." "Colburn would be screaming at people `Why

the f _ _ _ aren't we hitting our numbers?"" Defendant Colbum was AOL's top dealmaker and

chief architect of many of the transactions making up AOL's fraudulent advertising revenue .

According to a former AOL senior executive also quoted in the Rough Riders" article, "Colbur n

is the driver when it comes to deals at AOL . . . . He oversees all of the dealmaking the Company

does."

70. According to a former Senior Manager in AOL Time Warner's Interactiv e

Marketing Unit responsible for developing sales programs and strategic partnerships, a deal was

structured, it was designed to help AOL make its quarterly numbers . According to this source,

meeting quarterly revenue goals was the driving force behind the various accountin g

manipulations and fraudulent transactions undertaken by the Company. As this source stated :

"We were congratulating ourselves for being creative . In the long run, we are ultimately

providing value to our customers and our investors wanted to see revenue at all costs."' But, the

source added: "Deep down we knew our accounting practices were not that secure . We knew

what we were doing wasn't conventional ." The Washington Post reported on July 19, 2002, in,

an article titled "Creative Transactions Earned Team Awards", that another AOL sourc e

described the culture at AOL as follows : "The lavish parties, the crazy antics - - it rea lly

socialized you. You had to toe the line." (Emphasis added .)

71 . According to a former AOL Vice President, the pressure was always on for

making deals that would catch Wall Street's attention . AOL executives wanted to do deals tha t

would give them a "big fat press release" that would cause AOL's stock to go up. For thi s

48184 33

reason, as the same source stated , AOL entered into several deals that were not significant from a

cash flow standpoint, or, in fact, were a wash, but that ended up artificially inflating advertisin g

revenue and impressing shareholders . This witness described the pressure to impress Wall Stree t

as a predominant factor in AOL' s corporate culture created primarily by Defendants Pittman and

Colburn. The pressure "was something that was always there, and it got even more intense "

during the period before the Merger was completed and a week or two before the end of every

quarter . According to this witness, Colbum regularly told his people "you had better do it o r

else." According to a former Senior Manager in AOL Time Warner' s Interac tive Marketing Unit,

Colburn's Business Affairs Division developed the improper deals in order to book revenue an d

make quarterly sales goals . The former Senior Manager said "The idea in the back of their mind

was to show revenue as ad revenue . Our value as a company hinged on ad revenue and revenu e

growth. We were sales and revenue driven. There was a lot of pressure to make quarterl y

numbers . We had a core number to hit."

72. The pressure to maintain continually impressive revenue growth and the need t o

artificially inflate that revenue through the improper methods described herein, increased eve n

more as many of the Internet companies that had given up enormous sums in dollars and equity

to partner with AOL were achieving disappointing results . Many overvalued Internet companies

which took advantage of the Internet bubble were seeing their stock prices drop well below thei r

Initial Public Offering {"IPO') prices . Other Internet companies were seeing their stock price s

fall precipitously on concerns of not only declining advertising revenue, but on concerns that a

majority of Internet companies would disappear altogether. Individual Defendants knew that any

indication of weakness in AOL' s advertising revenue growth would swiftly and severely impact

its stock price.

48184 34

73 . Due to the critical importance of advertising revenue to AOL, this revenue source

was tracked closely by the companies and their top execu tives . According to a former AOL Vice

President, reports prepared by Robert O'Connor, Vice President of Finance for the Busines s

Affairs Unit, both before and after the Merger, showed every advertising deal that AOL had an d

the amount of annual revenue recognition expected from the deal . These reports indicated th e

amount of revenue initially expected on a deal and the revised- lower amount of anticipate d

revenue if that advertiser was experiencing financial difficulty . Additionally, AOL utilized a

periodic "pipeline report" prepared by the Interactive Services unit, which report describe d

advertising deals in the pipeline and anticipated to generate revenue . The Individual Defendants

had access to such reports . Also, weekly business meetings were attended by "Colburn' s

people," including Colburn, Bob O'Connor and Eric Keller. During these meetings variou s

advertising deals, including the significant financial problems of existing customers tha t

jeopardized continuing revenue from those contracts were discussed .

74. According to this same source, every Sunday morning, Colbum had telephone

conference calls with top executives .in which they discussed the status of advertising deals an d

revenue recognition. During the Sunday morning calls, Colburn would frequently ask Ja y

Rappaport, who did many of the major deals, in the Business Affairs unit, which "BA Specials"

were on the list. The "BA Specials", which consisted of deals that caused AOL's advertisin g

revenue to be improperly inflated , made up a substantial portion of AOL's advertising revenue ,

especially at the end of a quarter. These Sunday calls also involved discussions of problems with

dot-corn companies that had advertising deals with AOL and the restructuring of advertising

deals in order to maximize advertising revenue for AOL.

48184 35

75. By at least August 2000, internal company documents showed that AOL was a t

risk to lose substantial advertising revenue from existing customers the following fiscal year. In

September 2000, AOL documents estimated that AOL was at risk to lose $108 million in

advertising revenue in the 2001 fiscal year (July 1, 2000-June 30, 2001) due to the financial

difficulties of its advertising customers . In early October 2000, Defendant Pittman and other

AOL executives were told that as a result of many failing dot-com customers of the Company,

AOL was at risk to lose $140 million in advertising revenue the following calendar year.

C. The Creation of AOL Time Warner and the Additional Pressure to Report GrowingAdvertising Revenue

76. AOL's need to demons trate substantial and continuing revenue growth took o n

even greater importance when AOL and Time Warner discussed merging the two companies.

77. The proposed Merger was jointly announced by AOL and Time Warner with

much fanfare on January 10, 2000 . The media described the Merger as "the deal of the century ."

78. On January 11, 2000, The Los Angeles Times reported that the deal came to

frui tion when Time Warner was convinced that AOL 's stock value was "real" :

Levin and Case said they had worked carefully to strike a reasonable compromiseon the values of their two companies .

"One of the creative breakthroughs was in the valuation," Case told The Times ina joint interview with Levin . He said the key to coming to a final deal was TimeWarner's "recognition that these Internet values are real ." . . .

79. The value of AOL's stock for purposes of the Merger was based p rimarily on

AOL's reported adver tising revenue and histo rical growth in that revenue source. Salomon

Smith Barney, for example, which advised AOL on the Merger, valued AOL's "advertising and

commerce" business at a multiple of between 44 and 171 of estimated revenue for fiscal year

2000 , far greater than the multiples applied to the o ther segments ofAOL's business .

48184 36

80. The pressure to report impressive advertising revenue and growth became eve n

more intense after the Merger was announced . During the one year period between the Merger

agreement and the deal's consummation, Individual Defendants were desperate to ensure that the

deal went through, especially since the advertising market was weakening and the stock prices of

many dot-com companies were plummeting. Indeed, at least months before the Merger was

consummated, Individual Defendants were aware that AOL was at risk to lose substantia l

amounts of advertising revenue in the current fiscal year and the next calendar year. As reported

in the July 18, 2002 issue of The Washington Post, James Patti, who during the pendency of th e

Merger was a Senior Manager in AOL' s Business Affairs division, stated, "The bubble had

clearly burst, but senior management was under enormous pressure to hit the [financial] numbers

and close the Time Warner transaction, which would diversify the revenue base and lower th e

risk profile of the Company."

81 . On June 23, 2000, AOL and Time Warner announced that their respective

shareholders had voted to approve the Merger with AOL common shareholders to receive I

share of AOL Time Warner common stock for each share of AOL they owned (then having a

market price of $54.62 per share) and Time Warner common shareholders to receive 1 .5 share s

of AOL Time Warner common stock for each share of Time Warner they owned (then having a

market price of $79.50 per share). The Merger was finalized on January 11, 2001 .

D. AOL' s Pattern and History of Accounting Improprie ties

82. The schemes described herein follow a familiar pattern for AOL. Even prior to

the start of the Class Period, AOL engaged in accounting improprieties, resulting in SE C

investigations, and restatements of previously reported financial results .

48194 37

83 . For example, in early 1997, after AOL reported a profit for its fiscal year 199 7

third quarter, the SEC conducted an investigation into AOL's accounting practices . Specifically,

the SEC alleged that AOL had improperly inflated advertising revenue regarding an AOL deal

with Tel-Save Holdings, Inc. AOL improperly recorded as revenue $12 million from the

agreement with Tel-Save and the SEC required AOL to record $ 7 million of that sum over th e

remaining term of the con tract. The Company restated its 1997 fiscal year third quarter earnings ,

which changed the previously reported profit to a loss . In response to the SEC action, Defendant

Case promised the public that AOL would adopt "new gold-standard accounting practices ."

84. However , the very next fiscal quarter (ended June 30, 1998) AOL reported a

profit of $10.9 million based on more accounting improp rieties . The SEC again required AOL to

restate the quarterly results, which caused AOL to report an $ 11 .8 million loss .

85. In 1998, AOL attempted to immediately write-off two acquisitions totaling $31 6

million to avoid a drag on future earnings . In accordance with proper accounting standards, th e

SEC forced AOL to write-off the acquisition over a period of six years . The next business day

after the SEC decision, then-Chairman of the SEC, Arthur Levitt, stated publicly his concern s

with "earnings management ." As reported by A e Washington Post on October 5, 1998, Levitt

referred to the "gray area where the accounting is being perverted" and earnings reports tha t

"reflect the desire of management rather than the underlying financial performance of th e

company." According to The Washington Post article, Levitt also said, in a not-so-veile d

reference to AOL, that these accounting improprieties are not limited to small companies, bu t

also occur "in companies whose products we know and admire."

86. The SEC separately investigated other AOL accounting practices that took place

during fiscal years 1995-1997 . This SEC investigation involved the Company's improper

48194 38

allocation of hundreds of millions of dollars of costs associated with obtaining new subscribers

over a period of years rather than accounting for the costs as they were incurred. This improper

accounting had the effect of inflating AOL's earnings for fiscal years 1995, 1996 and 1997 . If

AOL had properly accounted for the expenses , it would have posted losses rather than profits in

each of the years.

87. Based on its investigation , on May 15, 2000 , the SEC ordered AOL to "Cease and

Desist" from further viola tions of the securi ties laws and required AOL to comply with

accounting rules in the future. As part of the SEC's action, AOL also paid a $3 .5 million fine

and restated its prior financial results for the repo rting periods in'ques tion, again converting

alleged profits to losses . AOL agreed to abide by the SEC Order, including compliance with the

securities laws and app licable accounting standards .

88. When the SEC disclosed the issuance of its Cease and Desist Order and $3 .5

million fine against AOL in May 2000, then-SEC Enforcement Chief, Richard H . Walker,

publicly stated that "[t]his case underscores the importance we attach to financial reporting and

should serve as a warning to others not to stretch the rules through aggressive accounting."

89. Notwithstanding the SEC actions in 1997, 1998 and 2000, as well as AOL' s

agreement to abide by accounting rules and cease and desist from securities violations in the

future, Defendant Steve Case's promise on behalf of AOL to adopt "new gold-standard

accounting practices", SEC Chairman Levitt' s comments regarding "perverted" accounting and

other SEC warnings regarding improper accounting prac tices , as detailed herein , AOL and AOL

Time Warner, and the Individual Defendants , with the blessing of the Company's auditor,

Defendant Ernst and Young, con tinued during the Class Period to violate the securi ties laws by

repor ting artificially inflated advertising revenue through the use of sham transactions and

48184 39

improper accounting practices . This was done in order to make sure the Merger went through

and to increase the value of the companies' securities for their own short-term personal financia l

benefit with respect to their holdings of the companies' securities and options, salaries, bonuses ,

etc .

E. Fraudulent Transac tions and Improper Accounting Used to Artificially Inflate AOLand AOL Time Warner Advertising Revenue

90. At all relevant times during the Class Period , AOL and AOL Time Warner

represented that their financial statements were prepared in conformity with GAAP, the uniform

rules, conventions and procedures that define accepted -accounting practice . As set forth in

Statement of Financial Accounting Concepts ("SFAC") No . 1, Objectives of Financial Reporting

by Business Enterprises, one of the fundamental objectives of financial reporting is that it

provide accurate and reliable information concerning an entity's financial performance during

the period being presented . SFAC No . 1, 1 42 states :

Financial reporting should provide information about an enterprise's financialperformance during a period . Investors and creditors often use information aboutthe past to help in assessing the prospects of an enterprise . Thus, althoughinvestment and credit decisions reflect investors' and creditors' expectationsabout future enterprise performance, those expectations are commonly based atleast partly on evaluations of past enterprise performance .

91 . GAAP is recognized and used by the accounting profession in order to define

acceptable accounting practices. Both annua l and interim Ce.g_, quarterly) financial statements

must be prepared in accordance with GAAP. The same GAAP applies to interim financial

statements that apply to annual financial statements . The SEC has also endorsed GAAP in

Regulation S-X, 17 C .F.R. § 210.401(a)(l), which provides that financial statements filed both

annually and quarterly with the SEC must comply with GAAP, except quarterly statements are

48184 40

not required to have the same level of footnote disclosure. If the filings do not comply with

GAAP, they are presumed to be misleading and inaccurate, despite footnote or other disclosure.

92. GAAP is comprised of a hierarchy of authoritative literature. The highest

authority is comp rised of FASB ("Financial Accoun ting Standards Board"} Statements of

Financial Accounting Standards ("SFAS"}, FASB Interpretations ("FIN"), APB Opinions

("APB'), and AICPA Accounting Research Bulletins {"ARB"). GAAP provides other

authoritative pronouncements including, among others , AICPA Statements of Position ("SOP"),

Consensus Positions of the FASB Emerging Issues Task Force ("ErTF T), and the FASB Concep t

Statements {"CON"}

93. Circumstances may require that analogies be drawn. AICPA Auditing Standards

{"AU") Section 411 .09 states, "Because of developments such as new legisla tion or the evolution

of a new type of business transaction, there sometimes are no established accounting principle s

for reporting a specific transaction or event. In those instances, it might be possible to report the

event or transaction on the basis of its substance by selecting an accounting principle tha t

appears appropriate when applied in a manner similar to the application of an establishe d

principle to an analogous transaction or event ."

94. AU Section 625 .08 also provides that to aid in forming a judgment , the reporting

accountant should perform the following procedures : (a) obtain an understanding ofthe form and

substance of the transaction (s); (b) review applicable GAAP ; (c) if appropriate, consult with

other professionals or experts ; and (d) if appropriate, perform research or other procedures to

ascertain and consider the existence of creditable precedent or analogies .

48184 41

95. The responsibility for preparing financial statements that conform to GAAP rest s

with corporate management, as set forth in AU Section 110 .03 of the AICPA Professional

Standards :

The financial statements are management 's responsibility . . . . Management isresponsible for ado tin sound accounting policies and for establishing andmaintaining internal control, that will, among other things initiate , record, process,and report transactions (as well as events and condi tions) consistent withmanagement's asser tions embodied in the financial statements . The entity'stransactions and the related assets , liabilities, and equity are within the directknowledge and control of management . . . . Thus, the fair presentation offinancial statements in conformity with [GAAP] is an implicit and integral part ofmanagement's responsibility.

(Emphasis added.)

96. Throughout the course of the quarterly and annual financial reporting during th e

Class Period , AOL, the Company and the Individual AOL and AOL Time Warner Defendants,

materially overstated AOL's and AOL Time Warner' s advertising revenue through sham

transactions and improper accounting. Consequently, the financial statements were false an d

misleading and constituted an extreme departure from GAAP, by violating the following GAAP

concepts and principles, among the many other principles identified herein :

a . APB 29 . The principle that nonmonetary transactions should be

accounted for based on the fair value of the assets (or services) involved which is the same basi s

as that used in monetary transactions . As more fully discussed below, AOL and AOL Time

Warner violated this accounting principle repeatedly when reporting round-trip/barte r

transactions, including deals with Homestore, Inc ., Sun Microsystems, Inc ., Veritas Software

Corporation , Bertelsmann AG, WorldCom, Inc ., Qwest Communications, Hughes Elec tronics

Corporation, Gateway, Inc ., PurchasePro, Monster .com, and Oxygen Media Inc .

48184 42

b . EITF 99-17. The principle that exchanges of advertising services between

two companies should be accounted for at fair value only if the fair value is determinable base d

on the entity's own historical practice of receiving cash or cash equivalents for similar

advertising from buyers unrelated to the counter-party in the exchange. If the fair value is no t

determinable within stated limits, "the transaction should be recorded at the carrying amount o f

the advertising, which likely will be zero ." AOL and AOL Time Warner violated these

accounting requirements by overstating revenue in advertising "swaps" when there was no

ultimate realization in cash, including deals with Homestore, Inc., PurchasePro and Monster.com.

c. EITF 99-19. The principle that revenue should be recognized in ne t

amounts, rather than gross, when acting as an agent and not as principal . In circumstances where

a company does not have the risks and rewards of a p rincipal , earns a fixed amount or percentage ,

and does not have credit risk, the company is an agent and should not recognize revenue in a

gross amount . AOL and AOL Time Warner violated this requirement in connection with at leas t

an arrangement with eBay when they improperly recognized revenue for advertising, placed a s

an agent, at gross rather than at the net amount of the commission actually earned .

d . CON 2 1 63 . The concept of "representational faithfulness ," which i s

defined as the "correspondence or agreement between a measure or description and th e

phenomenon it purports to represent . In accounting, the phenomena to be represented ar e

economic resources and obligations and the transactions and events that change those resource s

and obligations ." AOL and AOL Time Warner repeatedly violated this GAAP requirement i n

connection with all of the deals discussed herein .

C. CON 6 ¶ 79 and 82 . The concept that in order for revenue to be

classified as revenue (versus gains), the company must deliver or produce goods, render service s

48184 43

or perform other activities that constitute its ongoing major operations . Gains are defined a s

other events or circumstances which result from peripheral or incidental transactions to the

company. AOL and AOL Time Warner violated this requirement when, for example, the y

characterized as advertising revenue cash inflows that were from sham or round-trip transaction s

(kickbacks) and from real transactions such as li tigation settlements, deal terminations and the

modifications of terms of equity deals. As more fully discussed below, Defendants violated thi s

standard with respect to several transactions, including those with Homestore, Inc ., Bertelsmann

AG, Gateway Inc ., 24dogs.com, Ticketmaster, Dr .Koop.com, and PurchasePro .

f CON 5' 83 . The concept that in order to recognize revenue, it must b e

earned, realizable or realized . In order to consider revenue to be earned, the company must hav e

"substantially accomplished what it must do to be entitled to the benefits represented by th e

revenues." In order for revenue to be considered realizable or realized, "products (goods o r

services), merchandise or other assets are exchanged for cash or claims to cash ." AOL and AOL

Time Warner violated this requirement , for instance, when it recognized revenue by

"jackpotting" (not earned ) in deals with Telefonica and others and when it double -booked

revenue (not realizable) in a deal with Oxygen Media Inc., in addition to deals with Homestore ,

Inc., Gateway Inc., Dr.Koop.com, and PurchasePro.

g . SFAS 123; EITF 00.08 ; APB 29 . The principle that companies which sel l

goods and services in exchange for equity instruments issued by the purchaser should measure

the transaction at the fair value of the consideration received (given) or the fair value of th e

equity instruments issued , whichever is a more reliable measure. AOL and AOL Time Warner

violated this principle when they failed to report transactions based on the fair value of the equity

received (and held solely by AOL) by failing to adjust the amount of equity issued b y

48184 44

appropriate time value and marketability discounts . As more fully discussed below, thes e

standards were violated with respect to several deals, including transactions with Homestore, Inc. ,

Hughes Electronics Corporation, Gateway, Inc ., PurchasePro.com and Oxygen Media Inc .

h . EITF 00.08; CON 2163 . The principle that changes in fair value of th e

equity instruments received in exchange for goods or services may be recognized as additional

revenue from the transaction, if, on the measurement date, the quantity or terms of the'equity are

dependent on the achievement of the counterparty's performance and changes in fair value result

from an adjustment to the instrument upon achievement of a performance condition. AOL and

AOL Time Warner improperly repo rted advertising revenue when, for instance, customers like

PurchasePro adjusted the fair value of equity granted AOL through pricing changes even though

AOL was not entitled to such an adjustment under the terms of the o riginal agreement and no

further performance objectives were achieved .

APB 16,188. The principle that in an acquisition, the acquiring company

record receivables of the acquired company at present values of amounts to be received

determined at appropriate current interest rates, less allowances for uncollectibility and coll ection

costs, if necessary (fair value). AOL violated this principle in accounting for the 24dogs.com

deal when it failed to report litigation settlement proceeds owed to an acquired company as the

satisfaction of a purchased receivable and instead reported the proceeds as advertising revenue.

SOP 97.2, % 14. The principle that if an arrangement includes Multiple-

elements, the revenue should be allocated to the various elements based on evidence of fair value ,

regardless of any separate prices stated within the contract for each element. AOL and AOL

Time Warner violated this principle repeatedly when it improperly attributed revenue from cabl e

deals to its online division in transactions with Qwest Communications, Golf Channel, and

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Oxygen Media Inc., and, in the case of Oxygen Media Inc., double-booked the same revenue in

more than one division .

k . CON 1 1 34. The concept that financial reporting should provid e

information that is useful to present and potential investors, creditors and other users in making

rational investment, credit and similar decisions . AOL and AOL Time Warner violated this

requirement in connection with all the transactions discussed herein when it overstated

advertising revenue in its financial statements .

1 . CON 1 140. The concept that financial reporting should provide

information about the economic resources of an enterprise, the claims to those resources, and

matters that change such resources . AOL and AOL Time Warner repeatedly violated this

requirement by overstating the value of several of its various round-trip, barter and other

transactions .

m. CON 1 ¶ 42 . The concept that financial reporting should provid e

information about an enterprise 's financial performance during a time period . This information

is often used by investors and creditors in order to assess the prospects of the company . AOL

and AOL Time Warner repeatedly violated this requirement when they overstated thei r

advertising revenue.

n. CON 1 1 50. The concept that financial reporting should provide

information about how management of an enterprise has discharged its stewardshi p

responsibi lity to owners (stockholders) for the use of enterprise resources entrusted to it . AOL

and AOL Time Warner violated this requirement numerous times when it overstated advertisin g

revenue.

48184 46

o . CON 2 Z 58-59. The concept that financial reporting should be reliable

and relevant so that it represents what it purpo rts to represent. AOL and AOL Time Warner

violated this requirement as to at least each of the transactions discussed herein .

p . CON 2 1 79. The concept that financial reporting should be complete, in

other words, nothing material is left out of the information that may be necessary to insure that i t

validly represents underlying events and condi tions . AOL and AOL Time Warner violated this

requirement as to at least all of the transactions discussed herein, because they failed to report th e

underlying substance of the transactions.

q . CON 2% 95, 97 . The concept that financial reports should be

conservative. Preparers must adequately consider uncertainties and risks inherent in busines s

situations, reflect those issues in reports and insure that what is reported represents what it

purports to represent . AOL and AOL Time Warner violated this requirement as to each deal

when they overstated advertising revenue .

97. AOL and AOL Time Warner improperly recognized revenue in violation o f

GAAP during the Class Period as a result of multiple schemes which were specifically designe d

to and did artificially inflate advertising revenue. Certain of these advertising deals incorporated

mul tiple approaches utilized by AOL and AOL Time Warner to artificially manufacture

advertising revenue. However, these schemes are each best described by one of the followin g

approaches conceived and commonly used by AOL and AOL Time Warner :

] . Use of Sham Transactions and Improper Accounting Practices RegardingRound-Tripping. Back-to-Back, and Boomerang Deals

98. One of AOL and AOL Time Warner's more crea tive ways of inflating advertising

revenue was through the use of sham transactions and/or improper accounting in connection with

"round-trip," "back to back" or "boomerang" deals . These deals involved , in some instances ,

48184 47

the participation of multiple parties in elaborate advertising revenue schemes relating to AOL' s

purchase of goods, services, equity or some combination thereof from another party with th e

requirement of a reciprocal purchase of AOL' s advertising services . These circular " trades" or

"swaps", as accounted for by AOL and AOL Time Warner, frequently gave the appearance that

AOL or AOL Time Warner had entered highly profitable multi-year, multi-million dollar deals

to sell advertising . Rather, AOL or the Company had really funneled , or "round-tripped," the

entire value of the revenue it received from these sales directly back to the original customer

through simultaneous purchases of advertising, goods, services, or equity, resulting in no ne t

gain to AOL or AOL Time Warner .

99. In May 2001 , the SEC 's former Chief Accountant, Lynn Turner, expressed the

SEC's concern over such inherently fraudulent transactions when it appears that a company ". . .

has taken $1 million out of its left pocket only to receive that $1 million back in its right pocket ,

and wants to record the $1 million in revenue . . . .The staff questions how these types of `round-

trip' arrangements result in revenue , and whether, in substance, they are sham transac tions

engineered solely to inflate the revenue line in the income statement ."

2. Barter Transactions

100. Barter, a common practice of AOL and AOL Time Warner during the Clas s

Period, was one mechanism through which AOL conducted round-trip deals . Barter transactions

were often used by AOL and AOL Time Warner to lend an appearance of legitimacy to those

transactions . As described below, many of the improper transactions included aspects of bot h

round tripping and barter . However, barter deals involve an even greater ability to manipulate

the amount of advertising revenue ultimately reported .

48184 48

101 . The SEC has expressed great concern over the use of barter transactions to inflate

revenue. For example, on December 7, 1999, then-SEC Director of Enforcements, Richard

Walker, in a speech entitled `Behind the Numbers of the SEC's Recent Financial Fraud Cases "

given to the American Ins titute of Certified Public Accountants ("AICPA"), stated :

[C]ompanies are also using novel and creative methods to cook the books . Forexample, we are beginning to see an increase in the use of "barter" transactions,especially among high-technology companies, where the assets received inexchange for goods and services provided are greatly overvalued . We brought 4barter cases last year.

(Emphasis added .)

102. Similarly, on December 8, 1999, Jane B. Adams, Deputy ChiefAccountant of the

SEC, also spoke to the AICPA and stated :

With the emergence of Internet companies as a significant part of the economyand for which investment decisions have been based on revenues rather thanearnings, income statement classification and presentation has become a criticalarea. The staff is seeing a number of accounting issues for which the underlyingobjective seerns to be the grossing pp of the income statement. . . . Bartertransactions also are pretty hot . For example, two Internet companies agree toprovide banner advertisements on each other's websites, and record thearrangements as revenue and marketing expense .

The sign ficant pressure to report larger revenues raises questions as to the qualityof the information being provided . In the case of barter advertising, how has thevalue transferred or received been established? What evidence supported thatamount? Was the amount recorded in the financial statements based on reliableand verifiable valuations? Did it meet a reality check that that amount could havebeen realized in a cash transaction?

(Emphasis added.)

103. In the case of AOL and AOL Time Warner, barter deals used to overstat e

advertising revenue took at least three forms:

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a. Exchange of Advertising for Goods and/or Service s

104. AOL and AOL Time Warner regularly bartered advertising for a variety of goods

or services such as computers, telecommunication services and network devices . According to a

former Vice President for Business Development , AOL would typically target companies for

barter deals who sold equipment or services to AOL, and particularly companies selling network

devices, telecommunications services or computer equipment. These exchanges often were

consummated at the end of a fiscal quarter to meet analysts ' expectations . An August 26, 2002

Wall Street Journal article discussing AOL's prac tice of "squeezing" its suppliers for advertisin g

revenue quoted Defendant Pittman : "If we're one of their big customers, we expect them to b e

one of our big customers " AOL's and AOL Time Warner' s accounting for these types of barter

transactions often led to the artificial inflation of advertising revenues .

105 . Accounting for revenues and profits resulting from non-monetary transactions ,

including barter, has always been highly regulated and scrutinized by the accounting professio n

and government through the FASB and SEC, respectively. The Emerging Issues Task Force has

also issued several consensus positions on revenue recognition matters . The accounting

principles applicable to corporate ba rter transactions are derived from APB 29 . APB 29,

"Accounting for Non-Monetary Transactions," became effective for transactions occurring after

September 30, 1973 .

106. APB 29, in effect, provides that non-cash transactions, which include barter

transactions, be recorded at the fair value of the assets (or services) given up or received ,

whichever is more clearly evident . APB 29, 1 25 states that "fair value of a non-monetary asse t

transferred to or from an enterprise in a non-monetary transaction should be determined b y

referring to estimated realizable values in cash transactions of the same or similar assets, quote d

48194 50

market prices, independent appraisals, estimated fair values of assets or services received in

exchange, and other available evidence . If one of the parties in a non-monetary transaction coul d

have elected to receive cash instead of the non-monetary asset, the amount of cash that coul d

have been received may be evidence of the fair value of the non-monetary assets exchanged . "

Recording barter transactions based on the "full" or "list" price of assets received, violates AP B

29 if not adjusted for any discount that would normally be received .

107. In December of 1999, the SEC reiterated existing GAAP with the issuance of

Staff Accounting Bulletin 101,17 C.F.R. § 211 ("SAB 101"}, which summarized the proper

recognition, presentation, and disclosure of revenues in financial statements . Pursuant to SAB

101, revenues may not be recognized until they are "realized or realizable and earned ." In order

for revenues to be considered "realized or realizable and earned ," they must meet a ll of the

following criteria: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred o r

services have been rendered, (iii) the seller's price to the buyer is fixed or determinable, and (iv )

collectibility is reasonably assured . As the SEC stated , SAB 101 "is not intended to change

current guidance in the accounting literature ." For example, before recognizing advertising

revenue from a barter transaction a company must complete the "earnings process" by providing

services valued at the amount reported in the transaction .

108. In addition to being "earned ," revenues must not be self-generated . In this regard,

the characterization of the transactions must demonstrate "representational faithfulness" and not

subordinate the substance of the agreement to its form. CON 21160. In the case of a barter

transaction, this means both parties to the barter have purchased services, products or equity, a t

arms-length for reasons other than to artificially in flate revenue for one or both of the parties . A

48184 51

company selling advertising as part of a legitimate barter transaction can then only recogniz e

advertising revenue in accordance with the requirements of APB 29 .

109. Further, "revenues" are earned through transactions which involve or reflect the

major ongoing operations and services of the entity. CON 6 ¶ 79 ; CON 5 ¶ 83 . By contrast,

"gains" are recognized when obtained through an entity 's peripheral or incidental transac tions

not arising from the core operations of the entity. CON 6 ¶ 82 .

110. The SEC has also expressed concern over both round-trip and complex barter

transactions in which revenues are generated only as a result of the counterparty's agreement to

reciprocate; i .e., but for the counterparty's agreement to pay for advertising services, the

company would not have purchased goods, services or equity from the counterparty . In such

instances both parties must report the net, rather than gross, value of revenue derived from th e

transaction .

111 . In this regard, former SEC Chief Accountant Lynn Turner, in a speech on May 18 ,

2001, stated: "When an entity would not have entered into one of the separate contracts withou t

all the contracts being negotiated and agreed to as a `package', it will often be difficult t o

identify a separable benefit being received and to establish reliable and verifiable fair values fo r

each element of the arrangement. In those instances, the facts and circumstances will ofte n

dictate that the cash inflows and outflows be reported as a net revenue or cost amount, in th e

appropriate periods ."

b. Warrants or Stock (equity) Received in Barter or Partial BarterTransactions

112. AOL and AOL Time Warner also regularly bartered advertising for warrants or

stock as one component of complex deals entered into with other companies . In several deals ,

AOL and AOL Time Warner entered into such deals under the guise of making an investment ,

48184 52

yet required the counter-party to recycle the funds by purchasing advertisements . The companies

would then report advertising revenue without using the underlying investment (the equity) as a

basis for valuing the advertising revenue, resulting in revenue overstatements .

113. On March 16-18 , 2000, the Emerging Issues Task Force of FASB reached

consensus (thereby making it a GAAP requirement) on the issues surrounding exchange o f

equity for services in accordance with APB 29 . In so doing, the Task Force issued EITF Issu e

No. 00-8, entitled "Accounting by a Grantee for an Equity instrument to be Received i n

Conjunction with providing Goods or Services ."

114. Pursuant to EITF 00-8, 1 4 and APB 29, in transactions where a company receive s

equity (e.g., warrants or stock) as consideration or partial consideration for the services rendered

by the company, "the grantee should measure the fair value of the equity instruments using th e

stock price and other measurement assumptions" on the earlier of the date that a mutua l

understanding of the terms are established and a commitment to performance is reached or th e

date the grantee's performance is complete .

115. In addition, EITF 00-8, ¶ 10, requires that "companies should disclose, in eac h

period's financial statements, the amount of gross operating revenue recognized as a result of

non-monetary transactions addressed by Issue 00-8" (those involving equity received i n

conjunction with providing goods or services) . EITF 00-8, ¶ 10 goes on to state: "Furthermore,

the SEC Observer reminded registrants of the requirement under Item 303(a)(3)(ii) of Regulatio n

S-K to discuss known trends or uncertainties that have had or that a registrant reasonably expect s

to have a materially favorable or unfavorable impact on revenues . "

48184 53

c. Exchange of Advertising - "In Kind" Advertisin g

116. A typical barter transaction between internet companies involves trading

advertising space and then assigning a value to both revenue and expense . No cash is exchanged

between the parties .

117. AOL also improperly inflated its adver tising revenue by reporting revenues o n

such "in kind" advertising whereby AOL would provide customers with advertising on its

website and in return receive certain advertising services which usually consisted of rights to

advertise "America Online Keyword :j I" on a customer 's product.

118. According to a former Company account manager , AOL and AOL Time Warner

often made barter deals with their strategic partners towards the end of fiscal quarters involving

the exchange of banner advertisements which effectively served as the principal currency for

such deals . The deals involved a swap of banners on each others' sites . Both parties booked the

advertising impressions as revenue . If AOL and Company adverti sing customers complained

about the value of the advertising for which they had origina lly contracted , AOL's and AOL

Time Warner' s response was typically to provide "bonus banners" to the client rather than

renegotiate a contract, a practice known as "make good ." According to this source, such "banner

swaps" also occurred between AOL Time Warner divisions following the Merger and the AO L

online division frequently posted "family banners" for Time Warner channels, such as Turner

Broadcasting, and booked the advertisements as revenue for AOL .

119. In early 2000, FASB stated, with respect to barter : "To the extent that revenues

include barter transactions for which there is no ultimate realization in cash and no overall effec t

on net income, the practice may lead to overstated revenues and artificially inflated market

capitalization ." (EITF 99-17, T 2) . The FASB went on to rule that companies could book a

48184 54

barter advertisement as revenue only if they could compare it with a similar transaction wit h

another company in which cash was exchanged within the previous six months . AOL and AOL

Time Warner failed to comply with FASB requirements and in fact utilized improper accounting

for "in-kind" barter transactions to overstate advertising revenue .

120. Accounting for "in kind" advertising transactions is governed by EITF Issue No .

99-17, "Accounting for Advertising Barter Transactions" and APB 29 . EITF 99-17 becam e

effective for transactions entered into after January 20, 2000.

121 . The necessity for EITF 99-17 is stated in the text of the rule:

It has become increasingly popular for Internet companies to enter intotransactions in which they exchange rights to place advertisements on eachothers' web sites. In some of these transactions, no cash is exchanged betweenthe parties . In other transactions, similar amounts of cash are exchanged betweenthe two parties .

122. EITF 99- 17, 14 states :

The Task Force reached a consensus that revenue and expense should berecognized at fair value from an advertising barter transaction only if the fairvalue of the advertising surrendered in the transaction is determinable based onthe entity's own historical practice of receiving cash, marketable securities, orother consideration that is readily conver tible to a known amount of cash forsimilar advertising from buyers unrelated to the counterparty in the bartertransaction . An exchange between the parties to a barter transaction of offsettingmonetary consideration, such as a swap of checks for equal amounts, does notevidence the fair value of the transaction . If the fair value of the advertisinsurrendered in the barter transaction is not determinable within the limits of thisIssue, the barter transaction should be recorded based on the carrying amount ofthe advertising surrendered, which likely will be zero .

(Emphasis added .) This historical practice must be for a similar transaction in the six months

p rior to the transaction in question , pursuant to the provisions of the EITF .

123. Examples of AOL and AOL Time Warner round - t rip and barter deals that were

improperly accounted for by AOL and AOL Time Warner include the following:

48194 55

(1) Homes tore Inc.

124. Sixteen separate sham transactions with Homestore , Inc. ("Homestore") and AOL

and then AOL Time Warner occurred in the latter part of 2000 and the first half of 2001 .

Although these Homestore deals are just some of the transactions devised by AOL or AOL Time

Warner to artificially inflate revenue, much is known about these deals because of an ongoing

criminal investigation into the Homestore matter that has already resulted in publicly disclosed

guilty pleas to criminal offenses by four Homestore executives .

125. The concept for the sham Homestore transactions was devised by Defendant E ric

Keller, and approved by at least the person at AOL Time Warner to whom he directly reported,

Defendant David M . Colburn. The sham deals were designed to work to the mutual benefit o f

Homestore and AOL Time Warner so that they could both report bogus advertising revenue . As

discussed below, AOL Time Warner had a significant equity interest in Homestore, 3 .9 million

shares of Homestore stock, and therefore the Company benefited from the sham deals when both

it, and Homestore reported artificially inflated advertising revenue .

126. The Homestore deals involved "three legs" . In the first leg Homestore paid a

third-party for services and products that Homestore did not need , and for which it in fact,

overpaid . The secret second leg required the third parties to purchase advertising from AOL

Time Warner with most or all of the money Homestore paid to the third parties . Under the third

leg, AOL Time Warner purchased advertising from Homestore in the same amount that the third-

par ty paid to AOL Time Warner for advertising. Accordingly, AOL Time Wa rner and

Homestore secretly round tripped or purchased advertising revenue from themselves in sham

triangular transactions .

48184 56

127. As part of these sixteen fraudulent transactions, in 2001 the third pa rties paid

AOL a total of $45 . 1 mi ll ion for advertising, with the agreement that AOL would funnel the

monies back to Homestore, after deducting an approximate $9 million "commission ."

128. Homestore executives, and Keller and Colburn, agreed that the secret leg of th e

sham transactions would not be documented . The secret third parties included PurcbasePro, Inc . ,

Investor Plus, FX Consultants, Classmates .com, Wizshop, and Easy Roomates .

129. In May 2001, Keller worked with Homestore's top dealmaker, Peter Tafeen, to

avoid detection by Homestore 's auditing firm of the sham transactions that were to take place in

the second quarter of 2001 . However, in June 2001, Keller was placed on administrative leave

by AOL Time Warner.

130. At that time, in June 2001, Defendant Joseph Ripp, then the Executive Vic e

President and Chief Financial Officer of AOL, who became AOL's Vice-Chairman on

September 13, 2002 , and Defendant Steven Rindner , AOL's Senior Vice President for Business

Affairs and Development, handled the sham deals for AOL .

131 . Initially, Ripp and Rindner raised questions regarding documentation of the third-

party leg of the deal . During mid-to late June 2001, by phone and e-mail, Ripp and Rindner told

Homestore that they had concerns about the collectiblilty of money from the third parties . In

response, Homestore went to great lengths to resolve the collectibility issues, including

accelerating payments to the third par ties so that AOL received its money during the second

quarter of 2001 .

132. On June 29, 2001, the last business day of the second quarter, AOL told

Homestore that it had not received confirming letters from some of the third parties regardin g

48184 57

their purchase of advertising from AOL . Ripp and Rindner also said that Homestore could no t

be paid unless the confirming letters were received .

133. After the final confirming letters were subsequently received later on June 29,

2001, Homestore 's Chief Executive Officer, Stuart Wolff, caused a phone call to be placed to

Colbum who was not available. A message was left to have Colburn call Wolff. Instead, late in

the evening of June 29, 2001, Ripp returned the call to Wolff. Wolff and several Homestore

executives and Ripp and Rindner participated on the call . Wolff told Ripp and Rindner that

Keller had agreed to the deal long ago . Wolff threatened litigation . Ripp and Rindner said tha t

Keller was gone, but never denied that Keller agreed to the deal or that Keller did not have th e

authority to make the deal on AOL Time Warner' s behalf. Wolff suggested that they should get

Keller on the phone, but Ripp and Rindner declined the offer . Another Homestore executive said

he confirmed that money had already been paid to certain of the third-party vendors and AO L

had received the payments for the advertising .

134. That evening after the call, the Company sent to Homestore its confirmation o f

the deal .

135. The Company, and at least Ripp, Rindner, Colburn and Keller, were all aware of

the round-trip and fraudulent nature of the deals . Indeed, Keller and Colbum concocted th e

scheme and Ripp and Rindner clearly knew of the details of the deals, including where th e

money AOL Time Warner received was actually coming from and that it was round -tripped back

to Homestore . Ripp and Rindner, however, covered up the sham deals to allow the Company t o

inflate advertising revenue and avoid adverse publicity for both AOL Time Warner and

Homestore, in which the Company had a significant equity interest .

48184 58

136. The fraudulent Homestore transactions have been confirmed by the guilty pleas t o

criminal offenses of four Homestore executives in an ongoing DOJ investigation into th e

Homestore matter. Although the criminal charges and guilty pleas do not identify AOL Time

Warner by name, they refer to the company that engaged in these transactions with Homestore as

a "major media company." Furthermore, these documents describe the same three-legged

transactions referred to above and refer to the total of sixteen transactions and receipt by th e

"major media comp any" of $45 .1 million in 2001 for advertising as pa rt of these sham

transactions .

137. Numerous press reports have identified the Company, and its executives ,

including Colburn and Keller, as targets of the DOJ investigation. In addition, Colburn, Keller

and AOL Time Warner were named as defendants in a securities class action brought by

Homestore shareholders in the United States Court for the Central District of Californi a

regarding the sham transactions . On March 7, 2003, the Honorable United States District Judge

Marsha J . Pechman, issued an Order Regarding Motions to Dismiss . In re Hornestore .com, Inc .

Securi ties Litigation, No. COI-11 115 MJP, 2003 WL 1227643 (C .D. Cal . March 7, 2003) . In her

Order, Judge Pechman recounted in substantially similar fashion the Homestore allegations set

forth herein , and the sham three- legged transactions involving the Company , Homestore, and the

third parties . The court reluctantly dismissed the Company, Colburn, Keller and the third parties

because it concluded that no "aiding and abetting" liability of AOL as to Homestore shareholders

existed under the securities laws . However, the court stated :

While this Court feels compelled to arrive at this result, it does so withreservation . The acts alleged in the [Complaint], which this Court must accept astrue for purposes of this motion, describe a massive conspiracy driven byyureavarice. In particular. the detailed factual allegations describing the role of AOLand its agents in helping Homestore please Wall Street and in boostin its ownrevenues through bogus commissions give this Court great pause .

45184 59

This decision does not mean that the wrongs of these aiders and abettors w illnecessarily go unchecked ; the PSLRA expressly granted the SEC the authority tobring civil actions against alders and abettors of securities fraud, and it is thisCourt's understanding that some investigation is ongoing .

Id. at *24. (Emphasis added . )

138. On March 12, 2003, The Washington Post reported that the federal investigation

of AOL Time Warner had, indeed, been broadened to include the "aiding and abetting" of others

by the Company, Colburn and Keller, both before and after the Merger.

139. The Company improperly reported advertising revenue from these phony deals .

The transactions were shams agreed to with Homestore in order to repo rt advertising revenue

that nei ther party "earned" as required by SFAC No . 5 ¶ 83 . In addition, the fraudulent

transactions were not "representa tionally faithful" as required by SFAC No. 2 163 . Thus, even

if the Company only reported its bogus $9 million "commission" as advertising revenue, and

prorated it over the first two quarters of 2001, the Company's advertising revenue was overstated

by $4.5 mil lion for each of the quarters ended March 31, 2001 and June 30, 2001 . Of course, if

the Company repo rted the entire $45.1 million as advertising revenue , the overstated amount is

even larger.

(i) Sun Microsystems, Inc .

140. Ina barter transac tion with Sun Microsystems, Inc. ("Sun"}, AOL overpaid for

goods at list price when normally it would receive a discount, thereby overstating the

consideration exchanged for AOL' s services in violation of APB 29. This transaction continued

for three years and ultimately resulted in approximately $150 million of overstated advertising

revenue over the course of the deal .

48184 60

141 . The Sun transaction was announced on November 24, 1998 and involved the

swap of advertisements for computer equipment . A September 1, 2002, a New York Times

article entitled, "Ouster at AOL, but Where Does Trail End? ," repo rted that AOL agreed to buy

$500 mi ll ion in computer equipment from Sun at list price , even though companies like AOL

typically buy at a discount of more than 30 percent . For its part, Sun agreed to pay AOL $35 0

million for advertising services . A contemporaneous agreement provided for Sun to pay AOL

more than $310 million per year as part of a three-year partnership called "Iplanet " AOL treated

these payments from Sun as recurring revenue. Through this partnership, AOL was in effect

receiving back some of its own expenditures in order to artificially increase its own advertisin g

revenue and overstate income as a result . Furthermore, AOL and Sun would not have entered

into the transaction without the reciprocal purch ases . Accordingly, under APB 29 revenue

resulting from the deal should have been reported net of the overpayment rather than on a gros s

basis .

142. A former AOL Chief Technology Officer, Product Manager and Senior Busines s

Manager confirmed AOL's improper barter deal with Sun . According to this source, th e

announcement reporting the deal, which was signed by Jay Rappaport, was misleading becaus e

AOL did not realize the amount of revenue it was reporting .

143 . At a minimum, AOL's overpayment for Sun 's computer equipment, based on the

equipment's fair market value, should have been recorded as a reduc tion of AOL 's advertising

revenue resul ting from the round-trip transaction. Instead , AOL recorded the transaction based

on an inflated list purchase price for the computer equipment, resulting in at least a 3 0%, or $150

million, overstatement of advertising revenue . AOL therefore overstated its advertising revenu e

by at least $4.2 million for December 1998 and at least $12 .6 million per quarter starting with th e

48184 61

quarter ended March 31, 1999 through the quarter ended September 31, 2001, and $8.4 million

for the quarter ended December 31, 2001 . AOL's rela tionship with Sun would serve as a

template for numerous other deals in which AOL bartered with other companies, round -t ripping

money and reporting advertising revenue at greatly inflated values, in viola tion of GAAP.

{iii`) Verrtas Software Corporation

144. In a classic case of round-tripping reminiscent of the earlier Sun swap, AOL

negotiated a deal in September, 2000 to pay $50 million dollars for $30 million dollars worth of

software it purchased from Veritas Software Corporation ("Veritas') according to a former

Senior Contract Specialist at AOL . The extra $20 million dollars was then round-tripped back to

AOL in a purported separate deal in which Veritas purchased online advertising from AOL .

145. AOL then overstated its advertising revenue by $20 million in violation of AP B

29. According to the above source, the Veritas deal came about after AOL's Business Affairs

unit raised a "hue and cry" when it heard that AOL's network opera tions unit was planning t o

make a $30 million dollar purchase from Veritas without getting something in return. Veritas

said it did not want to advertise on AOL and was not going to spend any money to do so .

Consequently, Defendant Colburn and a Business Affairs Director, Jeffrey Tyeryar, instructed

the appropriate personnel to raise the contract amount to $50 million dollars and then structure

another deal in which Veritas would spend the extra $20 million dollars it had received for it s

software on AOL advertising . Business Affairs wanted the $20 million from Veritas so that i t

could be booked as revenue before the end of the last quarter of calendar year 2000, the las t

quarter before the Merger. The source described the Veritas deal as being j "kick-back"

arrangement.

48184 62

146. More specifically, according to the above source, AOL's Jeff Tyeryar negotiated

a new dual contract arrangement and Colburn signed off on it for AOL's Business Affairs Unit .

By using two different contracts, it was made to appear that the two transactions were unrelated

and that AOL had received $20 million dollars in adver tising revenue when, in fact, AOL wa s

just getting back the $20 million dollars it had overpaid for the Veritas equipment and software .

Veritas, for its part, agreed to the deal only because it was anxious to book revenue from the

AOL software sale before the end of 2000 . Mike Cahill, a Veritas Vice President, handled the

deal for Veritas .

147. In a Reuters news release dated November 14, 2002, Veritas repo rted that, i n

connection with the SEC's investigation of AOL's accounting, the SEC had subpoenaed Veritas'

records relating to transactions it entered into with AOL in September 2000.

148. On January 17, 2003, Veritas announced that, as a result of the SEC' s

investigation, it was restating its financial results for fiscal years 2000 and 2001, eliminating $2 0

million in revenue previously booked as licensing and support fees paid by AOL. Further, th e

Company announced that it would no longer record as an expense the $20 million it paid AOL

for advertising.

149. Then, on or about March 17, 2003, Veritas disclosed in an amended Form 10-K

filing with the SEC that the restatement resulting from the AOL deal was based on a

determination that the fair value of the goods and services purchased and sold in the deal coul d

not be "reasonably determined." In addition, Veritas disclosed that it was further restating its

financials based on "two additional contemporaneous transactions involving software license s

and the purchase of on-line advertising services" to reflect additional reductions in revenue .

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Veritas' auditor at the time of these transactions, Defendant Ernst & Young, was replaced

following the audit of the Company's year 2000 financial statements .

150. AOL's and AOL Time Warner's improper accounting for the Veritas dea l

resulted in an overstatement of advertising revenue by at least $4 million per quarter from th e

quarter ended December 30, 2000 through the quarter ended December 31, 2001 .

{1V) Bertelsmann AG

151 . Ina round-trip transaction with Bertelsmann AG ("Bertelsmann"), AOL

overstated advertising revenue by nearly $400 million when it bought out Bertelsmann's interes t

in a joint venture. Rather than take advantage of the discount being offered by Bertelsmann. on

the buy-out price if paid in cash, AOL arranged to have Bertelsmann round-trip or rebate tha t

portion of the buy out price which would have constituted the discount amount back to AOL

through the purchase of advertising services . This transaction continued for two years an d

ultimately resulted in AOL overstating advertising revenue by $400 million over the course of

the deal in violation of APB 29.

152. In the first quarter of 1998, Bertelsmann paid AOL $75 million fora 50% interest

in a joint venture to operate the CompuServe European online service . Each company investe d

an additional $25 million in this joint venture. In August 1999, AOL Europe introduced

Netscape Online in England and in May 2000, AOL Europe introduced CompuServe Office in

Germany.

153 . In March 2000, AOL and Bertelsmann announced plans to restructure their AOL

Europe joint venture and to undertake a new strategic alliance . The restructuring consisted of a

put and call arrangement for AOL to purchase, in two installments , Bertelsmann 's 50% interes t

in AOL Europe for consideration approximating $6.7 billion .

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154. According to a March 31, 2003 Wall Street Journal article, "A person familiar

with the situation said that when Bertelsmann initially asked AOL to be paid in cash for its AOL

Europe stake, it had offered a discount on the sale price in exchange. The person said AOL' s

response was that it wasn't interested in a cash discount, but wanted a bigger ad deal .

Bertelsmanm accounted for the advertising as a cost of the sale, the person said ."

155. A March 29, 2003 article entitled, "AOL Says SEC is Challenging it s

Accounting," The New York Times repo rted :

In a filing with the S .E.C. yesterday, AOL Time Warner disclosed that S .E.C.investigators had told the company that they think it improperly reported $400million in revenue from a two-way deal with the German media conglomerateBertelsmann. In 2000, America Online agreed to pay Bertelsmann $6 .7 billionfor its 50 percent stake in AOL Europe. As part of the deal, Bertelsmann agreedto buy $400 million in advertising from AOL, which acquired Time Warner in -January 2001 . The S .E.C. investigators contend, in essence, that the payment wasmore of a rebate on the larger payment than a genuine advertising sale and, thus,should have been deducted from the purchase price .

The article went on to state that "the agreement with Bertelsmann was negotiated at the top

levels of both companies" and also noted that, "current and former Bertelsmann executives" ha d

recently revealed that not only had they questioned the deal, but that they were instructed by

Bertelsmann 's headquarters "to buy online advertising from AOL at inflated prices to fulfill the

purchase commitment made as part of the larger transaction ."

156. The article also pointed to a connection with the sham transactions between AOL

and Homestore :

In a related investigation into accounting at the internet company Homestore, oneof the AOL's division's business partners, some former Homestore executiveshave also told S.E.C . investigators that AOL executives talked about a pool ofadvertising spending from Bertelsmann, people involved in that inves tigationhave said . The former executives of Homestore told investigators that theircounterparts at AOL spoke of possibly allocating Bertelsmann's advertisingspending to Homestore , which in turn paid money to AOL .

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157. Under the requirements of APB 29, AOL was obligated to report the deal at it s

fair market value and any overpayment should have been recorded as a reduction of the revenu e

that was recognized in connection with this deal . Since AOL would have received the discount,

AOL overstated its advertising revenue during the Class Period by $ 16.3 m illion, $65.5 million,

$39.8 million, $0 .5 million, $80 .3 million and $84.4 million per quarter, starting with the quarter

ended March 31, 2001 through the quarter ended June 30, 2002, respectively . The fact that

Bertelsmann recognized the advertising purchase as a cost of the sale provides even further

evidence that the Company improperly reported advertising revenue in connection with th e

Bertelsmann deal .

(y) Gateway Inc. Round-tria/Free Internet Service

158. In yet another round -trip transaction, AOL improperly accounted for the bundling

of its internet services on Gateway Inc .'s ("Gateway") computers, thereby overstating

advertising revenue by $470 million in violation of the directives set forth in APB 29 .

159. In or about late 1999 or early 2000, AOL and Gateway entered into an

arrangement pursuant to which Gateway agreed to promote AOL's internet service to purchasers

of its computers . Each time a Gateway computer purchaser subscribed to the AOL service,

Gateway would receive a fee or "bounty" from AOL. According to an Apri l 2, 2003 Washington

Post article entitled "Gateway to Amend Financial Reports - SEC Had Raised Concerns Over

AOL Deal," at the same time AOL paid a `bounty".. Gateway in turn paid AOL for providing a

free year of internet service on its computers .

160. Since there was no substance to the transaction other than swapping checks, AOL

should have reported the transaction at its zero value instead of improperly reporting the amount s

as sales and corresponding costs of sales . As a result, AOL overstated its advertising revenue b y

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$340 million in 2000 and $130 million in 2001 by recognizing the fees paid by Gateway as

revenue, despite the fact that AOL was cycling the same amount back to Gateway in the form o f

a "bounty" payment.

161 . On or about April 1, 2003, Gateway announced that it was restating previousl y

reported revenue from its agreement with AOL in response to accounting concerns raised by th e

SEC, which had been investigating Gateway's accounting since at least November, 2002. An

April 2, 2003 Washington Post article reporting on the announcement stated :

In 2000 and 2001, Gateway's method of reporting its dealings with AmericaOnline ar tificially boosted revenue because it failed to deduct the payments itmade to AOL from the revenue it received . Because money was moving backand forth between the companies, Gateway said it intends to restate its financialresults by reducing its revenue , a change that will more appropriately reflect thenet amount of cash it received .

The revision is related to how the company accounted for bundled AOL Internetservices, which it previously had reported on a gross basis, Gateway said in astatement. Current management has determined that it is more appropriate topresent such amounts on a net basis .

Gateway said the reduction of revenue on its books from restating deals withAmerica Online would be about $340 million, or 3 .5 percent of revenue, in 2000,and $130 million, or 2.2 percent of revenue, in 2001 .

(Emphasis added .)

162. AOL and AOL Time Warner's improper accounting for the Gateway internet deal

resulted in an overstatement of adver tising revenue, on a prorated basis, by at least $85 millio n

per quarter beginning with the quarter ended March 31, 2000 through the quarter ende d

December 31, 2000, and $130 million for the quarter ended March 31, 2001 .

(n) WorldCom Inc.

163 . Beginning in 1998 , WorldCom Inc. {"WorldCom') and AOL entered into a

"multi-year, multi-million dollar agreement" pursuant to which AOL paid at least $900 million

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dollars a year to WorldCom to carry the bulk of its internet traffic, and AOL became

WorldCom's largest customer. In July 2001, WorldCom and AOL Time Warner struck a

massive round-trip/barter deal in which WorldCom agreed to buy more than $200 million dollars

in advertising across all AOL Time Warner properties in exchange for AOL Time Warner

continuing to keep its network traffic on WorldCom 's network . While not disclosed in the press

releases announcing the deal , AOL Time Warner also agreed to buy internet capacity from

UUNet, a unit of WorldCom, to expand AOL Time Warner's online network . The reciprocal

transactions were used by AOL Time Warner as a vehicle to improperly recognize advertising

revenue of at least tens of mi llions of dollars in viola tion of APB 29.

164. An August 22, 2002 Wall Street Journal article entitled, "Questionable AOL

Revenue Has WorldCom Link," noted the close relationship between the two companies

(Defendant Case held a seat on WorldCom's Board of Directors and AOL was WorldCom' s

largest customer) and pointed out that, according to people familiar with the SEC's investigation

of AOL Time Warner, a substan tial portion of the $49 million of overstated advertising revenu e

initially reported by the Company involved revenue inappropriately booked from the WorldCo m

deal:

The money stemmed from the particularly close relationship America Online andWorldCom developed during the past few years, in which AOL becameWorldCom's biggest customer, paying the telecommunications inn at least $900million a year to carry the bulk of its Internet traffic. Most recently, in July 2001,the two companies struck a massive deal in which WorldCom agreed to buy morethan $200 million in advertising across AOL properties in exchange for AOLcontinuing to keep its network traffic on WorldCom's network .

People close to the situation said the latest deal was negotiated in part by DavidM. Colburn, a top AOL deal maker who was ousted two weeks ago, and ScottSullivan, WorldCom's former chief financial officer, who has been charged withsecurities fraud after the company, now in bankruptcy-court proceedings, found atotal of $7 .2 billion in improper accounting .

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165. In its SEC Form 10-Q for the quarter ended June 30, 2002, AOL Time Warner

revealed that the initial reported overstatement amount of $49 million impacted the quarter ende d

December 31, 2000 through the quarter ended March 31, 2002 . As a result, AOL Time Warner' s

improper accounting for the WorldCom deal resulted in an overstatement of adver tising revenue

by at least $12 .7 million for the quarter ended December 31, 2000, $5 .3 million for each of th e

quarters ended March 31, June 30 and September 30, 2001, $11 .8 million for the quarter ended

December 31, 2001 and $8.5 million for the quarter ended March 31, 2002 .

(vii) Owest Communica tions

166. In or about July, 2001 , AOL Time Warner entered into a reciprocal transaction

with Qwest Communications ("Qwest") . Under the deal, AOL reportedly agreed to use Qwest's

network and to purchase digital subscriber lines and network transport capacity . In return, Qwest

agreed to advertise in the Company's media properties including magazines, television

programming, and online services . In a related round-trip transaction , AOL agreed to buy

network capacity in Europe from KPNQwest, a Qwest affiliate, in return for which Qwest agreed

to purchase AOL advertising.

167. AOL Time Warner violated GAAP by failing to account for the transaction based

on the fair market value of the underlying instruments, either the network services or th e

advertising services, whichever was more reasonably and readily determinable . Thus, the

reciprocal transactions were used by AOL as a vehicle to improperly recognize mil lions of

dollars of advertising revenue in violation of APB 29 .

168. On August 23, 2002, The New York Times reported that another of the three deal s

being examined by AOL Time Warner in connection with the Company 's initial report of $49

million in improperly reported revenue was the swap deal between the Company and Qwest .

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(viii Hughes Electronics Corporation

169. AOL improperly accounted for a June 21, 1999 round -trip/barter transaction

involving AOL 's receipt of restricted stock in Hughes Electronics Corporation {"Hughes") in

exchange for advertising which allowed AOL and AOL Time Warner to overstate adver tising

revenue . By overvaluing the stock received, AOL artificially inflated its advertising revenue by

nearly $50 million per quarter over a 2 'A year period .

170. The June, 1999 transaction expanded upon a preexisting partnership, entered into

on May 11, 1999, by the two companies to develop a combination set-top box that would make

DirecTV and AOL TV available to customers . Under the expanded all iance, AOL invested $1 .5

billion in General Motors {"GM") Series H 6.25% automatically Convertible Preferred Stock .

GM immediately invested the $1 .5 bi ll ion received from AOL in the stock of its subsidiary,

Hughes . In return, Hughes committed to increase its sales and marketing expenditures to AOL

over the next three years by approximately $1 .5 billion dollars .

171 . As included in its June 29 , 1999 SEC Form 8-K, a GM press release regarding the

AOL and Hughes deal stated that "the investment would be non-dilutive to earnings ." Similarly,

a June 21, 1999 Internetnews.com article reported that "AOL said the investment will not have a

negative impact on its earni ngs." AOL made this statement because it knew the invested fund s

were to be round-tripped back to AOL and accounted for by AOL as advertising revenue .

However, the bartered services (advertising revenue) were overstated in violation of GAAP,

particularly APB 29, SFAS 123 and EITF 00 -08, since AOL did not properly value the ba rter

instrument (stock) exchanged for them . More specifically, while AOL entered into the round-

trip/barter deal under the guise of making an investment, the underlying instrument, not th e

money to be exchanged, should have provided the basis for valuation .

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172. Despite the amounts of money swapped (i .e ., $1 .5 billion from AOL for GM

Series H preferred stock in exchange for Hughes' commitment to purchase $1 .5 billion in

advertising from AOL), the underlying round-trip/barter deal was essentially an exchange of GM

Series H preferred stock for AOL advertising services. AOL's recognition of advertising

revenue at the full purported value of the stock violated GAAP . Since the stock was no t

publicly-traded but was a class of stock created only for AOL and was not convertible until June

2002 (three years later), the value of the stock at the time of the transaction was not $1 .5 billion,

and thus the associated AOL advertising services recorded based on that inflated amount over th e

period of the deal was improper. Though the stock tracked Hughes' common stock (GM Serie s

H common stock), the stock's value three years in the future should, at a minimum, have had a

time value and marketability discount applied to it . As a result, applying conservative factors for

time value and a marketability discount, AOL's and AOL Time Warner's advertising revenue

was overstated by at least $16 million for the quarter ended June 30, 1999, $48 million per

quarter beginning in the quarter ended September 30, 1999 through the quarter ended March 31 ,

2000, and $32 million in the quarter ended June 30, 2000.

173. In its Form 10-K for the fiscal year ended December 31, 2001, filed on March 25 ,

2002, the Company reported a charge of "approximately $270 million to reflect an other-than-

temporary decline in the carrying value of AOL Time Warner 's investment in Hughes

Electronics Corp. ("Hughes") , an available-for-sale investment." Three months after the close of

the Class Pe riod, AOL Time Warner acknowledged its material false statements relative to th e

value of its investment in Hughes . In its SEC Form I0-Q for the quarter ended September 30,

2002, filed on November 14, 2002, the Company reported :

Included in the non -cash pretax charges for three and nine month periods endedSeptember 30, 2002 are charges related to the writedown of AOL Time Warner's

48184 71

investment in Hughes Electronics Corp . ("Hughes") of $505 million for both thethree and nine month periods .

174. Finally, in January 2003, AOL Time Warner sold its 8 .4% stake (80 million

shares) in Hughes for approximately $800 million , resulting in a total writedown of $700 million ,

or approximately 47%. According to a Hughes SEC Form 8-K, filed on March 3, 2003, Hughes

and AOL entered into an agreement terminating their entire s trategic alliance. Under th e

termination, Hughes was released from its commitment to spend $1 billion in additional sales,

market, development and promotion efforts to support the companies' joint products and services .

(ix) Homestore - The 2000 House and Home Dea l

175. In May 2000, AOL and Homestore entered into a five-year agreement whereby

AOL artificially inflated advertising revenue by approximately $26.5 million per year by

improperly accounting for the value of stock it received in the deal . As part of the agreement,

Homestore became the exclusive dis tributor of home-buying and moving services across AOL

properties and AOL created the "House and Home" channel on its website . Homestore was the

exclusive content provider for the site. AOL and Homestore also agreed that they would share

revenue generated from the House and Home channel . In return, AOL received 3.9 million

shares of Homestore common stock, at a guaranteed value of $68 .50 per share, and $20 million

in cash .

176. Just prior to the announcement of the AOUHomestore agreement, Homestore' s

stock price was $18 .25 a share, and immediately after the announcement it rose to $22.875 a

share, a 25% increase .

177. As part of the deal, AOL also received a $90 mil lion letter of credit that

Homestore could draw upon up to a $50 million cap if Homestore's stock price did not reach the

guaranteed price.

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178. On May 1, 2000, Business Wire reported on the Homestore/AOL alliance:

America Online, Inc. (NYSE: AOL), the world's leading interactive servicescompany, and Homestore.com, Inc. (Nasdaq: HOMS), the world 's leading homeand real estate network on the Internet, today reached a new five-yearmultifaceted content, e-commerce and dist ribution alliance valued in excess of$200 million , to provide the most comprehensive source of home and real estatecontent to several key AOL brands .

Under the terms of the agreement, America Online, Inc. will receiveapproximately 3 .9 million shares of Homestore.com common stock, whichHomestore.com is required to guarantee meet certain performance targetsthroughout the term of the agreement . As part of the guarantee, Homestore .comwill issue a $90 million letter of credit, which will be drawn upon only ifHomestore.com's common stock does not meet the performance targets . AOLwill also receive $20 million in cash as part of the agreement .

179. This deal was orchestrated by Keller at AOL and Peter Tafeen at Homestore, with

Colburn having extensive involvement in the transaction .

180. Keller told Joe Shew , a Homestore executive, in March or April 2000 that AOL' s

auditors had looked at the deal and that the $20 million cash payment, the letter of credit an d

certain termination provisions , were included in the agreement so that AOL could recognize

revenue. These provisions were not initially part of the agreement . Keller told Shew that

Colburn was directly involved in the negotiations of these terms . Keller also told Shew that

AOL would be recognizing $50 million per year in revenue from the agreement.

181 . When the agreement was implemented, Homestore was very disappointed with

the deal . Homestore believed that it did not receive enough "hits" through the AOL interne t

properties and Peter Tafeen regularly complained to Colburn about his disappointment with th e

deal .

182. AOL reported the value of the deal to be $287 million, or about $57 million pe r

year over the five-year term of the deal . AOL, however, failed to properly account for th e

48184 73

consideration at its fair value, and thus violated APB 29, SFAS 123 and EITF 00-08, which

would have included discounts for time value and marketabili ty (transfer) restrictions. As a

result, the Company improperly overstated advertising revenue by at least $4.4 mi ll ion for the

qua rter ended June 30, 2000 and $6.6 mil lion per quarter for the quarter ended September 30,

2000 through the quarter ended June 30, 2002, the last reported quarter during the Class Period.

(x) Gateway Inc . Stock Purchase

183 . AOL again improperly accounted for a round-trip/barter transaction involving the

purchase of stock in a round-trip deal originally entered into with Gateway beginning on or about

October 10, 1999 . The stock was held only by AOL and unmarketable for three years .

184. According to a former AOL Vice President for Business Development, the deal

`vas not arm's length" and was misrepresented by AOL to the marketplace . AOL agreed to

invest approximately $800 million in Gateway, acquiring a 4 .5% stake in the company in

Gateway stock and warrants . The source reported that, in return, the agreement provided that

Gateway would use the entire $800 million dollars it received from AOL for advertising and

other strategic partnerships on AOL's service . These Gateway investments included an online

retail store joint venture of AOL and Gateway in which Gateway invested $75 million. Both

AOL and Gateway's stock went up as a result of the publicity about this deal which was

presented in press releases as being mutually beneficial to the companies . According to the

source, the deal was, in fact, a round-trip/barter transaction in which AOL, through improper

accounting, overstated advertising revenue.

185. Similar to the Hughes and Homestore House and Home transactions described

above, AOL failed to use the underlying instrument (stock), as opposed to the money exchanged,

as a basis for valuing the amount of advertising revenue to be recognized in the deal . As was its

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practice, in or about December, 2001, AOL invested $200 million in a class of stock -50,000

shares of non-voting Series A convertible preferred stock - that o y AOL held . The Gateway

stock was thus restricted and would not convert until 2002 and beyond (usually three years from

the transaction date) depending on the trading prices on those dates . Consequently, proper

valuation of the stock was critical to AOL's recognition of advertising revenue in the Gateway

deal. APB 29 required that a fair market value calculation be applied upon issuance of the stock

and that the advertising revenue reported by AOL be discounted accordingly . AOL did not do so,

thus violating APB 29, SFAS 123 and ETTF 00-08, which required that the transaction be valued

at the fair value of the instruments swapped, including time value and marketability discounts.

By failing to properly value the Gateway stock, AOL and AOL Time Warner overstate d

advertising revenue by at least $3 million in December, 2001 and $9 million per quarter for th e

quarter ended March 31, 2002 through the quarter ended June 30, 2002, the last reported quarte r

during the Class Period .

W) Oxygen Media Inc. Stock Purchas e

186. AOL Time Warner again improperly accounted for a round-trip/barter transactio n

involving the purchase of stock in a deal entered into with Oxygen Media Inc . ("Oxygen Media")

in April, 2001 . While not fully disclosed to the marketplace, AOL invested $30 to $50 million

dollars in Oxygen Media which operates a cable channel . As part of the deal, Oxygen Media's

cable channel would be carried on the Company's cable systems and Oxygen Media would

purchase $100 million in advertising mostly from the AOL division of the Company. According

to a former AOL account manager, the AOL deal with Oxygen Media was an instance of "round

tripping" or a "reinvestment deal ."

48184 75

187. The deal itself was announced on Apri l 4, 2001 , in a Wall Street Journal article

en titled , "AOL Time Warner Reaches Deal to Boost Stake in Oxygen Media" The a rticle stated :

AOL Time Warner inc. is boosting its minority stake in struggling Oxygen MediaInc., the closely held cable-television and online company , in a move that reflectsthe growing control ofAOL executives over Time Warner's far-flung operations .

AOL Time Warner also will send a certain amount of online traffic to Oxygen'sfour Web sites by weaving Oxygen's content into AOL's various online channels .AOL Time Warner declined to disclose the size of its cash investment in Oxygenor the size of its equity stake in the business .

188. On August 26, 2002, in an article entitled, "Officials Probe AOL's Actions With

Partners," The Wall Street Journal reported on the Company's round-trip/barter deal with

Oxygen Media:

For America Online, investing in companies that then advertised on the Internetservice was about as crucial to its growth as taking in oxygen . Literally .

Last year, AOL invested $30 million to $50 million in Oxygen Media Inc. andarranged for the women-focused cable channel to be carried on parent AOL TimeWarner Inc .'s cable systems . At the time, Oxygen agreed to buy about $100million in ads that mostly ran on America Online--a hefty amount for a start-upmedia company.

The Oxygen trades were one of the many complex deals that were a way of life atthe America Online unit--and many other technology companies-during theboom years. At AOL, these deals sometimes included an investment Othertimes, AOL squeezed its suppliers for advertising revenue . Either way, the dealsweren't much of a secret--AOL was proud of its ingenuity in crafting thearrangements and expected AOL partner companies to buy ads on AOL . "Ifwe're one of their big customers, we expect them to be one of our big customers,"Robert Pittman, the since-departed chief operating officer, said in an interviewlast year.

189. The Oxygen Media carriage deal was unusual for not including a launch fee .

Networks like Oxygen Media routinely pay cable operators substantial launch fees to obtai n

favorable channel positions on cable systems . Instead of paying the Company such a fee, which

could have been as much as $100 million dollars, Oxygen Media purchased advertising ,

48184 76

principally from the Company's AOL online division . To compensate Time Warner's cable

division for not receiving revenue from Oxygen Media in the form of a launch fee, the AOL

online division bought advertising on Time Warner cable . According to a Wall Street Journal

report on October 7, 2002 entitled, "SEC Probes AOL-Oxygen Pact For Double-Booking of

Revenue," Defendant Pace, AOL Time Warner's Chief Financial Officer, told a group of

investors that the SEC inquiries into AOL's accounting included AOL's involvement with other

AOL Time Warner divisions and singled,out the Oxygen Media deal as an example. By failing

to properly account for its round-trip deal with Oxygen Media, AOL Time Warner overstate d

that AOL advertising revenue by at least $19 .8 million per quarter for the five quarters ended

June 30, 2001 through the quarter ended June 30, 2002 .

(xii) PurchasePyro.co Inc. Advertising Swap

190. AOL and AOL Time Warner improperly accounted for an "in kind" advertising

deal with PurchasePro . com, Inc. ("PurchasePro "}, which AOL used as a vehicle to improperly

inflate advertising revenue by at least $13 .9 million during the Class Period . At that time,

PurchasePro was a start-up business-to-business software fine . According to PurchasePro's SE C

Form 10-K for 2000 and its SEC Form 10-Q for the second quarter 2001, pursuant to th e

marketing agreement, PurchasePro bought advertising space from AOL and, in two transactions,

AOL purchased promotional subscriptions for use with AOL customers for $13 .9 million .

AOL's purchase of $4.9 mi llion (in 2000) and $9 .0 million (in 2001 ) of PurchasePro's

subscriptions for AOL' s customers and PurchasePro ' s purchase of advertising from AOL were

round-tripped revenues. Rather than earned, the revenues were effectively self-generated. Thus ,

the cash transactions failed to demons trate "representational faithfulness" and subordinated the

48184 77

substance of the agreement to its form in violation of Statement of Financial Accountin g

Concepts No. 2 .

191 . Since AOL exchanged its advertising services for the PurchasePro subscriptions ,

AOL should have recognized the advertising revenue in accordance with the requirements of

APB 29. APB 29 states that the fair market value of the instruments (subscriptions and

advertising services) should be used as the basis of the transaction . If unable to determine the

fair market value, the recorded amounts (costs) should be used to value the transac tion (APB 29,

par. 26), which would be m inimal to zero . EITF 99-17 provides additional requirements as t o

the valuation of advertising services using the past six months cash transaction for simila r

amounts and similar terms as a basis . AOL overstated its advertising revenue by at least $4 . 9

million for the quarter ended December 31, 2000 and $9 million for the quarter ended June 30 ,

2001 because the fair value and cost of the virtually nothing . PurchasePro subscriptions and

AOL advertising was virtually nothing .

(du} Monster .com

192. AOL improperly accounted for another "in kind" advertising deal entered into

with Monster.com in late 1999, used by AOL to overstate advertising revenue by over $2 9

million during the Class Period. On December 2, 1999, Business Wire reported on AOL's "$100

million relationship" with Monster.com :

America Online, Inc. (NYSE: AOL), the world's leading interactive servicescompany, and Monster.com, the leading global careers network and the flagshipbrand of TMP Worldwide Inc. (NASDAQ: TMPW), today announced a four year,exclusive $100-million relationship to bring Monster .com's career managementresources directly to cyberspace's largest consumer audience across sevenAmerica Online brands .

193. According to a former AOL Vice President for Business Development, the

transaction entered into between AOL and Monster .com was a "profitless deal" in which AOL

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promoted Monster.com and Monster .com agreed to promote AOL by exchanging advertisements

with each other.

194. Similar to the PurchasePro deal discussed above, because AOL exchanged or

swapped its advertising services for the Monster .com advertising, AOL should have recognized

the advertising revenue in accordance with the requirements set forth in APB 29 and EITF 99-17 :

APB 29 states that the fair market value of the instruments (adver tising services) should be used

as the basis of the transaction . If unable to determine the fair market value within the limits o f

ETTF 99-17, the barter should be recorded based on the carrying amount of the advertising

surrendered, which would be zero . EITF 99-17 also provides additional directives as to the

valuation of advertising services using the past six months cash transaction for similar amounts

and similar terms as a basis . Further, applying the standards set forth in SFAC 2, the transaction

would be properly characterized as a sham and the substance would be a net zero transactio n

despite its form. No "real" revenue was reportable . By failing to comply with APB 29 and EITF

99-17, AOL and AOL Time Warner overstated advertising revenue by at least $2.08 million for

the quarter ended December 31, 1999 and $6.24 million for each quarter beginning with th e

quarter ended March 31, 2000 through the quarter ended June 30, 2002, the last quarter reporte d

in the Class Period .

3. "Front Loading" or "Jackpotting" to Record Advertising Revenue

195. Another category of deceptive advertising deals involved the practice o f

manipulating the timing and placement of advertisements to report the revenue generated fro m

those advertisements in a particular quarter, thereby meeting internal goals or external earning s

estimates . According to a former AOL Associate Project Manager in the Sales Planning

Operations Division, who was responsible for booking revenue and implementing sales o n

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AOL's website, the overall practice of flooding the website with advertisements at the end of the

month through this method of so-called "front loading" or "jackpotting" was common. Millions

of dollars were "fmntloaded" or "jackpotted" at the end of each quarter and many advertisers

were in the dark about this practice .

196 . A Washington Post article dated July 19, 2002 said that interviews with former

AOL employees revealed that the term "j ackpotting" referred to gambling slot machines where,

for example, three cherries in a row wins . In AOL's case, jackpotting meant it would run the

same ad three times on a single web page, often on the bottom of the screen, where it was less

visible.

(i) Catalina Marketing Corporation

197. According to a former Chief Technology Officer, Product Manager and Senior

Business Manager who worked for AOL, the Company often engaged in "jackpotting", an

example of which took place in the first quarter of 1998, even before the Class Perio d

commenced, in connection with Catalina Marketing Corporation ("Catalina") . Catalina had

signed a $10 million dollar two year contract to run supermarket advertising online with AOL .

Even though the food section of AOL was not ready to run the advertising, AOL executives

made sure the ads ran before the end of the quarter and in advance of the contractual obligation

so AOL could book the revenue . According to this source, the rule of thumb at AOL at the time

was that AOL would book 25% of the value of the contract in the quarter the advertising began .

198. The fact that AOL generated numerous advertisements in a short time frame,

allegedly many times on the same page (to the point that some customers complained of

excessiveness), to an earnings process does not alleviate the requirement of CON 5, p . 83 which

states, "Revenues are not recognized until earned . An entity's revenue-earning activities involve

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delivering or producing goods, rendering services, or other activities that constitute its ongoin g

major or central operations, and revenues are considered to have been earned when the entity ha s

substantially accomplished what it must do to be entitled to the benefits represented by th e

revenues ." (Emphasis added.)

199. When AOL engaged in "jackpotting" in connec tion with, inter ali% Catalina

Marketing, it overstated advertising revenue - by "squeezing" or "jackpotting" multiple

advertising impressions or banners, AOL did not perform under the contract . In other words ,

when the ads began to run in such a fashion under this, and other similar deals, there was n o

"earnings process" taking place with regard to the superfluous or excessive advertisements

because AOL had not "substantially accomplished" the substance of the contractlagreements .

(ii) Telefonica SA

200. According to a July 19, 2002 article in The Washington Post, an example of

"jackpotting" occurred just prior to the Merger in connection with a Business Affairs deal to sell

$ 15 mi llion dollars in online ads to Telefonica, SA, ("Telefonica") a large Spanish

telecommunica tions company. Confirming the existence of the relationship between AOL and

Telefonica, the Dow Jones International News Service reported on December 19, 2000 that

Telefonica Datacorp, the business telecom unit of Spanish telecommunica tions company

Telefonica SA (TEF) had signed a "'multimillion dollar" strategic agreement with AOL fo r

several years .

201 . In order to book revenue from the Telefonica deal in the quarter ended December

31, 2000, AOL needed to run the advertising during that month. According to the July 19, 2002

Washington Post article :

But with so little time left, AOL had to place the ads in high-traffic areas of AOL,such as its welcome screen , the first Web page people see when they use the

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service. More consumers saw ads on the welcome screen and AOL could getfaster credit for running the promotions .

AOL officials didn ' t care that the Telefonica link from AOL's English-languagewelcome screen took its users to a Spanish-language site, said AOL sourcesfamiliar with the deal . Nor did it matter to [AOL] that Telefonica 's computerservers couldn't handle all of the customer traffic from AOL, they said .

AOL succeeded in running the Telefonica ads fast to book the revenue beforeDecember 31, as accounting rules required .

202 . Under GAAP, however, AOL did not substantially accomplish what it would b e

required to do in order to recognize revenue. As a result, AOL's advertising revenue was

overstated by $15 million for the quarters ended December 31, 2000 and March 3 1 , 2001 ,

respectively.

203 . According to a former AOL Vice President for Business Development, AOL

regularly engaged in this type of "jackpotting" towards the end of each quarter in order to meet

targets similar to the "jackpotting" that occurred with respect to Telefonica . Specifically, thi s

source stated that similar "jackpotting" also occurred with regard to transactions with Gateway

and Cisco.

4. Converting Legal Disputes into Advertising Deals

204. Another impermissible accounting practice engaged in by AOL and AOL Time

Warner involved the improper conversion of a legal dispute into an advertising deal . To that end,

AOL demanded that its litigation opponent purchase advertising in settlement of a dispute . This

revenue was then improperly reported as advertising revenue .

(i) 24dogs.com Arbitration Awar d

205. AOL improperly converted a $22.8 million arbitration award into advertisin g

revenue. MovieFone Inc . (" MovieFone"), an online ticketing firm, had won an arbitratio n

award against a Wembley PLC subsidiary. When AOL purchased MovieFone a year later in

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1999, it turned the $22 .8 million arbitration award, plus interest, into online advertising revenue ,

recognized in AOL 's rascal quarter ended September 30, 2000 . In return, AOL agreed that this

purchase of advertising would satisfy the prior arbitration award . In a deal reached just days

before the end of the quarter ended September 30, 2000, when AOL knew it was short of its

targets for advertising revenue, Wembley agreed to purchase $23 .8 million in advertising for it s

online greyhound racing website, 24dogs .com. The importance of meeting revenue targets wa s

even more critical because the consummation of the Merger with Time Warner was only months

away. Accordingly, AOL quickly put together advertisements and ran enough of them to book

$16.2 million of advertising revenue in the quarter ended September 30, 2000 .

206. However, to book the advertising revenue in that quarter under this improper

conversion scheme, AOL needed to run the advertising before September 30, 2000 . Without

Wembley's knowledge, AOL created banner and button advertisements out of Wembley's

24dogs.com website and started running advertisements . In this case of jackpotting" similar to

Telefonica, AOL ran as many as three or four Wembley advertisements on a single webpage .

According to the July 18, 2002 Wa hington Post article, within about an hour of posting the

greyhound ads, Wembley's unfinished website crashed from an overload of customer traffi c

from AOL. Such "jackpotting" overstated advertising revenue because there was no "earning s

process" taking place with regard to the superfluous or excessive advertisements because AOL

had not "substantially accomplished" the substance of the Wembley deal .

207. Even more significant from an improper accounting standpoint, applicable

accounting standards do not allow for an arbitrary conversion of one type of revenue into another .

This is because the initial recording of income ( such as the MovieFone arbitration award) gav e

rise to the receivable in the first place . AOL's conversion of this receivable into advertisin g

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revenue is subordinating the substance of the transaction to its form . APB 16 ¶ 87 and SFAS

141 137 require that assets of an acquired company (MovieFone) be recorded on the opening

balance sheet at the time of the acquisition . The subsequent collection of that receivable would

therefore have no income statement impact. Here, the overall impact of AOL's accounting

manipulations was to overstate advertising revenue by $16.2 million and $7.5 million for the

quarters ended September 30, 2000 and December 31, 2000, respectively .

(U) Ticketmaster Legal Action

208. In the same fiscal quarter ended September 34, 2400 , AOL improperly converte d

another pending litigation, with Ticketmaster, into $13 million in advertising revenue. By

settling its action against Ticketmaster in exchange for Ticketmaster buying advertising from

AOL, a settlement payment was made and should have been recorded as other income, not

advertising revenue. CON 6 ¶ 82, and CON 5 ¶ 83 require that income resulting from peripheral

or incidental transactions be treated as gains rather than revenue because they do not arise from a

company's central operations. The settlement of the Ticketmaster litigation did not constitute

AOL's ongoing major or central operations . AOL's attempt to improperly characterize the

litigation settlement as advertising revenue violates the requirements of CON 2 ¶ 160 which

states, "The quality of reliability and, in particular, of representational faithfulness leaves no

room for accounting representations that subordinate substance to form ." Here, the reporting of

Ticketmaster transaction failed to demonstrate "representational faithfulness" and subordinated

the substance of the agreement to its form in violation of CON 2 . The impact of this accounting

manipulation was to overstate advertising revenue by $13 million for the quarter ended

September 30, 2000 .

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S. Bookie Sales on a Gross Rather Than Net Basis to Inflate Adver tisinRevenue

209. Another deceptive prac tice of AOL and AOL Time Warner was its

misrepresentation to investors of the nature of its agency relationship with particular customers .

With respect to certain deals , AOL Time Warner served as an adver tising broker for a customer

and then represented all (gross amounts ) of the resulting revenue to be AOL's and AOL Time

Warner's own adver tising revenue, rather than reporting only the percentage of revenue properly

accruing to AOL and the Company as a commission from the sale.

210: Reporting gross revenue as a principal versus net revenue as an agent was

highlighted by ETTF Issue No . 99-19, which became effective for financial statements for fiscal

periods beginning after December 15, 1999 . EITF 99-19 is intended to resolve any issue about

whether a company should report revenue based on (a) the gross amount billed-to a customer

because it has earned revenue from the sale of the goods or services or (b) the net amount

retained (that is, the amount billed to a customer less the amount paid out, i .e., to a supplier who

has earned a commission or fee) . As the FASB notes in EITF 99-19, "How companies report

revenue for the goods and services they offer has become an increasingly important issue

because some investors may value certain companies on a multiple of revenues rather than a

multiple of gross profit or earnings ." (Emphasis added.)

211 . The accounting requirements of EITF 99-19 are consistent with SAB 101 . SAS

101 states:

In asserting whether revenue should be reported gross with separate display ofcost of sales to arrive at gross profit or on a net basis, the [SEC] staff considerswhether the registrant :

1 . acts as principal in the transaction;2. takes title to the products ;

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3. has risks and rewards of ownership, such as the risk of loss for collection,delivery, or returns ; and

4. acts as an agent or broker (including performing services, in substance, asan agent or broker) with compensation on a commission or fee basis .

If the company performs as an agent or broker without assuming the risks andrewards of ownership of the goods, sales should be reported on a net basis.

eBay

212. AOL and AOL Time Warner had an agreement with the internet auction company ,

eBay, to broker advertisements on eBay's behal f

a. According to a Dow Jones News Service posting on March 25, 1999, Americ a

Online and eBay formed a four-year marketing alliance in which "America Online . . . may act as

the sole third-party advertising sales force for advertising sold on eBay's web site ,

www.ebay.com." This agreement was part of a broader relationship between the two companies

contained in an agreement entitled "Interactive Marketing & Advertising Representation ." The

March 1999 agreement was actually an amendment of an earlier agreement which resulted in the

previous contract being terminated in August 1999. Under the amended agreement in March

1999, eBay also expanded the scope of its strategic relationship with AOL under the followin g

terms:

• eBay granted prominent presence on AOL's proprietary services , including

AOL, AOL . com, CompuServe, Netscape 's Netcenter, ICQ and Digital City ;

• eBay was to develop a co-branded version of its service for each AOL property

which will prominently feature each party's brand ;

• AOL entitled to all adver tising revenue from the co -branded site;

• AOL continue to act as the sole third-party advertising sales force fo r

advert ising sold on eBay's website , www.ebay.com; and

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• eBay to pay $75 m illion over the four-year term of the contract.

eBay SEC Form 14-Q for the quarterly period ended March 31, 2000 .

b. According to a Wall Street Journal article on August 14, 2001 , AOL Time

Warner and eBay announced that AOL Time Warner would continue to serve as eBay' s

exclusive third-party advertising sales force for eBay. This announcement resulted from a n

August 2001 amendment to eBay's Interactive Marketing and Advertising Representatio n

agreements with AOL Time Warner . This amendment extended the term of the relationshi p

through March 2004 and "provide[d] additional exclusivity for AOL Time Warner." Under the

amended agreement, elay was obligated to pay $93.8 million over the Sve-year term of th e

contract in exchange for online advertising services .

eBay November 14, 2001 Form i 0-Q and eBay March 25, 2002 Form 10-K .

213 . Since AOL only served as an advertising broker or agent for eBay, it only earned

and received a commission on the sales it made for eBay. AOL, however, did not simply record

its earned commission, but recorded all of the eBay advertising revenue as if it were AOL' s

revenue. As a result of this improper recogni tion of revenue , AOL reported a larger amount of

advertising revenue than it was entitled to .

a. Indeed, according to Alec Klein's book Stealing Tame:

In the summer of 200 1 , AOL deal makers boarded the company jet for theSan Jose, California, headquarters of [eBayj . . .and returned a day later with atransaction that would help AOL meet its financial targets. AOL revised a deal inwhich it agreed to serve as an ad broker, selling eBay's on-line ad space,according to AOL's confidential executive summary of the deal . But AOL didnot simply take the customary ad rep's commission . Instead, AOL counted all ofthe eBay advertising revenue as if it were AOL's own. "AOL recognizes allrevenue generated from eBay inventory sales on a topline basis," AOL said in itsinternal documents. In this way, AOL booked $80 million in revenue in 2000 and2001, the gross amounts from selling eBay's ads . The gross sales didn't changeAOL's net income, because AOL counted the payments it forwarded to eBay-

48184 87

minus its broker's fee-as an expense elsewhere on its books . But with thisaccounting, AOL was able to report a larger amount of ad and commerce revenue .

Alec Klein, Stealing Time: Steve Case, Jerry Levin and the Collapse of AOL Time Warner 265(Simon & Schuster ed . 2003).

b. GAAP, specifically EITF 99-19, requires that revenue earned by an agent (as

opposed to the principal) should be reported in its net amount, meaning the commission earned

by AOL rather than eBay's total advertising revenue. As reported in the July 18, 2002

Washington Post, however, AOL "sold ads on behalf of online auction giant eBay, Inc ., booking

the sale of eBay's ads as AOL's own revenue." The Washington Post further stated : "AOL did

not buy eBay's advertising inventory," "AOL carried no financial penalty if it did not sell

eBay's ads" and "AOL would not explain how it shared that risk ." All of these terms and

conditions indicate that AOL operated as an agent, not principal . Commenting on the deal in the

Washington Post, "Michael Sutton, the SEC's chief accountant from 1 995 to 1998, said, `This

sounds more like an agency relationship than a principal relationship .' An agent should book a

commission, he said, not the gross sale, as AOL did ."

c. Like most internet companies, AOL and AOL Time Warner's valuation was

based on multiples of revenues rather than multiples of earnings. More specifically, AOL and

AOL Time Warner' s advertising was a key factor in the market's valua tion of the companies .

Consequently , accurate advertising revenue presentation for AOL and AOL Time Warner was o f

paramount importance . However, AOL and the Company overstated AOL's advertising revenue

from the eBay deal because AOL was acting as an agent and not the principal (by earning a

commission on the sale of the advertising). As such, AOL and AOL Time Warner should have

only recorded the commissions ea rned as the companies' revenue, not the gross revenue amounts .

AOL and AOL Time Warner' s failure to do so is a clear violation of GAAP, specifically CON 5

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¶ 83, and EITF 99-19 , which require that agents ( in this case AOL and AOL Time Warner)

report only their commissions earned as revenue rather than the revenue earned by the seller (in

this case eBay) as their own. AOL and AOL Time Warner therefore overstated advertising

revenue by at least $16 .8 mil lion for each quarter beginning with the qua rter ended September 30,

1999 through June 30, 2001 and $12.75- million for the quarter ended September 34, 2401 .

6. CountingRepricing of Equity Stock Rights as Advertising Revenue

214. AOL and AOL Time Warner also fraudulently reco gnized advertising revenue

when they revised the terms of their respective equity investment in existing advertisin g

customers in violation of applicable accounting principles .

PurchasePro

215. AOL improperly accounted for its marketing deal with PurchasePro by

recognizing advertising revenue with respect to stock rights AOL held in PurchasePro . A July

19, 2042 Washington Post article recounts Defendant Colburn arrogantly describing thi s

PurchasePro deal as "science fiction . "

216. Pursuant to an agreement entered into in or about March, 2000, AOL agreed to

distribute software for PurchasePro and, in exchange, received tens of millions of dollars in

performance warrants . The warrants, which are similar to stock options, gave AOL the right to

buy PurchasePro stock for $63 .26 per share. PurchasePro subsequently accelerated the vesting

schedule for three million of the warrants and adjusted the exercise price down to .01 a share.

Based upon the change in the vesting schedule for and pricing of these 3 million PurchasePro

warrants, the Company improperly booked $20.5 million dollars as advertising revenue in the

quarter ended December 31, 2000 and another $7 million in the quarter ended March 2001 .

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217. When PurchasePro reduced the exercise price of the warrants from $63 .26 to

$0.01, AOL should have recognized the change in value as a gain , rather than as advertising

revenue. CON 6 ¶ 82 states that "gains are increases in equity (net assets) from peripheral o r

incidental transactions of an entity and from all other transactions and other events an d

circumstances affecting the en tity except those that result from revenues or investments by

owners." CON 6 ¶ 78 states that "revenues are in flows or other enhancements of an entity or

settlements of its liabilities (or a combination of both) from delivering or producing goods ,

rendering services, or other activities that constitute the entity's ongoing major or central

operations." Since the adjustment in price was not attributable to additional services provided b y

AOL or achieved milestones previously set in an agreement, as provided for in E1TF 00-8, the

reduction in price has no correlation to performance . Thus, AOL and AOL Time Warner

violated GAAP and overstated advertising revenue by at least $20 .5 million for the quarter ended

December 31, 2000 and $7 million for the quarter ended March 31, 2001 .

7. Converting Contract Termination Fees into Advertising Revenu e

218. Another catego ry of false reporting of advertising revenue involved th e

renegotiation of certain long-term advertising contracts . This situation arose in cases where

companies, especially internet companies, with long-term advertising agreements with AOL and

AOL Time Warner were facing financial difficulties and were at risk of not ful fi lling their

contracts . Rather than taking these companies to court to enforce the contracts and risk attracting

negative attention to the health of AOL' s adver tising business , AOL renegotiated the deals and

required the companies to pay a fee for shortening the deal . AOL then improperly treated that

fee--a renegotiation or termination fee-as advertising revenue.

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219. A former AOL Chief Technology Officer, Product and Senior Business Manager

confirmed that when a dot-corn company could no longer meet the terms of its contract ,

Defendant Colbum and others would put pressure on it to pay up and then restructure the deals.

220. According to a former Account Services Manager in the Interactive Marketin g

Division of AOL, approximately 60% of the dot -corn contracts that person was responsible for

were renegotiated in the aforementioned manner. According to this source, the contracts with

dot-com companies were renegotiated because the customers determined at some point durin g

the con tract period that they would not be able to make payments to AOL. Account services

managers at AOL called customers who wanted to cancel their contracts customer "kills ." If a

customer contacted an account services manager or sales representative, the customer file was

pulled and forwarded to Business Affairs, which would then establish new terms for the

customer in order to prevent a default on the contract .

221 . According to a July 18, 2002 Washington Post article:

In some instances, AOL said in its written response to the Post, it wouldrenegotiate a struggling dotcoms ad deal to shorten the term of the contract . Thedot.com would pay AOL a fee for breaking the deal early, and that fee would beincorporated into the new, shorter-term ad deal, effectively creating a balloonpayment. AOL would count all of the revenue, including the fee for renegotiatinga shorter-term deal, as ad revenue .

From July 2000 through March 2001, AOL said, it booked $56 million dollarsfrom dot-corn deals that were terminated or restructured, about 3% of its $2 .1bill ion dollars in overall ad and commerce revenue during that time . In eachquarterly earnings report during the period , the terminated and restructured dealsrange from 1 .5 to 4 .4% of AOL's advertising and commerce revenue.

(Emphasis added .)

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Dr.Koop.com

222. An example of a termination fee improperly recorded as advertising revenue by

AOL is the $9.625 million termination fee paid by Dr .Koop.com ("Dr.Koop") when it cancelled

its contract with AOL. Dr.Koop entered into an $89 million four-year deal with AOL in July

1999. In April 2000 the deal failed, and according to Dr.Koop's 2000 SEC Form 10-K, the

original agreement between Dr.Koop and AOL was amended. In exchange for 3 .5 million shares

of Dr.Koop common stock, Dr.Koop was, in turn, relieved of any further cash payment

obligations to AOL and all existing warrants (vested and unvested) were cancelled . AOL and

Dr.Koop agreed to reduce carriage on AOL for a twelve-month period subject to the terms of the

amended agreement. The value of the shares given to AOL to terminate the deal was placed at

approximately $9.6 million.

223; AOL and AOL Time Warner violated GAAP by improperly recording the fees

received to sho rten or terminate these contracts, including the Dr .Koop deal, as advertising

revenue from ongoing opera tions , rather than gains . More specifically, CON 6182, requires

that income resulting from peripheral or incidental transac tions be treated as a gain rather than

revenue because it does not arise from the central opera tions of the company. AOL and AOL

Time Warner also violated CON 5, which requires that revenue be earned through major ongoing

operations , and CON 2, which requires representational faithfulness. The termination or

renegotiation fees did not result from the central operations of the Company. Consequently,

AOL and AOL Time Warner overstated adver tising revenue by at least $9.6 million by failing to

properly treat contract cancellation fees as gains . The improperly reported Dr.Koop advertising

revenue was reported for the quarter ended June 30, 2000 .

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8 . "Cross-Platform" Deals to Inflate AdvertlsinlZ Revenue

224. Time Warner clients soon learned that the "cross-promotions" and "synergies "

once touted as an inherent benefit of the Merger resulted in new deals with Time Warne r

divisions that now required the purchase by the customer of adver tising from the AOL division

as well . After the Merger of AOL and Time Warner, the two companies used their combined

strength to increase AOL's online advertising revenue by pressuring Time Warner clients to

convert purchases of, inter alia, cable programming into purchases of online advertising. And, in

at least one instance, the same advertising revenue was booked at more than one division .

225. In advertising deals involving so-called cross-platforms (including on-air, onlin e

and print media, or any combination thereof) the various elements must be recorded based on th e

relative fair value of each (as determined by "vendor specific objective evidence") . Though

AOL Time Warner 's cross-platform promotion/advertising transactions were not software sales ,

accounting literature relative to SOP 97-2 entitled "Software Revenue Recognition" most closel y

and reasonably provides accounting standards for such multiple -element deals . In December

1998, the AICPA issued SOP 98-9, "Modification of SOP 97 -2, Software Revenue Recognition,

with Respect to Certain Transactions ." SOP 98-9 clarifies certain provisions of SOP 97-2, and

effectively deferred the required adoption of those provisions until the fiscal year beginning

January 1, 2000 .

226. SOP 97-2, 110 states :

"If an arrangement includes multiple elements, the fee should be allocated to thevarious elements based on vendor-specific objective evidence of fair value,regardless of any separate prices stated within the contract for each element .Vendor-specific objective evidence of fair value is limited to the following :

• The price charged when the same element is sold separately,

48184 93

• For an element not yet being sold separately, the price established bymanagement having the relevant authority ; it must be probable that the price,once established, will not change before the separate introduction of theelement into the marketplace .

227. In cases where AOL Time Warner attributed revenue from cross-platform deals to

the AOL division, that revenue must be calculated in accordance with SOP 97-2 . "Vendor

specific objective evidence" for advertising must be cash or cash received historically in a

similar transaction (as defined in ETTF 99-17, ¶ 4-6) and even then, it must be further compared

with the relative fair values of the other elements bundled in the transaction, rather than th e

stated prices within the contract for each element .

228 . In those instances where the online advertising is not even desired, but added as a

required term of the deal, the relative fair market value of such online services would be very

low. At a minimum , the added online advertising would be a sales incentive for the actual

desired services, and would not constitute earned revenue .

(i) The Golf Channel

229. In June 2001, the Golf Channel agreed to pay AOL Time Warner $200 million for

advertising over five years in order to have its programming shown on Time Warner Cable .

After hearing about this deal, the AOL division weighed in and asked for a piece of the deal .

According to the July 18, 2002 Washington Post article, Time Warner cable successfully

pressured the Golf Channel into spending about $15 million of the $200 million on online

advertising with AOL . This amount helped the online division to report increased advertising

revenue for the quarter ended September 30, 2001 . According to The Washington Post, AOL

sources acknowledged that the Golf Channel had "few options" : "We told them where and

when" the ads ran . . . "They didn 't have a choice-" The $15 million transferred from the $20 0

48184 94

million cable deal was not legitimate AOL advertising revenue under SOP 97 2, 110, because

there was no relative fair value in the AOL advertising for the Golf Channel .

230. Ina May 18, 2001 speech at the 33rd-Rocky Mountain Securities Conference ,

then SEC Chief Accountant Lynn E. Turner stated , " . . . in order to report these types of

arrangements on a gross basis , the company must receive from its customer a separatel y

identifiable benefit that the company could have obtained from a third party, and there must be

sufficient, competent and verifiable evidence of the fair value of the benefit received . When an -

entity would not have entered into one of the separate contracts without all of the contracts bein g

negotiated and agreed to as a `package,' it will often be difficult to identify a separable benefit

being received and to establish reliable and verifiable fair values for each element of the

arrangement. In those instances, the facts and circumstances will often dictate that the cash

inflows and outflows be reported as a net revenue or cost amount, in the appropriate periods . "

Because the Golf Channel would not have agreed to spend money on online advertising in the

absence of the requirement that it do so as part of a larger advertising "package," AOL Time

Warner overstated AOL's advertising revenue by $15 mi llion for the quarter ended September

30, 2001 .

{i) Oxyze Media -Carriage Deal

231 . Ina Wall Street Journal article dated October 24, 2002, concerning AOL Tim e

Warner's decision to restate its financial results for two years and reduce advertising revenue by

$190 million, it was disclosed that certain of the improper transactions involved divisions other

than the AOL online unit . One of the deals identified in the article was AOL's deal with Oxygen

Media and the report of "double booking" the same revenue at more than one Company division .

According to the article :

43184 95

Oxygen's deal ca lled for Time Warner's cable systems to agree to carry thechannel , and instead of paying a fee for this carriage, Oxygen spent about $100million in advertising on AOL properties, mostly on the online service . Peoplefamiliar with the situation say AOL engineered intercompany ad transactions sothat the revenue was effectively reflected in the divisional numbers of both theonline and cable units.

232. In the course of employing cross platform marketing to generate adver tising

revenue for the Company, AOL Time Warner overstated advertising revenue for its online

division by including revenue from other media platforms . In addition, the Company, "double-

booked" revenue received from Oxygen Media in more than one business segment, i .e., it

recorded the same revenue in two sets of books beginning in the quarter ended rune 30, 200 1

through the quarter ended June 30, 2002 (the time period during which the advertising ran) .

233 . In addition, like Golf Channel, Oxygen Media would not have agreed to spend th e

$100 million on advertising in the absence of the cable carriage agreement . As described above,

Oxygen's carriage deal was unusual for not including a launch fee, even though cable network s

routinely pay significant launch fees to obtain favorable channel positions . Instead of paying the

Company such a fee, which could have been as much as $I00 .miiiion dollars, Oxygen Medi a

purchased advertising, principally from the Company's AOL online division. To compensate

Time Warner's cable division for not receiving revenue from Oxygen Media in the form of a

launch fee, the AOL online division bought advertising on Time Warner cable .

234. For AOL, the $100 mil lion commitment represented 3.4% of ACL's advertising

over the five quarters the deal ran - second quarter of 2001 through second quarter of 2002. For

Oxygen Media, the deal came just four months after the Company had cut the number of we b

-sites it operated from more than a dozen to four. Following announcement of the deal, Oxygen

Media reduced its web presence even further, to just two sites and eventually acknowledged tha t

"Me deal was less lucrative than originally anticipated ." As reported in an August 26, 2002

48194 96

WallStreet Journal article discussing the deal, when asked whether Oxygen media would hav e

bought advertising if it was not seeking carriage, the company's chief operation officer stated i t

was a three-way deal and "I wouldn't separate" any of the elements. As stated above, Oxygen --

Media would-not have agreed to spend the $100 million on online advertising in the absence of

. the carriage deal being an inseparable part of the "package .' Accordingly, AOL Time Warner

overstated advertising revenue by at least $19 .8 million per quarter over the five quarter s

beginning with the quarter ended June 30, 2001 through the quarter ended June 30, 2002 .

F. The Company's Admissions of Materially Overstated Adver tising Revenue andViolations of the Securities Laws

235. Subsequent to the MSBI's filing of its initial complaint, the Company restated its

advertising and commerce revenue in the amount of $190 million for the eight consecutive

quarters ended September-30, 2000 through June-30, 2002, with the restatement reducing ACL' s

advertising revenue by $168 million. According to the Company, the remaining overstate d

amount of $22 million "represents a reduction in revenues from certain transactions related to th e

AOL segment in which the advertising was delivered by other AOL Time Warner segments."

236. According to the Company's SEC Form 8-K filed on October 23, 2002, the

restatement by quarter of AOL's advertising and commerce revenue is as follows :

QUARTER RESTATEDQuarter Ended ($66 million)

9/30100Quarter Ended ($22 million)

12131/00Quarter Ended ($ 13 mi llion)

313 1101Quarter Ended ($28 million)

6/30/0 1Quarter Ended ($16 million)

9/30/0 1Quarter Ended ($ 17 million )

12131/01 -

481" 97

Quarter Ended ($6 million)3/31/02

Quarter Ended -6/30/02

237. In addition, at the same time the Company restated its financial results, it publicl y

stated:

As a result of the restatement announced on October 23, 2002 by AOL and AOLTime Warner Inc . (the "Company"), the Company 's financial statements for theaffected periods should no longer be relied n including the audited financialstatements for 2000 and 2001 contained in the Company's annual report on

Form10-K for the year ended December 31, 2001 .

(Emphasis added.)

238 . Under GAA.P, restatement of previously issued financial statements is the most

serious step, reserved only for circumstan ces where no lesser remedy is available. Under APB

20, Accounting Changes, restatements are only permitted, and are required, to correct material

accounting errors or irregularities that existed at the time the financial statements were prepared .

By restating AOL and AOL Time Warner's financial statements, the Company admitted tha t

each document publishing the original financial statements contained untrue statements and/o r

omissions, of material fact. Similarly, by restating; the Company also conceded that each of the

press releases disseminated to the investing public and each of the annual and quarterly report s

on Form 10-K and Form 10-Q that were filed with the SEC, contained untrue statements o f

material fact, and/or failed to disclose material facts .

239. On March 28, 2003, the Company reported that it may have to restate up to

another $400 million in advertising revenue for the years 2001 and 2002, regarding transaction s

with Bertelsmann AG. The Company also reported on March 28 , 2003, that further restatement

of advertising revenue was "possible" due to the "range of other transactions" that were the

subjects of the continuing SEC and DOJ investiga tions .

W-

48184 98

G. The Materially False and Misleading Statements, Omissions-of Material Fact andDevices Schemes or Artifices to Defraud Regarding Artlci Inflated Adverlis'Revenue

240. The sham transactions and improper accounting practices of the Company an d

AOL, and the Individual Defendants, which Ernst & Young permitted , caused the financial

statements of AOL and the Company for various fiscal periods, the press releases related thereto ,

pro forma and statements of Individual Defendants, to be materia lly false and misleading, and to

omit material facts . Such conduct, including the sham transactions, also constituted schemes,

devices or artifices to defraud the public.

241 . These material misrepresentations and omissions and devices , schemes or artifices

to defraud had the desired effect of manipulating stock market analysts to favorably comment on

the companies and causing investors to purchase or otherwise acquire AOL, and later AOL Time

Warner, stock at artificially inflated prices .

242. During the .Class Period , AOL and AOL Time Warner reported tremendous

growth in AOL advertising revenue based on phony numbers . Near the end of the Class Period,

when the advertising market was so weak that the Company was forced to report decreasin g

AOL. advertising revenue, it still continued to artificially inflate the reported advertising revenue.

243. As detailed previously in this Complaint, AOL and the Company overstated AOL

advertising revenue by at least $1 .7 billion during the Class Period . This artificially inflated

AOL advertising revenue was typically included as part of the companies' periodic reporting of

AOL "advertising and commerce", or AOL "advertising, commerce and other" revenue. Prior to

the Merger, AOL also typically reported "advertising and commerce backlog" which represented

"the contract value of advertising and commerce agreements signed, less revenues alread y

recognized from these agreements".

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a. The Fiscal Quarter Ended December 31, 1998

244. The Class Period begins on January 27, 1999, when AOL reported .arti$cially

inflated advertising revenue for the quarter ended December 31, 1998 . On January 27,1999, just

prior to release ofAGL's quarterly results , the Dow Jones News Service reported on the high

market expectations created by AOL:

America Online, Inc. (AOL) could beat the consensus estimate of 14 cents ashare for its fiscal second quarter by a penny or two, but analysts said thecompany is unlikely to exceed projections by much more than that .

Wil liam Blair & Co. analyst Abhisbek Gami estimates AOL will post servicerevenue, which is revenue from the company's $21 .95-a-month subscription fee,of $765 mi llion. He estimates the company wi ll post "other" revenue, whichincludes revenue from advertising and elect ronic commerce on the service, of$163 million .

AOL reported service revenue of $483 million, and other revenue of $109 mi llion,in the year-ago quarter.

(Emphasis added.)

245. Later that day, January 27,1999, the AOL Individual Defendants caused AOL to

issue a press release reporting its financial results for its fiscal quarter ended December 31, 1998 ,

that exceeded analyst's projections of the company's advertising and commerce revenue and beat

analysts ' earnings predictions by 3 cents per share . As reported in BusinessWire :

America Online, Inc. (NYSEAOL) today announced results for its fiscal secondquarter of 1999, ended December 31, 1998, setting new records in total revenues,advertising, commerce and other revenues, net income and membership growth.

The Company' s net income totaled $88 million , or $0.17 per diluted share, on afully taxed basis for the 1999 second quarter, a 340% increase over last year'ssecond quarter fully taxed net income of $20 million , or $0.04 per diluted share.

Total revenues increased by 62% over the same quarter last year to $960 million .Advertising, commerce and other revenues reached $181 million, up 66% overlast year's second quarter.

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Steve Case, Chairman and Chief Executive Officer of America Online, said :'With this quarter's record result& we continued to build excellent momentumthroe out our ❑ erations and across our brands . In 1998, the Internet truly cameof age and became even more integral to people's everyday lives . As the industryleader, America Online is better si tioned than ever to continue delivering strongprofit growth on a consistent, predictable basis .""

Mr. Case added: "Electronic commerce is changing forever the way businessessell and consumers buy goods and services . We're excited about theopportunities presented by our pending combination with Netscape as well as ouralliance with Sun Microsystems to drive the growth of this new medium and servenew customers and markets in valuable and innovative ways." _

Bob Pittman, President and Chief Operating Officer, said : ". . . With advertisingand commerce revenues more than doubling„ mainstream marketers increasinglysee the superior value' of reaching cybersnace's biggest audience through ourbrands."

-- Advertising and Electronic Commerce Revenues : Revenues from advertisingand commerce climbed to $126 million, an increase of 133% over the $54 millionin last year's second quarter and 22% above the $103 million recorded duriniz th efirst quarter

- Advertising and Electronic Commerce Backlog : The Company_ grew itsbacklog of adver tising and electronic commerce revenues from $598 million onSeptember 30, 1998 to $729 million on December 31, 1998 .

(Emphasis added . )

246. On January 27, 1999, the Dow Jones News Service reported that AOL declared a

two-for-one stock split .

247. On or about February 10, 1999, the AOL Individual Defendants caused AOL to

file its SEC Form 10-Q for the company's fiscal quarter ended December 31, 1998 . The Form

Z 0-Q was signed by Defendants Case and Kelly . It contained substantially the same financial

information as the January 27, 1999 press release, including $126 million in advertising and

commerce revenue, an increase of 133% over the year ago quarter, and $729 million i n

advertising and commerce backlog, up from $320 million in the year ago quarter. The Form 10-

48194 101

Q also stated that advertising and commerce revenue for the six month period ended December

31, 1998 was $229 million, an increase of 134% over the six month period ended December 31,-

1997. In addition, the Form I O-Q assured investors that the Company's financials were prepare

d in accordance with GAAP:

The accompanying unaudited condensed consolidated financial statements, whichinclude the accounts of America Online, Inc . (the "Company") and its wholly andmajority owned subsidiaries, have been prepared in accordance with generallyaccepted accounting principles for interim financial information and with theinstructions to Fonn 1 O-Q and Article 10 of Regulation S-X .

248. In fact, AOL's reported advertising and commerce revenue'for the quarter and six

months ended December 31, 1998 was overstated by at least $42 million as a result of AOL' s

improper accounting for the Sun deal, as discussed above . Further, AOL's representation to the

public in its press release and related SEC Form 14-Q filing that its advertising revenue backlog

as of December 31, 1998 was $729 million was false because, due to AOL's imprope r

accounting for the Sun deal, the actual backlog was overstated by at least $147 million, or by at

least 25%. Moreover, without this overstatement of the advertising backlog, the backlog would

have decreased from the prior quarter .

b. TheFiscal -Quarter Ended March 31, 1999

249. On February 25,1999 The Wall Street Journal reported that AOL 's advertising

and commerce revenue was even more important to market analysts' views of the Company than

its earnings :

AOL be an r rtin consistent profits in 1997 and showed g -profit in evpryquarter of 1998. For its most recent full fiscal year, ended June 30, 1998, AOLreported net income of $91 .$ million, or 17 .5 cents a share adjusted fora two-for-one stock split earlier this week, on $2.6 billion in revenue. Analysts estimateAOL's fiscal 1999 earnings will amount to about 33 cents a share, according to asurvey by First Call .

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But analysts say an even more pertinent indicator is AOL's revenue from

advertising and electronic commerce, which totaled $126 million in the secondquarter ended Dec. 31 , up from $54 million a year earlier. That revenue carries asubstantially higher profit mar ' than the revenue from members' subscriptionfees .

(Emphasis, added .)

250. On April 27,1999, the AOL Individual Defendants caused AOL to issue a press

release reporting its financial results for its fiscal qua rter ended March 31, 1999. AOL

announced `record" advertising and commerce revenue of $210 million for the quarter and

advertising and commerce backlog of $1 .3 billion. As reported in Business Wire :

America Online, Inc. (SE:ADL) today announced results for its fiscal thirdquarter ended March 31, 1999, setting new records for total revenues, advertisingand commerce revenues fully taxed net income before one-time events, andAOL membership growth .

Revenues reached nearly $1 .3 billion, representing a 66% increase over thecombined AOL and Netscape revenues in last year's March quarter . Adverts ing,commerce and other revenues reached $275 million up 94% over last year'sthird quarter

Mr. Pittman added: "We have moved quickly to integrate Netscape andreorganized the Company to take advantage of new opportunities in thisfastmoving environment. With virtually all companies seeking to put theirbusinesses on the Internet, our strategic alliance with Sun will aggressivelydevelop and market a full suite of e -commerce solutions for our partners andother customers . Both MovieFone and When.com will make the onlineexperience of our members and other Internet consumers even more valuable totheir everyday lives. We will continue to be opportunistic as our industryconsolidates, taking advantage of our focus, efficiency and scale, and we areconfident our business momentum will continue ."

Key operating metrics from the quarter include . . . Revenues from advertisingand commerce climbed to $210 million, increasing 119% over last year'scorresponding quarter . . . . The consolidated backlog of advertising and commercerevenues grew to approximately $1 .3 billion at the end of this quarter, from $804million at the end of the last quarter.

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AOL also expanded its strategic relationship with eBay the largest online persan-to-person trading community. Through a mew $75 million . four-year agreement,eBay wi ll have prominent presence across the Company 's brands . . . . AOL willbe entitled to all advertising revenues generated by these sites, and may act as theexclusive third-party advertising sales force for advertising sold on eBay's Website .

(Emphasis added.)

251 . On April 28,1999, a Dow Jones News Service article reported that analysts were

extremely impressed by AOL's staggering reported growth in advertising revenue:

Coming off a "high quality" third quarter, America Online. Inc . LAQLJ appearsto have a b right future, said Donaldson Lufkin & Jenrette Securities CorpInternet aniEst Jamie K gg en .

"They were ahead of our model on every key metric," Kiggen said during aCNBC interview Wednesday, referring to the Internet giant's fiscal third-quarterearnings results, posted late Tuesday.

America Online posted "tremendous" growth in advertising revenue, whic h- - - Kiggen said is the driving force,behind the'company's earnings model . America

Online said its advertising and commerce backlog grew to about $1 .3 billion atthe end of the latest third quarter from $804 million at the end of the second -quarter.

(Emphasis added . )

252. On or about May 7, 1999, the AOL Individual Defendants caused AOL to file its

SEC Form 1 O-Q for the fiscal quarter ended March 31, 1999 . The SEC Form 1 O-Q contained

substantially the same financial infvrmation as the April 24, 1999 press release, includin g

advertising and commerce revenue of $210 million, an increase of 119% from the year ago

quarter, and $1 .3 billion in advertising and commerce backlog. The Form 10-Q also reported

advertising and commerce revenue for the nine months ended March 31, 1999 as $530 millon,

an increase of 127% from the nine months ended March 31, 1998 . In addition, the Form 10-Q

assured investors that the Company's financials were prepared in accordance with GAAP:

48194 104

The accompanying unaudited condensed consolidated financial statements, whichinclude the accounts of America Online, Inc . (the "Company") and its wholly andmajority owned subsidiaries, have been prepared in accordance with generallyaccepted accounting principles for interim financial information and with theinstructions to Form 10-Q and Article 10 of Regulation S-X.

253. In fact, AOL's reported advertising and commerce revenue for the qua rter and th e

nine-months'ended March 31, 1999 was overstated by at least $12.6 million and $16 . 8 million,

respectively, as a result of AOL 's improper accounting for the Sun deal , as discussed above.

Further, AOL's representation to the public in its press release and related SEC Form 10-Q filing

that its advertising revenue backlog as of March 31, 1999 was $1 .3 billion was false because, due

to AOL' s improper accounting for the Sun deal, the actual backlog was overstated by at least

$134.4 million, or at least 12% .

c. The fiscal Quarter and Year Ended June 30,1999

254. On July 20, 1999, a Dow Jones News Service article, titled "America Online Seen

Beating 4Q Views By 10-2¢ a Share," reported that analysts had high expectations for the

Company's performance in the quarter, reflected in a "whisper number" two cents above th e

consensus earnings estimate, and that the Company was under pressure to make the whisper

number to keep share prices high :

America Online, Inc . (AOL) is expected to report earnings above the analysts'consensus earnings estimate of 11 cents a share when it releases fourth-quarterresults after the markets close Wednesday.

Some analysts, while officially maintaining previous estimates, have suggestedthe top Internet service provider will exceed the consensus estimate . The so-called whisper number, or unofficial earnings estimate, is 13 cents a share for thequarter ended June 30 . . . .

The whisper numbers are significant because AOL has a history of beatinganalysts' estimates . Many investors expect the Dulles, Va ., company to do thesame this quarter, and they could be disappointed if AOL falls short of thewhisper number, even if it beats the official consensus .

48184 105

America Online exceeded Wall Street earnings expectations by 2 cents a share inthe third quarter and by 3 cents a share in the second quarter, according to FirstCall Corp., which tracks earnings estimates .

255. On July 21, 1999, the AOL Individual Defendants caused AOL to issue a press

release announcing "record" financial results for its fiscal quarter and year ended June 30, 1999 .

AOL's reported earnings of 13 cents for the quarter was equal to the "whisper" number, two

cents higher than the analysts' consensus estimate. AOL also reported $233 million of

advertising and commerce revenue for the quarter, $1 billion of advertising and commerce

revenue for the fiscal year, and $1 .5 billion in advertising and commerce backlog . As Business

)ire reported :

America Online, Inc . (NYSE: AOL) today announced results for its fiscal fourthquarter and full fiscal year ended June 30, 1999 - setting new records across theboard for consolidated revenues, advertising and commerce revenues, operatingincome, and AOL membership growth.

Fourth quarter revenues rose to $1 .4 billion, or 46% over last year' scorn ndin period. Advertising, commerce and other revenues reached 306million 87% over fiscal 1998's fourth arter.

Steve Case, Chairman and Chief Executive Officer , said : "Ms has been a year oftremendous owth and achievement. We added more than five million newmembers to our flagship AOL service , generated $1 billion in advertising andcommerce revenues . and achieved record operating profits .

Key operating metrics from the quarter included :-- Advertising and Commerce Revenues: Revenues from advertisine andcommerce climbed to $233 mil lion, increasing 86% over last year' scorresponding quarter.

(Emphasis added .)

256. On July 21, 1999 a Dow Jones News Service article titled, "AOL's Strong

AdvertisingfE-Commerce Revs Boosts Results," reported that AOL's advertising and commerce

revenue was its fastest growing revenue source and helped offset slowing subscriber revenue :

48184 106

A sharp increase in adver tising and electroni c-commerce revenues helpedAmerica Online Inc. (AOL~ beat analysts' earnings expectations for its fourthcru ear even as its European subscriber growth slumped.

The Dulles, Va., company reported fourth-quarter revenues of $1 .3 8 billion, up46% from $943 million a year ago . The latest results included $233 million inadvertising and c-commerce revenue, up 86% from a year ago, a sharper rate ofincrease than the other categories of revenue, subscriptions and enterpris esolutions .

(Emphasis added .)

257. On or about August 13, 1999, the AOL Individual Defendants caused AOL to file

its SEC Form 10-K for the Company's fiscal quarter and year ended June 30, 1999 . The Form

10-K was signed by Defendants Case and Kelly . It contained substantially the same financia l

information as the July 21, 1999 press release, including $1 bi llion in advertising, commerce and

other revenue in the fiscal year, an 84% increase over the $543 million in such revenue in fiscal

1998, and $1 .5 billion in advertising, commerce and other backlog . The Form 10-K also

reported $765 million in advertising and commerce revenue in fiscal 1999, an increase of 114 %

over fiscal 1998 . The Form 10-K highlighted AOL's increasing dependence on advertising

revenue and the reported as tronomical growth in advertising and commerce backlog:

. . . An important component of the Company's business strategy in its InteractiveOnline Services business is an increasing reliance on advertising„ commerce andother revenues . These revenues include advertising and electronic commerce fees,the sale of merchandise, as well as other revenues . . . . The growth of advertising,commerce and other revenues is important to the Company's business objectives,as these revenues provide an important contribution to the Company's operatingresults . Advertising revenues are expected to grow in importance as the Companycontinues to leverage its large, active and g user base. . . . Affecting thegrowth in advertising, commerce and other revenues is the backlog balance as ofJune 30, 1999, 1998 and 1997 of $1,519 million, $511 million and $180 million,respectively. During fiscal 2000, approximately $680 million of revenue will begenerated from the June 30, 1999 backlog .

(Emphasis added . )

48194 107

258. In addition, the Form 10-K assured investors that the Company's financials wer e

prepared in accordance with GAAP :

The management of America Online, Inc . is responsible for the integrity andobjectivity of the financial and operating information contained in this AnnualReport on Form 10-K, including the consolidated financial statements covered bythe Report of Independent Auditors . These statements were prepared inconformity with generally accepted accounting principles and include amountsthat are based on the best estimates and judgments of management, which itbelieves, are reasonable under the circumstances .

259. The Form 10-K also incorporated, with Defendant Ernst & Yonng's consent, the

July 21, 1999 report of Ernst & Young which assured investors that the financial statements wer e

audited in accordance with GAAS and were in compliance with GAAP :

We conducted our audits in accordance with generally accepted auditingstandards . . . . We believe that our audits provide a reasonable basis for ouropinion.

In our [Ernst & Young] opinion, the financial statements referred to abovepresent fairly, in all material respects, the consolidated financial position ofAmerica Online, Inc. at June 30,1999 and 1998, and the consolidated results ofits operations and its cash flows for each of the three years in the period endedJune 30,1999, in conformity with generally accepted accounting principles.

260. In fact, AOL's reported advertising and commerce revenue for the quarter and

year ended June 30, 1999 was overstated by at least $28 .6 million and $45.4 mi lion, respectively.

The overstatement of $28 .6 million for the quarter was due to AOL's improper accounting for

the Sun ($12.6 million) and Hughes ($16 million) deals, respectively, as discussed above . The

overstatement of at least $45.4 million for the year ended June 30, 1999 was also due to AOL's

accounting improprieties in connection with the Sun ($29 .4 million) and Hughes ($16 million)

deals, respectively, as discussed previously. Further, AOL's representation in its July 21, 1999

press release and the related SEC Form 10-K that its advertising revenue backlog as of June 30 ,

1999 was $1 .5 billion was false because the actual backlog was overstated by at least $686 .8

a-

481" 108

million, or 84%, due to the improper accounting of the Sun ($121 .8 million) and Hughes ($565

million) deals.

d. The Fiscal Quarter Ended September 30, 1999

261 . On August 11, 1999, Dow Tones Business News reported that market analyst

Youssef Squall of Ladenburg Thalman & Co ., "expects [AOL] to post $329 million in ad and o-

commerce revenue, up from $306 million in the fourth quarter ended June 30 ."

262. On October 19,1999, Dow Jones News Service reported:

Strong subscriber g rowth and an increase in advertisingaand electronic commercerevenue should help America Online, Inc. (AOL) beat analysts' expecta tions forits first fiscal quarter.

The Dulles, Va., Internet service provider is expected to report earnings of 13cents a share for the quarter ended Sept . 30, up from 5 cents a share a year ago,according to a First Callfihomson Financial survey of analysts . . . . The unofficialestimate, or whisper number, puts America Online's first-quarter earnings at 15cents a share . . . .

The report also said that securities analyst , Arthur Newman, "expects thecompany's revenue from advertising and e-commerce to rise to $325 millionfrom $175 million a year ago . . . "

(Emphasis added.)

263. On October 20, 1999, the AOL Individual Defendants caused AOL to issue a

press release announcing f nancial results for the qua rter ended September 30, 1999, which met

the "whisper" number for earnings and beat analysts' expectations for advertising and commerc e

revenue. Business lire reported:

America Online, Inc . (NYSE: AOL) today announced results for the first quarterof fiscal 2000 ended September 30, 1999 -- setting new records for consolidatedrevenues, advertising and commerce revenues, operating income, andmembership growth in the first quarter.

The Company's frilly taxed net income totaled $184 million, or $0 .15 per dilutedshare, up from $50 million, or $0.04 per diluted share, on the same basis in fiscal

s-.

48184 109

1999"s first quarter . Operating income for the quarter climbed 244% over theyear ago quarter to $265 million.

First quarter revenues rose to $1 .5 billion, or 47% over last year's first quarter,and advertising. commerce, and other revenues reached $350 milli on, doublingover the fiscal 1999's September quarter .

Steve Case, Chairman and Chief Executive Officer of America Online, said :'This quarter's results clearly demonstrate America Online's leadership and

win power."

--- Advertising, Commerce and Other Revenues : Revenues from advertising

commerce and other revenues climbed to $350 million, doubling from $175

million during the year ago quarter.

- Backlog: The Corn an brought its consolidated bacIdog of advertising andcommerce revenue to over 2.0 billion at the end of the arter adding a net ofmore than $500 million since June 30,1999.-

(Emphasis added.)

264. Analysts commented very favorably on the company's financial results. For

example, on October 21, 1999, PR Newswire reported :

"Yesterday, AOL reported Ql:O0 results ahead of consensus expectations,"reported E*Ofering analyst Andrea Williams. "In our opinion, America Onlinecontinues to be the dominant force in interactive media today, with a compellingproduct offering a large and loyal customer base, robust advertising, andsponsorship demand . We believe that AOL remains the company best--positioned for the long term on the Internet"

(Emphasis added.)

265. On October 28, 1999, Business Wire reported that AOL had again declared a two-

for-one split of its common stock and Defendant Stephen Case, AOL's Chairman and Chief

Executive Officer, said :

"We are delighted that we are able to split our common stock for the second timethis year. We are committed to making ownership of our Company accessible tothe average investor, and we are very encouraged by the phenomenal growth inindividual shareholder accounts in the past year. We hope that this latest split willmake it possible for even more people to share in the promising growth of ourComo an and our indus!ly as we enter the 21st Cen "

48194 110

(Emphasis added.)

266. On November 2,1999, the AOL Individual Defendants caused AOL to file its 0_

SEC Form 10=Q for the fiscal quarter ended September 30, 1999 . The Form 10-Q was signed by

Defendants Case and Kelly. It contained substantially the same financial information as th e

October 20,1999 press release, including advertising, commerce, and other revenue of $35 0

million, an increase of 100% from the year ago quarter, and advertising and commerce backlo g

of $2 billion. It also repo rted advertising and commerce revenue of $272 million for the quarter.

In addition, the Form 10-Q assured investors that AOL's financials were prepared in accordance

with GAAP :

The accompanying unaudited condensed consolidated financial statements, whichinclude the accounts of America Online, Inc. (the "Company") and its wholly andmajority owned subsidiaries, have been prepared in accordance with generallyaccepted accounting principles for interim financial information and with theinstructions to Form 10-Q and Article 10 of Reg lation S-X .

267. In fact, AOL's reported advertising and commerce revenue for the quarter ended

September 30, 1999 of $272 million was overstated by at least $77 .4 million , an overstatement of

the actual advertising and commerce revenue by at least 40 %, as a result of AOL's improper

accounting for the Sun ($12 .6 million), Hughes ($48 million) and eBay ($16 .8 million) deals, as

discussed previously . Further, AOL's representation to the public in its October 20, 1999 press

release and the related SEC Form 3 aQ that its advertising revenue backlog as of September 30 ,

1999 was $2 billion was false because the actual backlog was overstated by at least $726 million ,

or 57%, due to the improper accounting of the Sun ($109.2 mill ion), Hughes ($517 million), an d

Monster .com ($100 million) deals.

49194 111

e. The Fiscal Quarter Ended December 31,1999

268. Analysts continued to be impressed with AOL's financial results and projected

excep tional g rowth in AOL advertising revenue, based on AOL 's reported results . For example,

on December 8, 1999, Business Wire reported :

Wit Capital Research Analyst Jordan Roban today increased estimates forAmerica Online (NYSE : AOL). Rohan also reiterated a Buy rating on the sharesof America Online, and increased his 12-18 month target price to $105 per share .In addition, Rohan indicated: "Applying the findings of the updated model, wearrived at a considerably higher (and, we think, still conservative) projection forthe company's advertising and e-commerce revenues . We have increased ourfiscal 2000 advertising and e-commerce revenue estimate to $1 .7 billion from$1 .6 billion. Accordingly, our total revenue estimate has increased to $6 .5 billion

from $6.4 billion in 2000. Similarly, we have raised our 2001 revenue estimateto $8.2 billion from $7.8 billion based on more accelerated growth in e-commerce and advertising revenues than previously anticipated ."

The analyst increased his fiscal 2000 and 2001 EPS estimates to $0 .35 and $0.53per share, from $0 .34 and $0.47, respectively.

(Emphasis added .)

269. On December 17, 1999 Merrill Lynch analyst Henry Blodget similarl y

commented favorably on AOL and, in particular, its growth in revenue from advertising :

He stated that "investors should focus on AOL's pro fit growth, not subscribergrowth or access pricing. They should focus on how much advertising and e-commerce revenue AOL will ultimately be able to receive each month from itscustomers ." Blodgett said that if advertisinglo-commerce increases to $20 ofmonthly revenues per subscriber, than AOL Stock is "under-valued." Blodgetconcluded that "it's reasonable to project that AOL's revenue from advertisingk-commerce will rise to $20 per customer each month in five years ."

(Emphasis added .)

270. On January 10, 2000, the Individual Defendants caused AOL and Time Warner to

issue a joint press release announcing that the board of directors of both companies ba d

unanimously approved a merger agreement to create a new company called AOL Time Warner.

48184 112

271 . On January 19, 2000, the AOL Individual Defendants caused AOL to issue a

press release announcing "record" financial results for the quarter ended December 31, 1999,

including record revenue of $1 .6 billion, 27% of which was advertising, commerce and other

revenue. Business Wire reported:

America Online, Inc. (NYSE: AOL) today announced results for the secondquarter of fiscal 2000 ended December 31, 1999 -- setting new records forconsolidated revenues , advertising and commerce revenues operating incomeand qua rterly membership growth.

Second quarter revenues rose to $1 .6 billion, or 41 % over last year's secondquarter, and advertising, commerce and other revenues reached $437 million,79% over fiscal 1999's December quarter.

Steve Case. Chairman and Chief Executive Officer said: "This is a momentoustime for America Online, as we're announcing the strongest results in ourCompany's history. During the quarter, we achieved record growth in revenuesadvertising and commerce, operating income and subscriber growth - attractingmore than 2 .1 million new AOL and CompuServe members and millions moreWeb users to our family of brands ."

Mr. Case added : "With Time Warner, we are taking a bold step to extend ourleadership as the Internet moves into its next wave of explosive growth. Ourcombined company will be uniquely equipped to take full advantage of theInternet's growth to create value for our shareholders, and we are committed tomaking the most of this opportunity."

Bob Pittman, President and Chief Operating Officer said : "Our operatingperformance this quarter demonstrates that we continue to build enormous valuethrough the creation and development of powerful interactive brands that deliverunmatched benefits to consumers. While our flagship AOL service continues toset subscriber growth and advertising/commerce records in the premium massmarket segment, we're also leading the value segment with CompuServe ."

- Advertising Commerce and Other Revenues : Revenues from advertising,commerce and other revenues climbed to $437 million, an increase of 79% from244 million during the year-ago arter.

-- Backlo : The Com an brought its consolidated backlog of advertising andcommerce revenue to more than $2.4 billion at the end of the quarter .

48184 113

The Company also completed agreements with: Gateway, to acceleratedistribution of each company's products and services including DSL access . . . .

The Company extended its advertising and o-commerce leadership through aseries of agreements during the quarter. Ina four-year, $100-million partnership,Monster.com became the exclusive career-search resource across a range ofAmerica Online brands .

(Emphasis added.)

272. On January 20, 2000, the AOL Individual Defendants caused AOL to file with the

SEC its (parent Report on Farm 8-K dated January 19, 2000 which was signed by Defendan t

Kelly and incorporated AOL's press release ofJanuary 19, 2000 announcing AOL's financial

results for the quarter ended December 31, 1999.

273. On January 20, 2000, The Wall Street Journal praised AOL's reported growth in

advertising revenue and stated that AOL executives had announced high earnings expectations

for the Company following the planned Merger with Time Warner :

Analysts were impressed with AOL's performance in one closely watched area :advertising and commerce revenue . The company said that figure almostdoubled to $437 mi llion from $244 million a year earlier. Advertising andcommerce fees tend to carry a higher profit margin than other areas ofAOL'sbusiness. "We knew it was going to be strong, but it was really, really strong,"James Preissler , an analyst at PaineWebber Inc., said ofAOL's revenue in thatcategory.

AOL offered bullish growth predictions for the new AOL Time Warner, sayingthe Companies' combined earnings before interest, taxes, depreciation andamortization could grow at a 30% annual rate .

(Emphasis added .)

274. On or about February 11, 2000, the AOL Individual Defendants caused AOL t o

file with the SEC its Current Report on Form 8-K dated January 10, 2000 which was signed by

Defendant Kelly and incorporated AOL Time Warner's pro forma consolidated condensed

49184 114

financial statements for the three months ended September 30, 1999, the year ended June 30,

1999, the nine months ended September 30, 1999 and year ended December 31, 1998. The pro

forma consolidated condensed financial statements were materially false and misleading, 0 _

because they included AOL's fraudulently inflated advertising revenue reported for the

respective fiscal periods as discussed herein at IN 248, 264 and 266 .

275. On or about February 14, 2000, the AOL Individual Defendants caused AOL to

file its SEC Form 10-Q for the fiscal quarter ended December 31, 1999 . The Form 10-Q was

signed by Defendants Case and Kelly. It contained substantially the same financial information

as the January 19, 2000 press release, including advertising, commerce, and other revenue o f

$437 million, an increase of 79% from the year ago quarter, and an advertising and commerc e

backlog of $2.4 billion. The Form 10-Q also stated that AOL had $352 million in advertising

and commerce revenue for the quarter ended December 31, 1999, an 87% increase over the year

ago quarter, and commerce and advertising for the six month period ended December 31, 199 9

of $624 million, an increase of 94% over the six months ended December 31, 1998 . In addition,-

the Form 1 O-Q assured investors that America Online's financials were prepared in accordanc e

with GAAP:

The accompanying unaudited condensed consolidated financial statements, whichinclude the accounts of America Online, Inc. (the "Company") and its wholly andmajority owned subsidiaries, have been prepared in accordance with accountingprinciples generally accepted in the United States for interim financia linformation and with the instructions to Form 14-Q and Article 10 of RegulationS-X.

276. In fact, AOL's reported advertising and commerce revenue of $352 million fo r

the quarter and $624 million for the six-months ended December 31, 1999 was overstated by at

least $79.5 million, and $156.9 million, respectively, or in percentage terms, an overstatement of

the actual adver tising and commerce revenue by at least 29% and 34%, respectively. AOL's

48184 115

reported advertising, commerce and other revenue was similarly overstated by $79.5 mi llion and

$156.9 million for the three and six-month periods, respectively. The overstatement of $79 .5

mi llion during the quarter was due to AOL's improper accounting of the Sun ($12.6 mil lion), a_

Hughes ($48 million), Monster com ($2 .1 million) and eBay ($16.8 million) deals, as discussed

above. In addition, the overstatement of at least $156 .9 million during the six-months ended

December 31, 1999 is att ributable to AOL's improper accounting for the Sun ($25 .2 million) ,

Hughes ($96 million), Monster .com ($2.1 million) and eBay ($33 .6 million) deals, as discussed

above.

277. Further, AOL's representation to the public in its press release of January 19,

2000 and the related SEC Form 10-Q filing that its advertising revenue backlog as of Decembe r

31, 1999 was $2.4 billion was false because the actual backlog was overstated by at least $1 .2

billion, or at least an outrageous 101°/0, due to the improper accounting of the Sun ($96.6

million), Hughes ($469 million), Monster.com ($97.8 million), and Gateway ($541 .5 million)

deals .

f The Fiscal Quarter Ended March 31 .2000

278. On April 3, 2000, Dow Jones News Service again reported that ING Barings LLC

market analyst Youssef Squall, based on AOL' s prior financial results , predicted s trong revenue

growth at AOL, driven by growth in the Company's advertising and commerce revenue:

America Online's subscription growth is remarkable . . . . But the growth story aterica Online is the way it takes advantage of its large customer : by charging

other companies to advertise and conduct electronic-commerce on its proprietarynetwork. Squali estimated that revenue from advertisinWe-commerce rose 71 % to$470 million from $275 million a year earlier .

Including sales of business software, overall revenue at America Online shouldrise 38% to $1 .72 billion in the third quarter from $1 .25 billion a year earlier,Squall said. America OnIine's earnings were expected to rise to 9 cents a sharefrom 4 cents a share a year ago, excluding one-time items .

49184 116

(Emphasis added.)

279. On April 3, 2000, the AOL Individual Defendants caused AOL to file with th e

SEC its Current Report on Form 8-K dated April 3, 2000, that incorporated AOL Time warner

pro forma consolidated condensed financial statements for the six months ended December 31 ,

1999, the year ended June 30, 1999, and the year ended December 31,1999 . The pro form a

consolidated condensed financial statements were materially false and misleading, because the y

included AOL's fraudulently inflated advertising revenue reported for the respective fiscal

periods, as discussed herein at 11260, 276 and 277.

280. On April 18, 2000, the AOL Individual Defendants caused AOL to issue a press

release, again announcing "record" financial results for the quarter ended March 31, 2000, an d

soundly beating analyst predictions of advertising, commerce and other revenue by over $10 6

million. As reported by Business Wire :

America Online, Inc . (NYSE: AOL) today announced record results for the thirdquarter of fiscal 2000, ended March 31, 2000 -- reaching new highs forconsolidated revenues, advertising and commerce revenues, operating income,and EBITDA .

The quarter's net income, fully taxed and excluding one-time items, totaled $271million, or $0.11 per diluted share, up from $104 million, or $0 .04 per, dilutedshare, on the same basis last year. The Company reported net income of $438million, or $0.17 per diluted share, up from $411 million, or $0 .16 per dilutedshare, in fiscal 1999's third quarter. Reported net income included one-timegains from the sale of investments totaling $275 million this quarter and $567million in last year's third quarter. The year-ago quarter also includes one-timecharges of $103 million . Excluding these items, operating income for the quarterclimbed more than 155% over the year-ago quarter to $383 million .

Third quarter revenues rose to $1 .8 billion, or 47% over last year's March quarter .Advertising, commerce and other revenues climbed 103°/a over fiiscal 1999'sthird quarter to $557 million - marling a record $120 million increase, or 27% .over this year's second quarter.

48184 117

Steve Case, Chairman and Chief Executive Officer, said: 'This quarter 's resultsunderscore the tremendous strength ofAmerica Online 's opera tions, anddemonstrate that we are on a clearpath to continued strong growth and increasedprofitability. Since we announced our landmark merger with Time Warner, wehaven 't missed a beat"

Bob Pittman, President and Chief Operating Officer, said: "This quarter is anexcellent example of how America Online is uniquely positioned in the Internetindustry. We have built an unmatched collection of interactive brands, whichwill be further enhanced by the Time Warner merger, and we have anunparalleled connection to consumers . We're taking online advertising andcommerce to new heights. yet we've barely scratched the surface in terms of theimpact our medium can have."

Key operating metrics from the quarter included :

-- Backlog: The Company brought its consolidated backlog of advertising andcommerce revenue to more than $2 .7 billion at the end of the quarter, up from$2.4 billion on December 31,19 .9

Working closely together in anticipation of their merger, America Online andTime Warner this quarter launched a number of cross-promotional agreementsinvolving their world-class brands .

Extending its advertising and commerce leadership, the Company announced aseries of significant advertising/commerce alliances this quarter with such marketleaders as General Motors, American Airlines, Sears, Kinko's, Footlocker-corn,Oxygen Media, and PurchasePro.com.

(Emphasis added.)

281 . The press release was included in AOL's Current Report on Form 8-K dated April

18, 2000 and signed by Defendant Kelly that was filed with the SEC on April 21, 2000 .

282. On April 18, 2000, in commenting upon AOL's just released financial results ,

Dow Jones News Service stated :

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Advertising and electronic-commerce activity soared in America Online , Inc.'s(AOL) third quarter, helping the company soundly beat analysts ' earningsexpectations.

We saw across-the board, and across all brands , strong growth in advertising andcommerce, revenue, said [Defendant) Michael Kelly, AOL's Chief FinancialOfficer.

283 . On April 21, 2000, a Dow Jones News Service article, titled "Tech Week in

Review", likewise reported AOL's very strong advertising and commerce revenue g rowth. It .

also noted that a J.P. Morgan analyst warned investors to stay away from most internet stocks,

but continued to rate AOL a top recommendation . .

Earnings reports were strong throughout the week . . . . . America Online, Inc.'s netincome advanced 7% on growth in advertising and its electronic-commercebusiness, underlining its emergence as a media force.

I .P. Morgan Securities Inc. analyst Susan Walker White warned investors to stayaway from consumer-oriented Internet stocks this summer. In a 50-page reportreleased Friday, White lowered price targets for most of the stocks in he rcoverage area.

White's too recommendations include America Online, Inc . . . . White maintainedher 12-month price target of $90 million for America Online. . . .

(Emphasis added.)

284. On or about May 15, 2000, the AOL Individual Defendants caused AOL to file its

SEC Form 10-Q for the fiscal quarter ended March 31 , 2400. On May 17, 2440, the AOL

Individual Defendants caused AOL to file a SEC Form 10-Q/A for the period ended March 31 ,

2000 . Both the Form 10-Q and 14-Q/A were signed by Defendants Case and Kelly. Both the

Form 10-Q and Form 14-QIA contained substantially the same financial information as the Apri l

18, 2000 press release, including advertising, commerce and other revenue of $557 million, a

103% increase from the year ago quarter, and $2.7 billion in advertising and commerce backlog.

The Form I O-Q and Form 10-Q/A also stated that AOL had $463 million in advertising an d

48184 119

commerce revenue, a 119% increase over the year ago quarter, and $1,087 million in advertisin g

and commerce revenue for the nine months ended March 31, 1999, a 104% increase over the

nine months ended March 31, 1998 . In addition, both the Form 10-Q and the Form 10-Q/A

assured investors that America Online' s financials were prepared in accordance with GAAP:

The accompanying unaudited condensed consolidated financial statements, whichinclude the accounts of America Online, Inc. (the "Company' or "AmericaOnline") and its who lly and majority owned subsidiaries, have been prepared inaccordance with accounting principles generally accepted in the United States forinterim financial information and with the instructions to Form I 0-Q and Article10 ofRegulation 5-X.

285. In fact, AOL's reported advertising and commerce revenue of $463 million for

the quarter and $1.1 billion for the nine-months ended March 31, 2000 was overstated by at least .

$168.6 mi llion, and $325.5 million, respectively, or on a percentage basis, an overstatement o f

the actual advertising and commerce revenue by at least 57% and 43%, respectively, as a resul t

of AOL' s improper accounting. The overstatement of $168.6 million during the quarter was due

to AOL's improper accounting for the Sun ($12.6 million), Hughes ($48 million), Monster.com

($6.2 mill ion), Gateway ($ 85 mil lion) and eBay ($16.8 million) deals, as discussed above. The

overstatement of at least $325 .5 million during the nine months ended March 31, 2000 was du e

to AOL's improper accounting for the Sun ($37.8 million), Hughes ($144 million), Monster.com

($8.3 million), Gateway ($85 million) and eBay ($50.4 million) deals, as discussed above .

286. Further, AOL's representation to the public in its press release dated April 18 ,

2000 and the related SEC Forms 10-Q and 10-Q/A filings that its advertising revenue backlog as

of March 31, 2000 was $2 .7 billion was false. The actual backlog was overstated by at least $1 . 1

bi llion, or at least 73%, due to the improper accounting of the Sun ($84 million), Hughes ($42 1

mill ion), Monster . com ($91 .5 million), Gateway ($456.6 million), DrKoop .com ($9.6 million)

and Homestore .com ($79.4 million) deals.

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287. The SEC Form 14 -QIA for the quarter ended March 31 , 2400 also reiterated th e

advertising and commerce revenue and advertising backlog previously reported for the yea r

ended June 30,1999 , again overstating AOL's financial results for the period, as previously

discussed herein in 1260.

288. On February 11, 2000 the Company filed the Merger Registration Statement as

amended on March 24, 2000, April 25, 2000, May 18, 2000 and May 19, 2000, which containe d

or incorporated by reference all items referenced in ¶¶ 648 and 652-660, including the Merger

Agreement, historical AOL financial data, pro forma consolidated financial data of AOL Time

Warner, including AOL Time Warner' s consolidated balance sheet as of March 31, 2000, and

Ernst & Young's unqualified audit reports as referenced in ¶ 657, all of which were materially

false and misleading for the reasons set forth in 661-667 .

289. Unaware of the concealed adverse information discussed herein, the shareholder s

of AOL and AOL Time Warner voted to approve the Merger of the two companies on June 23 ,

2000.

g. The Fiscal Quarter and Year Ended June 30, 200 0

290. On July 6, 2004, Dow Jones News Service reported that, despite the collapsing

internet advertising market, AOL was expected to report another record-breaking quarter.

Many smaller Internet companies ran into cash problems during the quarter endedJune 30, causing them to cut back on advertising spending . In turn, this had adomino effect on other Internet companies, in particular those that collect the bulkof their revenue by selling advertising on their Web sites .

But don 't expect the cutbacks to have much of an effect on the leaders in theonline advertising markeLAmerica Online Inc. GAOL) and Yahoo! Inc. (MOO) .These corn anies have large and diversified rtfolios of ad customers, whichabsorbed the lost business from struggling "dot-corn" firms, analysts sax.

48184 121

America Online, Dulles, Va ., should report revenue from advertising andelectronic-commerce of $557 million for its fourth quarter ended June 30,Newman estimated. That represents an 82% surge from the $306 million reporteda year earlier. W-

(Emphasis added)

291 . Two weeks later, on July 19, 2000, Dow Jones News Service reported that, based

on AOL 's prior financial results, expectations for AOL's advertising and commerce revenue an d

earnings were very high, notwithstanding the weakness in the internet advertising market:

Buoyed by strong advertising and electronic-commerce revenue, America Online,Inc. (AOL) is expected to post fourth-quarter earnings ahead of the analysts'consensus estimate.

A First CaRrIhomson Financial survey of 30 analysts predicted that the Dulles,Va., Internet service provider would post earnings of 11 cents a share for thequarter ended June 30, up from 6 cents a share year ago . America Online, theworld's largest ISP, is scheduled to report results after the market closesThursday.

But analysts expect the company to continue its lengthy streak of beatinganalysts' expectations. Merrill Lynch analyst Henry Blodget, for example, saysit's possible the company will post earnings of 12 cents a share. Some so-called"whisper number" estimates, which purport to be more accurate than formalestimates, put fourth-quarter net as high as 13 cents a share . In recent quarters,AOL has beaten estimates by at least a penny per share .

America Online, which plans to close its acquisition of media giant Time WarnerInc. {TWX) in the fall, had a strong quarter despite reports of softness in theonline advertising, market, analysts say. The demise or near-demise of smallerInternet companies prompted many of them to slash their online advertisingbudgets . But top Web site operators like America Online were mostly immune tothe crunch . . . . Squall estimated America Online's fourth-quarter revenue fromadvertising and e-commerce operations rose 96% from last year to $599 million .Overall revenue, which includes Internet-access subscriptions and businesssoftware sales, should come in at $1 .95 billion, up 42% from a year earlier.

(Emphasis added . )

292. On July 19, 2000, Associated Press Newswires reported that Ken Kiarash, a n

analyst with Buckingham Research Group, said : "I don't think [AOL's] advertising revenue ha s

48184 122

peaked yet. The issue is how fast they will be able to grow that line, which I think i s crucial to

this company's success." [Emphasis added . )

293. In July 20, 2000, the AOL Individual Defendants caused AOL to announce record

financial results for the quarter ended June 30, 2000, again surpassing analysts' expectations fo r

advertising, commerce and other revenue and meeting the `whisper" number for earnings per

share . The Dow Jones News Service reported:

America Online, Inc.'s (AOL) fourth-quarter results beat analysts' expectations,helped by strong advertising revenue and lower network operation costs .

The Dulles, Va., Internet service provider reported earnings excluding charges of13 cents a share for the quarter ended June 30, up from 6 cents a share a yearearlier and ahead of the analysts' consensus estimate of 11 cents a share .Revenue rose to $1.93 billion from $1.38 billion a year ago.

The company's fourth-quarter revenue from advertising and electronic commercejumped 95% from a year ago to $609 million, ahead of most analysts estimates .

The numbers showed that AOL weathered what some analysts expected would bea slump in online adver tising during the quarter .

America Online President and Chief Operator Officer Bob Pittman said thecompany's outlook for advertising revenue was strong. He pointed to AOL'srecent deals with top advertisers like Target Corp . (TGT), Coca-Cola Co. (1(0)and Ci tigroup Inc . (C) .

In addition, America Online's backlog of adyertising/e-commerce revenue rose to$3 billion at rune 30 from $2.7 billion at March 31 . The backlog represents theamount of revenue the company expects to receive in future quarters under theterms of contracts that have already been signed .

"We're getting more advertising dollars than anyone except the top fourtelevision networks." Pittman said during Thursday 's conference call .

Kelly said AOL and Time Warner were on pace to meet financial targets for thecombined company. He said AOL Time Warner expects to post revenue of morethan $40 billion in 2001, representing an annual growth rate of 12% to 15% .

*t *

48184 123

"Clearly, we are on our way to mating our financial objectives a reality ," he said .

Pittman said AOL Time Warner would be an advertising behemoth. He said thatonly four advertisers are on both companies' respective lists of top 10Oadvertisers

. (Emphasis added.)

294. On July 20, 2000, Dow Jones News Service reported that in an interview with

Defendant Case after AOL reported its fourth quarter earnings , Case emphasized that investors

need not be concerned that the online advertising slump would lower AOL advertising revenue:

. . . Case said "all our-numbers were at or above consensus estimates ." AOL'searnings of 13 cents a share, excluding items, beat the consensus by 2 cents ashare. Case said AOL's fourth-quarter results were helped by strong advertisingand electronic-commerce revenue, a development that should reassure investorswho had feared that a "dot com" shakeout would hurt the online advertisingmarket. -

(Emphasis added .)

295. On or about September 22, 2000, the AOL Individual Defendants caused the

Company to file its SEC Form 10-K for the Company's fiscal quarter and year ended June 30,

2000. On October 30, 2000, the AOL Individual Defendants caused AOL to file a SEC Form

1 D WA for the fiscal quarter ended June 30, 2000. Both the Form 10-K and Form 10-KIA were

signed by, inter alia, Defendants Case, Pittman and Kelly. Both the Forms 10-K and 10-K/A

contained substantially the same financial information as the July 20, 2000 press release ,

including advertising, commerce, and other revenue of $609 million for the quarter, and

advertising and commerce backlog of $3 bill ion . Both the Forms 10-K and 10-KIA also stated

that AOL had $ 1 .6 bi ll ion in advertising and commerce revenue in fiscal 2000, an increase of

107% over - scal 1999, as well as $1,986 million of advertising, commerce, and other revenue i n

fiscal 2000.

48134 124

296. Both the Forms 10-K and 10-K/A also incorporated, with Defendant Ernst &

Young's consent, the July 20, 2000 report of Defendant Ernst & Young which assured investor s

that the Company's financials were audited in accordance with GAAS and in compliance with 0-

GAA.P :

We conducted our audit in accordance with auditing standards generally acceptedin the United States . . . . We believe that our audits provide a reasonable basis forour opinion .

In our [Ernst & Young] opinion, the financial statements referred to abovepresent fairly, in a ll material respects, the consolidated financial position ofAmerica Online, Inc. at June 30, 2000 and 1999, and the consolidated results ofits operations and its cash flows for each of the three years in the period endedJune 30, 2000, in conformity with accounting principles generally accepted in theUnited States .

297. In fact, AOL's reported advertising and commerce revenue of $513 million for

the quarter and $1 .6 billion for the year ended June 30, 2000 was overstated by at least $166 .7

million, and $492.2 million, respectively, or in percentage terms, an overstatement of the actual

advertising and commerce revenue by at least 48% and 94%, respectively, as a result of AOL's

improper accounting . Likewise, AOL's advertising, commerce, and other revenue-for the quarter

and year ended June 30, 2000 of $609 million and $1 .986 billion, respectively, was overstated by

at least 38% and 33%, respectively. The overstatement of at least $166 .7 million for the quarter

was due to AOL's improper accounting of the Sun ($12 .6 million), Hughes ($32 million),

Gateway ($85 million), Homestore ($4 .4 million), DrKoop.com ($9.6 million), Monster.com

($6.2 million) and eBay ($16 .8 million) deals, as discussed above . The overstatement of at least

$492.2 million for the year ended June 30, 2000 was similarly due to AOL's improper

accounting of the Sun ($50 .4 million), Hughes ($176 million), Gateway ($170 million),

Homestore ($4.4 million), DrKoop .com ($9.6 million) Monster.com ($14 . 6 million) and eBay

($67.2 million) deals, as discussed above .

48194 125

298. Further, AOL's representation in its July 20, 2000 press release and its related

SEC Form 10 -K and Form 10-K/A filings that its advertising revenue backlog as of June 30,

2000 was $3 billion was false because the actual backlog was overstated by at least $1 billion, or --

52%, due to the improper accounting of the Sun ($71 .4 million), Hughes ($389 million),

Monster.com ($85.3 million), Homestore.com ($75 million), Gateway ($371 .7 million),

Ticketmaster ($13 million) and 24dog s.com ($23.7 million) deals, as discussed previously.

299. Both the Form 10-K and 10-KIA incorporated by reference the Merger

Agreement between AOL and Time Warner, which contains false representation and warranties

by AOL, as discussed herein at % 667

300. Both the Form 10-K and 10-KIA for the fiscal quarter and year ended June 30,

2000 also stated that the advertising, commerce and other revenue for the quarter ended Marc h

31, 2000 was $11 million more than originally reported due to a merger, again overstating

AOL's advertising, commeice and other revenue for the quarter ended March 31, 2000, a s

discussed previously in 71285-286 .

h. The Fiscal Quarter Ended September 30, 200 0

301 . The Washington Post reported in an article of July 18, 2002, titled

"Unconventional Transactions boosted Sales," that by at least August 2000, AOL executives ,

including Defendant Colburn, knew that various advertising customers of the Company were

experiencing financial problems that jeopardized existing AOL advertising agreements .

Sometime in September 2000, i nternal AOL documents showed that AOL was "at risk" to lose

more than $108 million in advertising revenue for the 2001 fiscal year (July 2000-2001) due to

the many failing dot- com companies. This estimate quickly increased within the Company .

Indeed, at the beginning of October 2000, Bob O'Connor, then AOL's Vice President of Finance

49384 126

for its advertising division , warned Defendant Pittman and several other Company executives

that AOL was at risk of losing $140 million in advertising revenue in the 2001 calendar year

because many internet companies which had advertising contracts with AOL were failing. the --

Washington Post ar ticle also reported that AOL considered suing the fai ling dot-com companies,

but chose not to do so "because the public fi lings would show some weakness in its business ."

302. On October 18, 2000, the Dow Jones News Service reported that analysts were

concerned about the potential impact of the internet advertising slump on AOL's advertising

revenue, the Company's fastest growing and most profitable revenue source :

America Online, Inc. (AOL) is expected to meet, and possibly beat, analysts'earnings estimates when it reports first-quarter results Wednesday.

The Dulles, Va., Internet service provider, should post earnings of 13 cents ashare, excluding special items, for the quarter ended Sept . 30, according to a FirstCalllxhomson Financial survey of 28 analysts . . . .

AOL usually beats the analysts' consensus estimate by a penny or two a share .Some analysts, however, appear a little less certain that the results in the latestfirst quarter will beat estimates as soundly as in previous quarters .

Merrill Lynch analyst Henry Blodget said in a research note Tuesday that it's

possible AOL would beat the consensus by a penny, but "it's not expected." ING

Barings analyst Youssef Squall said "there's a good chance" AOL will beat the

mean estimate. J .P. Morgan analyst Susan Walker White sees "s light upside."

Advertisingle-commerce is the segment that has generated nervousness among

investors . While it represents a minority ofAOL's overall revenue, it is thecompany's fastest-growing, and most profitable, segment. In recent weeks,concerns about a slowdown in online advertising spending have hit Web portalssuch as Yahoo ! Inc . (YHOO) . The concerns fnally caught up to AOL Tuesday,

with its shares falling 17% .

(Emphasis added . )

303. However, once again , AOL's reported numbers beat analysts' estimates by a

penny a share. On October 18, 2000 , the AOL Individual Defendants caused AOL to issue a

press release announcing "Record-Breaking Results for FY2401 First Quarter . . . Advertising,

48184 127

Commerce and Other Revenues Jump 80% to $649 Million ." These financial results were for

the last publicly reported fiscal period prior to the consummation of the Merger . As the press

release reported :

America Online, Inc. (NYSE: AOL) today reported results for its fiscal first

quarter ended September 30, 2000 - reaching new highs for consolidated

-revenues, advertising, commerce and other revenues , operating incom. EBITDA

and first-quarter AOL membership growth.

The quarter's net income, fully taxed and excluding one-time items, totaled $350

million, or $0.14 per diluted share, up from $182 million, or $0 .07 per dilutedshare, on the same basis last year the Company reported net income of $345

million, or $0.13 per diluted share, up from $181 million, or $0 .07 per diluted

share, in fiscal 2000's first quarter. Reported net income included onetime

merger-related charges of $6 million . Excluding these items, operating incomefor the quarter climbed more than 86% over the year-ago quarter to $484 million .

The quarter's consolidated revenues climbed 34% to $2 .0 billion from $1.5

billion in last year's first quarter. Advertising, commerce and other revenues

reached a record $649 million climbing 80% over fiscal 2000's corresponding

quarter.

Mr. Pittman added: "Our distinctive strategy of focusing on large strategicmarketing agreements with major mainstream companies is paving off in the

continuing stren of our advertising and commerce revenues, which will

substantially benefit from the merger. Our advertising and commerce growthprospects are underscored when you look at the top 100 advertisers each for TimeInc., Turner Networks and AOL, and find that only four out of the 300 are

d licated on all three lists.

Other operating highlights from the quarter include: Revenues from subscriptions

increased to $1 .2 billion, a 21 % rise over the fiscal 2000 first quarter, advertisingcommerce and other revenues climbed to $649 million, increasing more than80% over last year's co ndin arter and the consolidated backlog oadvertising and commerce revenues grew to more than $3 .0 billion at September

30, 2000, from $2.0 billion a year earlier.

(Emphasis added .)

304. In a conference call with analysts on October 18, 2000 following the release o f

the quarterly results, then AOL President, Defendant Pittman , responded to a question regarding

481S4 128

whether AOL was feeling the effects of an industry-wide slowdown in advertising as follows: "I

don't see it and I don't buy it" (Emphasis added .) In the same telephone conference, Defendant

Stephen Case, AOL's Chairman and Chief Execu tive Officer at the time , said "AOL's

advertising growth is right on target . . . The current advertising environment benefits us because

it will drive a flight to quality." (Emphasis added..) Defendant Michael Kelly, then AGL's Chief

Financial Officer, similarly characterized AOL's advertising and commerce revenue growth as

"very healthy" and emphasized, "1 can 't save that strongly enough ." Kelly reiterated his prior

predictions that AOL Time Warner's revenue wi ll rise 12% to 15% annually and the merged

company's EBITDA would rise 30% in the Company's first year. (Emphasis added .)

305. The market responded very favorably to the midday financial statements released

by AOL on October 18, 2000, and the stock rose over 7% to $46.91 per share at the close of the

market on October 18, 2000, up from a price of $43 .60 per share at the close of the market on

October 17, 2000.

306. In an October 19, 2000 research note, Mary Meeker, an analyst at Morgan Stanley ,

commented on ACL's advertising revenue : "This has developed quickly into AOL' s fastest

growing revenue stream and a key element of growth going forward ." At about the same time,

Christopher Dixon, a PaineWebber Inc . analyst, wrote that AOL's strong advertising and

commerce revenue "should alleviate some concerns about the health of the Internet advertising

environment ."

307. On October 19, 2040, ING Barings LLC analyst, Youssef H. Squall , reiterated his

"strong buy" rating noting the Company's "[s]olid advertising revenues . . . ."

308. On October 23, 2000, The Wall Street Journal reported that "[i]nitially, AOL

shareholders wondered if the link [with Time Warner]would weigh down the company's risin g

48194 129

stock. Now, a solid affiliation with a traditional company seems a good bet for the future . Of

course , AOL is also greatly helped by its reliable earnings and its sustained domination of online

access ." (Emphasis added.)

309. On or about November 2, 2000, the AOL Individual Defendants caused AOL to

issue its 1999 Annual Report for the fiscal year ended June 30, 1999, in which Defendants Cas e

and Pittmanf touted AOL's remarkable advertising revenue growth:

In short, we are pleased to say that America Online has never been stronger. Ourfiscal 1999 highlights include . . . . Advertising, commerce and other revenuesclimbed 84% to $1 billion, with a backlog of committed revenue of $1.5 billion.

During fiscal 1999, we signed 58 mul ti-year advertising and commerceagreements , each worth in excess of $1 million .

The 1999 Annual Report also appended AOL's SEC Form I O-K for the fiscal quarter and yea r

ended June 3% 1999 filed August 13, 1999. For the reasons discussed previously in 1250, the

Form I0-K and related statements regarding AOL's advertising revenue for the quarter and year

ended June 30, 1999 were materially false and misleading.

310. On November 9,20-00, the AOL Individual Defendants caused AOL to file its

SEC Form 10-Q for the fiscal quarter ended September 30, 2000. The Form 10-Q was signed by

Defendants Case and Kelly . It contained substantially the same financial information as th e

October 18, 2000 press release, including $649 million in advertising, commerce and other

revenue, an 80% increase over the year ago quarter, and a $3 billion advertising and commerce

backlog. The Form I O-Q also stated that AOL had $534 million in advertising and commerce

revenue, a 95% increase over the year ago quarter . In addition, the Form 10-Q assured investors

that AOL's financials were prepared in accordance with GAAP :

The accompanying unaudited condensed consolidated financial statements, whichinclude the accounts of America Online, Inc . (the "Company") and its wholly

48184 130

owned subsidiaries, have been prepared in accordance with generally accepted

accounting principles for interim financial information and with the instructionsto Form 10-Q and Article 10 of Regulation S X.

311 . In fact, AOL's reported advertising and commerce revenue for the quarter ended '-

September 30, 2000 of $534 million was overstated by $156 million, an overstatement of the

actual advertising and commerce revenue by at least 41 %, as a result of AOL's improper

accounting for the Sun ($12 .6 million), Gateway ($85 mi llion), 24dogs .com ($16 . 2 million),

Homestore ($6.6 million), Monster.com ($6 .2 million), Ticketmaster ($13 mi ll ion) and eBay

($16.8 mill ion) deals, as, discussed above . For the same reasons , AOL's reporting of advertising,

commerce and other revenue was likewise overstated by $156 million for the quarter. The

Company has already admitted overstatement of $66 mil lion of AOL advertising and commerce

revenue for the quarter ended September 30, 2000, based on its restatement of the quarter's resul t

in the SEC Form 8-K filed October 23, 2002 .

312. Further, AOL's October 18, 2000 press release and related SEC Form 10-Q filing

stating that its advertising revenue backlog as of September 30, 2000 was $3 billion was false

because the actual backlog was overstated by at least $1 billion, or by at least 51%, due to the

improper accounting of the Sun ($58.8 million), Hughes ($389 million), Homestore .com ($68.4),

Gateway ($286 .8 million), 24dogs .com ($7.5 million), Veritas ($20 million), Telefonica SA ($15

million), PurchasePro ($41.4 million) and WorldCom ($48.9 million) deals.

313. The statements made by Defendants Case, Pittman and Kelly to market analysts

on the conference call of October 18, 2000, as reproduced above, are also false and misleading

for the same reasons, and were particularly egregious in light ofthe internal AOL informatio n

showing that $140 million of AOL advertising revenue was "at risk" for the following calendar

year.

48194 131

314. On October 30, 2000 the AOL Individual Defendants caused the Company to fil e

a SEC Form 10-KIA for the quarter and fiscal year ended June 30, 2000 in which the Company

reiterated the advertising and commerce revenue and advertising and commerce backlog a--

previously reported for the quarter and year ended June 30, 2000, again overstating AOL' s

financial results for the period, as previously discussed in IN 296-297, herein.

The Fiscal Quarter and Year Ended December 31, 2000

315. On January 11, 2001, the Individual Defendants caused the Company to issue a

press release announcing that the Merger between AOL and Time Warner bad been complete d

that day, creating AOL Time Warner.

316. One day alter the Merger was consummated, on January 12, 2001, The Wall

Street Journal reported that despite the weakening advertising market, AOL Time Warner wa s

standing by its revenue targets for the merged company and that advertising and e-commerc e

would remain the fastest growing revenue source for the Company:

Mike Kelly, AOL's chief financial officer and holder of the same title at the newcompany, said yesterday that executives are sticking by their targets„ which callfor revenue to g row by 12% to 15% to total more that $40 billion in 2001, and forearnings before interest, taxes, deprecia tion and amortization to rise about 30% to

$1 I bill ion. He added that the new AOL Time Warnerhad alwa Tanned toaggressively look for cost savings and ways to generate extra revenue .

Analysts' concerns intensified last month after Time Warner warned that itsfourth-quarter earnings would be hurt by weaker ad revenue . . . . At theAOL said its fourth-quarter advertising and online commerce revenues were "on-track" to meet Wall S treet expectations .

Mr. Kelly said yesterday he s ti ll expected advertising and e-commerce "would beour fastest- owin revenue corn anent."

(Emphasis added.)

317. On January 12, 2001, the Individual Defendants caused the Company to file an

SEC Form 8-K dated January 11, 2001 and signed by Defendant Cappuccio that incorporated th e

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Merger Agreement between AOL and Time Warner, which contains false representations and

warranties by AOL as discussed herein at 1667.

318. On January 13, 2001 , The Los Angeles dimes repo rted that AOL Co-Chief *-

Operating Officer, Defendant Pittman, indicated that softness in the advertising market woul d

not hurt AOL's advertising revenue . As The Los Angels Times quoted Defendant Pittman:

"In the advertising world, you hear people say there's a slowdown . But it's notacross the board . When [buyers] cut back, they don't cut back on their primary adbuys, which provide a big reach. Turner Networks, WB and the Time magazinegroup all fit into that category. . . . Also, if you do have a slowdown in traditionalmedia and there's open inventory on our existing media properties, we're a majoradvertiser ourselves. We're No. 7 in the country in advertising-sales. We havethe -ability to .take our own ads and put them on our own properties, so we can fill.up the slack there."

(Emphasis added .)

319. On January 26, 2001, the Individual Defendants caused the Company to file an

SEC Form 8-K/A dated January 11, 2001 . The Form 8-K/A was signed by Defendant Kelly and

James Barge and incorporated the AOL Time Warner consolidated balance sheet as of

September 30, 2000 and AOL Time Warner's pro forma conso lidated condensed financial-

statements for the three months ended September 30, 2000, year ended June 30, 2000 and yea r

ended December 31, 1999, which were materially misleading because they incorporated the

fraudulently inflated AOL advertising revenue for the respective fiscal periods, as discusse d

herein at 11 276-277, 297-298 and 311-312 .

320. Similarly, on January 26, 2001, the Individual Defendants caused the Company to

file its SEC Form 8-K/A amending its SEC Form 8-K dated January 18, 2001 that updated the

financial results for the quarter ended September 30, 2000 and reiterated the advertising an d

commerce revenue and advertising and commerce backlog previously reported for the quarter ,

again overstating AOL's financial results for the period, as discussed herein in 11311-312.

48194 133

321 . On January 31, 2001, the Individual Defendants caused the Company to report th e

first financial results since the Merger was constrnmated, including "all-time records" in AO L

advertising revenue. The press release stated :

AOL Time Warner Inc . (NYSE: AOL) today reported record December quarterresults for America Online , Inc. and pro forma results for the combinedCompany's December quarter and fu ll year. In addition, the Company releasedthe results for Time Warner Inc.'s December quarter and full year.

As a result of the ACL Time Warner merger, the Company is reporting the resultsof America Online, Int .'s December quarter and AOL Time Warner's pro formaquarter and full year ended December 31, 2000.

In the December quarter, America Online reported all-time records in-revenues,advertising, commerce and other revenues a tin income EBITDA and AOLmembership growth.

The Company's net income, fully taxed and excluding one-time events, climbed67% to a record $365 million, or $0.15 per diluted share, up from $219 million, or$0.09 per diluted share, on the same basis last year. Including non-cash chargesof $535 million related to write-downs of various investments, the Company'sreported net income was $37 million, or $0 .01 per diluted share . On the samebasis in the year-ago quarter, reported net income was $280 million, or $0 .11 perdiluted share .

America Online's December quarter revenues climbed 27% to nearly $2 .1 billionfrom $1 .6 billion in the year-ago quarter. Advertising, commerce and otherrevenues reached a record $741 million, climbing 65% - over last year'scorresponding quarter.

Further, AOL operating highlights from the quarter include :

Advertising & Commerce Revenues: Revenues from advertising and commerceclimbed to $686 million, increasing 71 % over last year's correspondingquarter. . . .

AOL Time Warner Pro Forma Results :

Driven by strong performances at America Online, Cable, Publishing andNetworks, AOL Time Warner' s p ro forma 2000 revenues rose 11 % to $36.2bi llion , and adjusted EBITDA increased 19% to $8 .4 billion . That compares to1999's $32.5 billion in revenues and $7.0 b il lion in adjusted EBITDA. AOL

48184 134

Time Warner's 2000 adjusted diluted cash earnings per common share climbed32% to $0.94, compared to $0 .71 in 1999. The Company's subscription revenuesincreased 13% to $14.7 billion, and the Company finished the year with 130million subscriptions, an increase of 16% over the prior year. Fa-advertising and commerce revenues increased 24% to more than $8.7 billion.

For the December quarter, AOL Time Warner's revenues rose 8% to $10 .2 billion,and adjusted EBITDA increased 14% to $2.4 billion. That compares to $9 .5billion in revenues and $2 .1 billion in adjusted EBITT]A in last year'scorresponding quarter. Subscription revenues increased 11% to $3 .8 billion,compared to $3.5 billion in 1999's December quarter, and advertising andcommerce revenues increased-14%14% to $2.6 billions compared to the year-agoquarter's $2 .3 bi ll ion. AOL Time Warner's December quarter adjusted diluted,cash earnings per common share climbed 17% to $0.28, compared to $0 .24 in1999.

(Emphasis added.)

322. On January 31, 2001, Dow Jones News Service reported that AOL Time Warner' s

first reported financial results included strong AOL advertising and commerce revenue, despit e

the depressed online advertising market :

AOL's revenue from advertising and electronic-commerce was strong-rising 55%to $741 mill ion exceeding the expecta tions of many analysts. The performanceshowed that AOL was more than able to weather an overall soft market for onlineadvertising.

"AOL's online advertising and commerce platform is alive and well ," said WitSoundview analyst Jordan Rohan . "The unit 's 741'million in revenue impliesthat despite being more than twice the size of Yahoo, AOL is U~tw g morequickly, and gaining market share."

. . . AOL Time Warner Co-Chief Operating Officer Bob Pittman said thecorn an can prosper even in a soft ad market and a broader economic slowdown .

(Emphasis added.)

323. On January 31, 2001, Dow Jones Business News reported that the strong revenue

growth for the merged Company's first quarter was boosted by a remarkable increase in

advertising, commerce and other revenue :

48184 135

Pro-forma revenue rose 8.1 % to $10.23 billion . AOL Time Warner at tributed theincrease to strong performances from its America Online cable , publishing andnetworks businesses .

"We are seeing exciting momentum in our subscription and advertisingJcommercebusinesses across the company, " Bob Pittman, co-chief operating officer, said in aprepared statement.

AOL's revenue rose 27% to $2.06 billion, boosted in part by a 65% jump inrevenue from adver tisin% commerce and related ac tivities.

(Emphasis added .)

324. On January 31, 2001, Dow Jones News Service reported :

AOL Time Warner Inc. (AOL) Chief Financial Officer J. Michael Kelly reiteratedthe Company's ambitious 2001 owth targets Wednes d

In a meeting with analysts here after reporting fourth-quarter results, Kelly saidthe newly merged Internet and media company expects 2001 revenue of $40billion, compared with pro forma revenue of $36.2 billion in 2000. It also expectsearnings before interest, taxes, depreciation and amortization, or EBITDA, to riseabout 30% to $11 billion from $8.4 billion in 2000. "Me guidance that we gaveover a year ago remains unchanged," Kelly said .

Some analysts have questioned whether AOL Time Warner can meet suchambitious targets, particularly in light of Time Warner's weaker-than expectedfourth quarter. Indeed, AOL Time Warner's fourth-quarter pro forma EBTTDArose just 14% from a year earlier, less than half the targeted 2001 growth rate .

Kelly reiterated the company's overall revenue growth tar et of 12% to 15%.

"Look at the results that are out there " said AOL Time Warner Chief ExecutiveJerry Levin. "Look at the financial disci line in this c "man ."

In another sign of the company's optimism, Chairman Steve Case said he'sfocused on two numbers the company hopes to achieve someday: a marketcapitalization of $1 trillion and $100 billion in annual revenue.

(Emphasis added .)

48184 136

325. On January 31, 2001, Business Wire reported that Defendant Kelly, AOL Time -

Warner's Chief Financial Officer, said :

"Strong wth in subscription and advertising revenues will drive the Company's .performance. with the benefit of multiple revenue streams from a diverse array ofworld class brands and customer relationships . AOL Time Warner has all thefinancial strength necessary to back our vision for the future."

326. On February 1, 2001, The Los Angeles mimes reported that AOL Time Warner

again told investors they shouldn't worry about the newly merged company meeting its financial

targets because advertising revenue growth at AOL would continue to boost the Company's total

revenues, despite the slowing advertising market :

AOL Time Warner tried to reassure Wall Street on Wednesday that the newlymerged company-fueled largely by its fast-mowing America Online unit -remains on track to meet its financial targets, despite a slowing economy andsoftening advertising market .

The article con tinued :

They are in good control of the underlying operations and seem to have theintegration process in hand,' said CIBC World Markets analyst John Corcoran. "Ihave more con fidence in their abi lity to make their numbers .' Corcoran said hewas particularly impressed by AOL's subscription base, which gained another 2 .1million members in the fourth quarter to reach 26 .7 mi llion worldwide, and by theonline company's strong advertising and c-commerce revenue, which surged-65%over last year's fourth quarter. Èven though the outside environment is slowingdown , AOL continues to do well ,' Corcoran said . Ìt's the engine that drives allthe other parts of this business . '

According to Gerald Levin, chief executive at AOL Time Warner, `We are payinga lot of attention to top-line revenue growth . '

To help calm investor worries about the advertising slowdown, the companynoted that it was already reaping the benefits of its larger size . It announcedmarketing deals with Nortel Network Corp., Cendant Corp ., Compaq ComputerCorp. and Purchase Pro, a business-to-business e-commerce company .

(Emphasis added .)

48154 137

327. On February 13, 2001, Dow Jones News Service reported that AOL Time Warner

again emphasized the AOL unit's advert ising and commerce revenue to assure investors that the

merged Company's revenue growth would remain strong :

M ichael Kelly said the AOL side of the business would be the "catalyst forchange across the whole company."

AOL Time Warner expects the fastest-growing; segment of its business to beadvertisin , and commerce revenue. Revenue in this area rose 29% last year, on apro forma basis, with the AOL side posting the sharpest rowth. For 2001, AOLTime Warner expects advertising/commerce revenue to rise 18% to 22% .

(Emphasis added .)

328. On March 8, 2001, Dow Jones News Service reported that individual Defendants

boasted that the increasing weakness in the adve rtising market would not affect AOL Time

Warner's advertising business:

Despite increasing signs of a weak advertising market, AOL Time Warner Inc.(AOL) Chief Operating Officer Bob Pittman reaffirmed the company's ambitiousfinancial targets for 2001 .

Speaking at the Merrill Lynch Internet Conference in New York today, Pittmanput it bluntly "our businesses are doing great ."

While acknowledging that the overall advertising market has weakened, he saidAOL Time Warner remains strong because its numerous properties make it amust-buy for advertisers .

"I want to assure you we gave The Street our guidance in January and we aresticking to it . Peri "he said .

Pittman said , "fin addi tion, the soft economy has sparked a "flight to ali 'among advertisers , who are shifting their spending to AOL Time Warner from itscompetitors . "

(Emphasis added .)

329. On March 8, 2001, Lehman Brothers, Inc ., issued an analyst report on AOL Time

Warner in which it rated the Company's common stock a "Buy." In making the recommendation,

a-

48184 138

the analyst report relied heavily on the reported strength of the "AOL division's advertising

business 23

330. On March 14, 2001, Merrill Lynch analyst Henry Blodgett similarly issued a

favorable report on AOL's advertising business :

For Q2, we did not change any estimates, and in fact believe AOL will have asolid quarter, possibly even ahead of our estimates (which would be remarkable inthis environment). We note that despite the disastrous state of the online admarket with blowups from Yahoo!, CNET, and other ad supported companies, westill expect AOL to increase adcom revenue slightly sequentiall y AOL is theleast exposed to the weakness in advertising demand, and continues to sign largecross platform advertising deals with traditional advertisers .

(Emphasis added.)

331 . On March 27, 2001, the Individual Defendants caused AOL Time Warner to issue

its 2000 Annual Report in which Defendant Case and Levin touted AOL's phenomena l

advertising revenue growth :

The ability to monetize the fundamental building blocks of value that we possessis rooted in multiple revenue streams from subscriptions, advertising andcommerce. and content. . . .Continuing to capitalize on its status as the premierInternet brand, America Online extended its industry leading position inadvertising and commerce, growing its base by a remarkable 91% last year .

(Emphasis added.)

The Annual Report continued :

Advertising and commerce revenues increased by 91° o from $1 .240 millionduring the year ended December 31, 1999 to $2,369 million during the year endedDecember 31, 2000. This increase was primarily attributable to additionaladvertising and electronic commerce on America Dnline's AOL servi as wellas its other branded services and portals.

(Emphasis added.)

332. On March 27, 2001, the Individual Defendants caused AOL Time Warner to file

its SEC Form 10-K for the transition period from July 1, 2000 to December 31, 2000 . The Form

48184 139

10-K was signed by Richard Parsons and Defendants Case, Levin, Kelly and Pittman . It

contained substantially the same financial information as the January 31, 2000 press release,

including $686 mil lion in advertising and commerce revenue at the AOL unit for the quarter --

ended December 31, 2000 . The Form 10-K also stated that AOL advertising and commerce

revenue was $1 .3 billion for the six months and $2 .4 billion for the year ended December 31 ,

2000, a 91% increase over the year ended December 31, 1999 . Starting with this financial report,

the Company discontinued the reporting of advertising and commerce backlog .

333 . In addition, the Form 10-K incorporated, with its consent, the January 31, 200 1

report of Defendant Ernst & Young, which assured investors that AOL's financials were audited

in accordance with GAAS and found to be compliant with GAAP :

We conducted our audit in accordance with auditing standards generally acceptedin the United States . . . . We believe that our audits provide a reasonable basisfor our opinion .

In our [Ernst & Young LLP] opinion, the financial statements referred-to abovepresent fairly, in all material respects, the consolidated financial position ofAmerica Online, Inc . at December 31, 2000 and 1999, and the consolidatedresults of its operations and its cash flows for each of the three years in the periodended December 31, 2000, in conformity with accounting principles generallyaccepted in the United States.

334. The Form 10-K farther stated that "An important component of America Online' s

strategy is to continue increasing revenues from advertisin . . . . ."

335. In fact, AOL's advertising and commerce revenue reported in its financial

statements of $686 million for the quarter, $1 .3 billion for the six months and $2 .4 billion for th e

year ended December 31, 2000, was overstated by at least $186.8 million, $343 million and

$678.1 mi ll ion, respectively, an overstatement of the actual advertising and commerce revenu e

by at least 37%, 37%, and 40%, respectively, as a result of AOL's improper accounting. The

overstatement of at least $ 186.8 million for the quarter was due to AOL's improper accountin g

48184 140

of the Sun ($12.6 million), eBay ($16.8 million), Gateway ($85 million), 24dogs.com ($7 .5

million), Homestore .com ($6.5 million), Veritas ($4 million), Telefonica SA ($10 million),

WorldCom ($12 .7 million), Monster.com ($6.2 million) and PurchasePro ($25 .4 million) deals,

as discussed above. The overstatement of at least $343 million for the six months ende d

December 31, 2000 was due to AOL's improper accounting for the Sun ($25 .2 million),

Gateway ($170 million), eBay ($33 .6 million), 24dogs .com ($23.7 million), Veritas ($4 million),

Telefonica SA ($10 million), WorldCom ($12.7 million), Homestore.com ($13.2 million),

Monster.com ($12.5 million), PurchasePro ($25.4 million) and Ticketmaster ($13 million) deals,

as discussed above. The overstatement of at least $678 .1 million for the calendar year ended

December 31, 2000 was due to AOL's improper accounting for the Sun ($50 .4 million), eBay

($67.2 million), Homestore ($17.6 million), Hughes ($180 million), Gateway ($340 million),

24dogs .com ($23.7 million), Veritas ($4 million), Telefonica SA ($10 million), WorldCom

($12.7 million), Monster.com ($25 million), PurchasePro ($25 .4 million), Ticketmaster ($13

million) and Dr.Koop.com ($9.6 million) deals, as previously discussed .

336. The Company has already admitted overstatements of $22 million , $88 million

and $88 mi ll ion, ofAGL advertising and commerce revenue -for the quarter, six months and year

ended December 31, 2000, respectively, in the SEC Form 8-K filed October 23, 2002 .

337. The oral statements made by Defendant Kelly as reported by The Wall Street

Journal on January 12, 2001, Defendant Pittman's statements as reported by The Los Angeles

7Ymes on January 13, 2001, Defendant Kelly's comments to market analysts on January 31, 2001

and Defendant Pittman's comments at the Merrill Lynch Internet Conference on March 8, 2001,

as reproduced above, are also egregiously false and misleading . Indeed, these representations

that the advertising market slowdown would not adversely affect the advertising revenue growt h

49184 141

at AOL were patently misleading and false for the reasons discussed above and in light o f

internal information within AOL which showed that AOL was at risk to lose substantial

advertising revenue .

j . The Fiscal Quarter Ended March 31, 2001

338. On April 2, 2001, he Wall Street Journal reported that AOL Time Wamer wa s

one of a few large companies continuing to see sharp gains in stock price despite a softenin g

economy and weak stock market :

In a rocky stock market. LAOL Time Wamerl is one of few big companies whosestock has shown a sharp gain so far this year, partly because it has stuck byaggressive revenue and earnings targets. The newly merged company, facing aweakening economy, is pulling out all,the stops to meet its original forecasts for2001 : 12% to 15% growth in revenue, to $40 billion, and a 30% increase inearnings before interest, taxes, depreciation and amortization, to $11 billion . Thecompany says not to worry, and many analysts and investors are confident it willdeliver. "

(Emphasis added.)

339. On April 3, 2001, AFXNews repo rted that Individual Defendants continued t o

state that the Company could meet its financial goals notwithstanding declines in the economy :

AOL Time Warner Inc . chiefexecu tive Gerald Levin said the company is "ontrack" to meet its 2001 sales and profit targets despite a less favorable economicenvironment.

Speaking at the Salomon Smith Barney/Broadcasting and Cable Magazine BigPicture Conference, Levin said business is very strong .

340. On April 12, 2001 , AFXNews reported :

Analysts are confident that AOL Time Warner's first-quarter numbers will notdisappoint .

"AOL Time Warner is best positioned . . Ito weather, the on-going weakness inad land and concerns about upcoming talent spikes," said UBS Warburg'sChristopher Dixon .

W-

48184 142

"America Online continues to attract additional marketing dollar from b itradi tional advertisers, add new subscribers worldwide and produce metrics thatblow the competition away," argued Lehman Brothers' Holly Becker.Becker . . . rates AOL Time Warner a `buy.' Dixon has a "strong buy"recommendation on the stock .

(Emphasis added . )

341 . On April 16, 2001, Barron's reported that Individual Defendants predicted strong

advertising revenue for the Company' s fiscal quarter driven by the Company's AOL division :

Indeed, the folks at AOL Time Warner e t advertising and c-commercerevenues to grow nicely this ear despite the punk economy.

But the real owth engine for AOL Time Warner' s ad revenue w ill incontestably

be AOL, which has seen its annual advertising and e-commerce revenues soarfrom zero to $2 billion in the last six years . Indeed , AOL may be immune to thedown cycle in the media because what it sells to advertisers is somewhat differentfrom traditional image or product advertising.

"We're renting out the eyeballs and increasingly the fingers of our subscribers,who are primed to buy products as a result of the adjacency, context and productinformation surfing the AOL service lends itself to," says Barry Schuler,chairman and CEO of America Online .

(Emphasis added .)

342. On April 18, 2401, the Individual Defendants caused the Company to issue a

press release announcing its financial results for the quarter ended March 31, 2401, including

strong revenue gains for the Company, driven by large gains in advertising and commerce

revenue at the AOL unit As stated in the press release:

A OL Advertising and Commerce Revenues Climb 37% to $721 Million

AOL Time Warner Inc . (NYSE: AOL) today reported results for its first quarterended March 31, 2401, posting strong gains in total revenues, EBITDA, cashearnings per share, and Free Cash Flow over pro forma results from last year'scomparable quarter .

Total revenues rose 9% to $9 .1 billion, compared to $8.3 billion in the 2000 firstquarter . Excluding one-time events, EBITDA increased 20% to $2 .1 billion, from$1.8 billion in the corresponding 2000 quarter, cash earnings per common shar e

48184 143

were $0.23, versus $0 .19 in last year's first quarter, and Free Cash Flow climbedto $651 million, up 409% from the year-ago quarter's $128 million .

[AOL Time Warner] Revenue growth was driven by a 9% increase in subscriptionrevenues to $3 .9 billion, a 10% increase in advertising and commerce revenues to$2.1 billion, and an 8% increase in content and other revenues to $32 billion.This compares to $3.5 billion, $1 .9 billion and $2 .9 billion respectively in lastyear's March quarter.

In addition, the Company's press release stated that : "strong growth in advertising and commerce

revenues were led by year-over-year increases of 37% at America Online ." (Emphasis added.)

343. On April 18, 2001 , AFX News reported that the strong revenue growth reported by

AOL Time Warner in its first quarter as a merged entity helped the Company significantly

exceed forecasts of earnings per share:

AOL reported a rise in first quarter cash earnings per share to 23 cents from aproforma 19 cents a year. ago, beating Wall Street consensus forecasts by 3 cents .

Speaking after the release of the figures, AOL Time Warner chief executiveofficer Gerald Levin said the company is "on track" to meet its fiilI year revenueand EBTTDA targets .

"1 think we have made an excellent start," Levin said during a conference ca ll.

Analyft who had feared the slowdown in online advertising may have hit thegrouy's performance, were buoyed by the figures .

In a note to clients, Merrill Lynch described the company' s results as"impressive ."

Salomon Smith Barney was equally upbeat .

(Emphasis added . )

344. On April 18, 2001, Dow Jones News Service reported that Individual Defendants

told the inves ting public that strong advertising and commerce revenue at the AOL division

would be instrumental in achieving the Company's fiscal year goals :

AOL Time Warner Inc. expects the advertising market to improve in the secondhalf of the year, Chief Financial Officer Michael Kelly said Wednesday .

48194 144

"I'd say we are assuming the second half of the year will see some s treng1heningof the ad markets," Kelly said during a conference call Wednesday after AOLTime Warner reported better- than-expected first-quarter results.

An improving advertising market could be key to helping AOL Time Warnermeet its ambi tious financial targets for 2001 . Chief executive Jerry Levin saidfirst-quarter results put the company "on track" to meet those targets.

Levin called AOL service the "jewel in the crown of the companx"

(Emphasis added.)

345. On April 19, 2001, Lehman Brothers, Inc., issued an analyst report on AOL Time

Warner in which it rated the Company's common stock a "Buy." In making the recommendation,

the Lehman analysts noted that advertising revenue was "robust" and that online advertising had

grown 37% makin& AOL' s "first quarter online advertising revenues of $721 million . . . equal

to our full year revenue forecast of $725 million for Yahoo!" (Emphasis added . )

346. On April 19, 2001 , Merri ll Lynch issued an analyst report on AOL Time Warner

in which it stated that "[a]dvertising commerce segment results were :singjy strong,

considering the widespread weakness across the in . Results were boosted by 37%o

advertisinggrawth at AOL, which represents nearly 34°/% of total advertising revenue."

(Emphasis added.) The report concluded that "[w]ith an estimated 25% of revenue coming from

advertising related business , AOL Time Warner is in an advantageous position relative to its

peers in the current weak advertising environment" (Emphasis added .)

347. On April 19, 2001, The Los Angeles Times reported in an article titled , "Company

Town AOL Time Warner Restores Confidence with Strong First Qua rter Earnings," that the

49184 145

surprisingly strong revenue growth in advertising and commerce had a significant positiv e

impact on the market's confidence in the Company:

AOL Time Warner Inc. delivered surprisingly solid earnings Wednesday to awary Wall Street, putting to rest for now-doubts about the media andentertainment giant's ability to hit its financial targets amid the advertisingslowdown. Fueled by double-digit growth at its Internet and cable businesses, theNew York-based company said first-quarter revenue rose 9% to $9 .1 billion.Quarterly earnings, before certain costs, soared 20% to $2 .1 billion. The strongshowing was in sharp contrast to those of other Internet and media companies,which have disappointed investors in recent weeks with rising losses and fallingsales . Last week, Yahoo Inc. said it would fire 12% of its work force and reportan $11 .5-million first-quarter loss.

Even with a solid first-quarter performance, the company will have to work .overtime to meet its ye ar-end goal of generating $40 bi ll ion in revenue and $11billion in earnings . .AOL Time Warner' s chief executive, Gerald Levin, reiteratedthose targets Wednesday and said his company is not as vulnerable as others tothe ad slowdown . Òur company rides above the normal market dynamics.'Levin said . . .Advertising and e-commerce revenue-a trouble spot at manyInternet companies-rose 10% during the qua rter, thanks largely to increase atthe flagship AOL Internet service and the Time Warner cable business.

(Emphasis added.)

348. On April 19, 2041, The Wall Street Journal reported that AOL Time Warner's

growth in online advertising and its confidence in its previously stated goals for fiscal 2001 se t

the Company apart from other companies in the online advertising business :

In its first quarter as a merged company, AOL Time Warner Inc . met most of itsfinancial tar ets driven by strop wth at America Online and Time WarnerCable, and renewed its pledge to meet its aggressive full-year goals. The mediaconglomerate's projections assume a pickup in advertising in the second half ofthe year in areas that have endured an ad slowdown in recent months .

For the full year, AOL predicts EBITDA of about $11 billion, up about 34% .Wall Street applauded the results. `This sets the tone for a big year for thecompany,' said Frederick W . Moran, an analyst at Jeffries & Co . Ìt shows theirresilience in the face of a difficult advertising market . '

AOL overcame so ftness in the advertising market to st a 10% higher ggartedadvertisin revenue- $2.05 billion, in line with projections released in January.Mr. Kelly said AOL's online unit in particular had seen `very strong, performance

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in the adver tising marketplace.' Advertising and commerce revenue at the unitrose 37% to $721 million from $528 mi llion a year earlier. That helped driveAmerica Online's Ebitda up 35% to $684 million .

Analysts said America Online 's success was noteworthy considering the striking •Ìnternet advertising slowdown at rival Yahoo ! Inc. `They're clearly takin gmassive market share in online advertising,' said Jamie Kiggen, analyst at CreditSuisse First Boston .

(Emphasis added)

349. On April 27, 2001, Salomon Smith Barney issued an analyst report by Jill S .

Krutick on AOL Time Warner which rated the Company's common stock a "Buy," an d

highlighted the unusual strength in the Company's on line advertising revenues compared to it s

competitors. In making the recommendation , the Salomon analyst noted that during AOL's firs t

quarter earnings conference "management exgressedconfidence in a s tren thening, [of the

advertising market in the second half of 2001 ." (Emphasis added .) The Salomon analyst also

stated: "Despite the current challenges in the overall advertising market and the onlin e

advertising market in particular, we believe AOL has strong prospects in its advertising and

commerce line in the next few years [and described AOL as] the most desirable advertising and

marketing venue on the Internet at present." (Emphasis added.)

350. Salomon analyst Krutnick concluded that "AOL's stock should rise as earnings

targets are met. AOL Time Warner's first quarter 2001 results were ahead of our

expectations . . . " The report went on to do a detailed comparison of AOL and its peers, an d

noted that "AOL's ad/e-commerce revenues were $721 million. representing 5% sequential

owth and 37% ear-over- ear owth. In con arison Yahoo?'s ad/c-commerce revenues were

down 28% ear-to- ear in the same quarters ."' (Emphasis added.) The Salomon report stated

that these " [healthy gains in ad/e-commerce revenues at AOL also contributed to margin

improvement. . ." (Emphasis added .) For instance, AOL's adle-commerce revenues rose from

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29% of AOL's total revenues in first qua rter 2000, to 34% in first quarter 2001, with the total

ad/e-commerce dollars rising 37% year to year. "To put that number in some context," the

Salomon analysts wrote. ". . . both Yahoo! and DoubleClick recently reported steeper-than-20%

year-to-year declines in their first quarter online ad revenues. AOL is the online advertising

market 's growth d river." (Emphasis added.)

351 . Comparing AOL's performance with Excite( Wome. Krutnick's report stated tha t

"[t]he difference between +37% year-to-year growth at AOL and a -41% decline in ad/commerc e

revenue at ExcitefalHome in first quarter 2001 is a wider performance gap than we have eve r

seen between these two companies . The Salomon report went on to compare AOL with

EarthLink and concluded that with respect to advertising revenue, "the race is not even close :

AOL produced healthy year-over-year adver tising revenue growth while EartbLink experience d

a steep year-over-year ad revenue decline ." The report noted the difference between AOL' s

+37% year-to-year growth and EarthLink's -57% decline, and observed that while "others put

erasing losses ahead of growth, AOL accelerates ." In sum, the Salomon report concluded that

"fi}n the sea of uncertainty that is 2001 . we believe AOL Time Warner has . . . the market share

growth of its advertising franchises . . ." (Emphasis added .)

352. On May 2, 2401, Salomon Smith Barney issued another analyst report on AOL

Time Warner which again rated the Company's common stock a "Buy." In making the

-recommendation, the Salomon report stated :

An area of obvious interest is the advertising market where AOL Time Warnermade the point that tough economic times breed defensive spending and reversionto "core" ad vehicles like those Time Warner provides . In our judgment, solidfirst quarter results did much to chase away skepticism and we expect this to lifteven further as the year unfolds and the company delivers .

(Emphasis added.)

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353. On May 4, 2001, the San Jose Mercury News reported that Defendant Cas e

boasted of the unusually strong advertising and commerce revenue at the AOL unit :

As Internet stocks flounder around him, AOL Time Warner Chamuan Steve Caseon Thursday boasted that his company is hitting Wall Street targets . . .The mergedcompany announced financial results last month that were in line withexpectations of most analysts . He Minted out that even as Internet advertisinhas declined for others, AOL operations reported advertising and e-commerce hadincreased 37 percent .

(Emphasis added.)

354. On or about May 15, 2401, the AOL Individual Defendants caused the Company

to file its SEC Form I aQ for the Company's first fiscal quarter as a merged enti ty ended March

31, 2001 and subsequently caused the Company to file a SEC Form 10-Q/A for the same perio d

on May 16, 2001 . The Form 10-Q and Form 14-Q/A was signed by Defendant Kelly an d

contained substantially the same financial information as the April 18, 2001 press release,

including the 37% increase in advertising and commerce revenue for AOL, which means that

although it was not broken out as such, the Form I aQ financial results of $2 .1 billion revenu e

for the AOL business segment included $721 million in AOL advertising and commerce revenue .

In addition, the Form 10-Q and Form 10-Q/A assured investors that the Company's financial s

were prepared in accordance with GAAP:

The accompanying consolidated financial statements are unaudited but, in theopinion of management, contain all the adjustments (consisting of those of anormal recurring nature) considered necessary to present fairly the financialposition and the results of operations and cash flows for the periods presented inconformity with generally accepted accounting principles applicable to interimperiods .

355. In fact, AOL Time Warner's reported AOL segment advertising and commerce

revenue for the quarter ended March 31, 2001 of $721 million was overstated by at least $214 .3

million, an overstatement of the actual advertising and commerce revenue by at least 42%, as a

48194 149

result of AOL's improper accounting . The $214 .3 mill ion overstatement was a result of AOL

Time Warner's improper accounting for the Sun ($12 .6 million), eBay ($16 .8 million),

Homestore.com ($11 .1 million), Gateway ($130 million), Veritas ($4 million), Telefonica S A

($5 million), WorldCom ($5 .3 million), Monster.com ($6.2) PurchasePro.com ($7 million), and

Bertelsmann ($16 .3 million) deals, as discussed above. Based on the restatement of th e

Company's financial results in its SEC Form 8-K filed on October 23, 2002, the Company has

already admitted overstating at least $13 million of AOL advertising and commerce revenue for

the quarter ended March 31, 2001 .

356. Defendant Levin's statements to market analysts on April 18, 2001 that the AO L

unit was the crown jewel of the merged entity, as reproduced above, are egregiously false an d

misleading. Again, not only w as the Company improperly recording AOL advertising revenue,

but internal AOL information revealed that AOL was suffering from the same weak advertisin g

market as the rest of the industry .

357. In addition, the Form 10 -Q and Form 10-Q/A for the quarter ended March 31,

2001 contained a footnote reclassifying certain revenue amounts a year after they were firs t

reported , resulting in a decrease in "advertising, commerce and other" revenue for the quarte r

ended March 31, 2000. The SEC Form 10-Q and Form 14 -Q/A failed to specify the origin of the

reclassified revenue, continued to inflate AOL' s adver tising, commerce, and other revenue, and

the reclassified revenue amount was substantially less than the amount of the allege d

overstatement. Thus, the reclassified advertising revenue remained materially overstated, as set

forth herein at U 285-286 .

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k. The Fiscal Quarter Ended June 30, 200 1

358. On dune 7, 2001, Merrill Lynch Capital Markets issued an analyst report on AOL

Time Warner in which it rated the Company's common stock a "Buy." In making the --

recommenda tion, the Merrill Lynch analyst stated: "We believe AOL continues to be the `crown

jewel' within the group, with the COO [Parsons] giving many examples of how the tradi tional

business had been able to plug into the AOL growth engine (and vice versa) ."

359. On June 20, 2001, The Wall Street Journal reported that concerns about onlin e

advertising deals made with PurchasePro led AOL Time Warner to investigate, but the Company

stated that it bad accounted properly for a ll revenue related to PurchasePro :

America Online suspended top deal maker Eric Keller as part of an inves tigationinto the company 's involvement with PurchasePro .com Inc. Mr. Keller is a seniorvice president for business affairs at America Online, a unit of New York's AOLTime Warner Inc . He runs a team of negotiators who hammer out deals such asthe one with PurchasePro, a start-up business-to-business software fiun that thispast year agreed to pay America Online $50 mil lion for a marketing agreementand 20 million for a software agreement . America Online owns 5 .7% ofPurchasePro, Las Vegas, and is entitled to a cut of PurchasePro 's softwarerevenue. . . . An America Online okesman said Àll revenues related toPurchasePro have been accounted for appropriately and accurately by AOL.'

(Emphasis added . )

360. On June 21 , 2001, Dow Jones-News Service reported that AOL Time Warner

continued to advise the market that its advertising revenue was a reliable revenue source despit e

the continuing decline in the advertising market :

Offering a glimmer of good news for the struggling media industry. AOL TimeWarner AOL) Chief Executive Jerry Levin said advertising revenue at thecompany has started to stabilize.

Earlier this week, a number of top newspaper publishers said that the state of theadvertising market remains gloomy . Dow Jones & Co. (DJ), publisher of TheWall Street Journal and this and other newswires, said the company hasn't seenany improvement in the advertising climate this month .

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Knight Bidder Inc. (KRl), the U .S.'s second-largest newspaper publisher, expectsadvertising revenue to fall between 8% and 9% for the second quarter .Washington Post Co. (WPO) estimates its ad revenue dropped 8 .4% in the firstfive months of the year.

However, AOL has boasted that its diverse media properties have allowed it tosell lucrative ad packages, helping to cushion the blow of the weakened economy.

AOL closed its acquisition of Time Warner Inc. on Jan. 11 and reported its firstquarter as a combinedcompany in April . At the time, the company said itovercame softness in the advertising market to post a 10% higher quarterlyadvertising revenue, $2.05 billion, in line withprojections released in January.

(Emphasis added.)

361. On June 25, 2001, Lehman Brothers , Inc. issued an analyst report on AOL Tim e

Warner in which it rated the Company' s common stock a "Buy." In mating the recommendation,

the Lehman analysts noted : "While the ad market in general sti ll remains in flux. . . .AOL

continues to do deals and remains committed to strong; ad/commerce revenue growth this year.

We are currently forecasting $3 .4 billion in ad/commerce revenues for America Online, up 45%0

over last year." (Emphasis added .)

362. In a Salomon Smith Barney report, dated June 27, 2001, the analyst stated:

Based MRon our ex ectation that industry-wide Online advertising revenue will bedown 30% in 2001 vs . 2 40, AOL continues to dramatically outperform itscompetitors and grab market share in the near term . In particular, we note thatAOL captured a 45%+ market share of online ad dollars in 1 Q01, up from 25-30% in IQ00, and we believe AOL will con trol more than half of the onlineadvertising market in 2Q01 .

(Emphasis added .)

363 . On July 18, 2001 , the Individual Defendants (except for Keller who wa s

dismissed in June 2001) caused the Company to issue a press release stating its record financia l

results for the fiscal quarter ended June 30, 2001, led by 26% growth in advertising and

48194 152

commerce revenues in the AOL business segment as compared to the year ago quarter. The

press release stated :

AOL Time Warner Inc. (NYSE: AOL) today reported results for its secondquarter ended June 30, 2001, posting records in total revenues, EBITDA and cashearnings per common share .

Total revenues rose 3% to $9 .2 billion, up from $8 .9 billion, on a pro forma basis,in last year's corresponding quarter, led by a 10% increase in subscriptionrevenues to $4.1 billion . . . . Advertising and commerce revenues ew 1 % to $2.3billion, with America Online and Time Warner Cable Rpsting, strong increases of26%o and 19% r 'vel . . . .EBITDA increased 20% to $2.5 billion; cash EPS,climbed 28% to $0.32; and Free Cash Flow climbed 55% to $519 million,excluding merger-related costs . These compare to pro forma EBITDA of $2 .1billion, cash EPS of $0 .25 and Free Cash Flow of $334 million in last year'scorresponding quarter . . .

AOL Advertising and commerce revenues reached $706 million, climbing 26%over last year's June quarter. . .

(Emphasis added .)

364. On July 18, 2001, Dow Jones News Service reported that AOL Time Warner's

financial results increased dramatica lly, due to strong growth in AOL's advertising an d

commerce revenue:

In a prepared statement, chief execu tive Jerry Levin said, "We couldn't be moreproud of what we accomp lished this quarter . We achieved outstanding bottom-line results, dramatic improvement in profit margins and a huge increase in FreeCash Flow. Our record results are further proof that we are delivering on thepromise of the AOL Time Warner merger."

***

America Online 's revenue increased 13% to a record $2 .14 billion . AOL'sEBITDA improved 37% to a record $ 801 million on higher advertising andcommerce revenue, increased operating efficiencies, and reduced network costsper hour and selling, general and adminis trative expenses .

Levin added, "In just six months, we've made great progress integrating theCompany."

(Emphasis added .)

49184 153

365. On July 18, 2001, a Dow Jones News Service article entitled, "AOL CEO: Co.

Was 2nd Largest U .S. Advertiser In 2Q," reported that AOL Time Warner was increasing its

forecast of 2001 cash earnings growth by ten percent, asserting that the company could continue

to grow advertising revenue :

' We are assuming only a sli t turn in the advertisin market in the secondhalf of the year''' in the company's networks and publishing units, Ke lly said .

Kelly said AOL was lifting its forecast of 2001 cash earnings growth to a range of35% to 40%, compared with 2000 levels, from a range of 25% to 30%. Kelly'sremarks came as the New York media and entertainment company reportedsecond-quarter cash earnings that beat analysts' expectations, but with revenuethat fell short of estimates .

One way AOL has responded to the advertising market downturn is to step up itsown adyertis€ng filling up unused ad inventory. Levin said AOL was the second-largest U.S. advertiser in the second gparter. normally, the company is somewherein the top 10, he said .

366. On or about August 14, 2001, the Individual Defendants (except Keller) cause d

the Company to file its SEC Form 10-Q for the Company 's second quarter ended June 30, 2001 .

The Form 1 O-Q was signed by Defendant Kelly and contained substantially the same financia l

information as the July 18, 2001 press release, including a reported 26% increase in advertisin g

and, commerce revenue for the AOL business segment over the year ago quarter, which means

that although it was not broken out as such, the reported financial results of $2.1 billion AOL

business segment revenue for the quarter included $706 mil lion in AOL business segment

advertising and commerce revenue. The Form 10-Q also asserted that the "growth in [AOL]

advertising and commerce revenues was due to an overall increase in advertising . . . . . . The Form

1 O-Q also reported a 31 % increase in AOL business segment advertising and commerce revenu e

for the year ended June 30, 2001 over the year ended June 30, 2000 . In addition, the Form 10- Q

assured investors that the Company's financials were prepared in accordance with GAAP:

48184 154

The accompanying consolidated f nandial statements are unaudited but, in theopinion of management, contain all the adjustments (consisting of those of anormal recurring nature) considered necessary to present fairly the financialposition and the results of operations and cash flows for the periods presented inconformity with generally accepted accounting principles applicable to interimperiods.

367. In fact, AOL Time Warner' s reported AOL segment advertising and commerce

revenue for the quarter ended June 30, 2001 of $706 million was overstated by at least $150 .3

million, or an overstatement of the actual advertising and commerce revenue by at least 27% .

The overstatement of at least $150.3 million for the quarter was due to AOL Time Warner's

improper accounting for the Sun ($12.6 million), eBay ($16.8 million), Homestore.com ($11.1

million), Veritas ($4 million), WorldCom ($5 .3 million), Monster.com ($6.2 million), Oxygen

Media ($19 .8), PurchasePro ($9 million) and Bertelsmann ($65 .5) deals, as discussed above.

The Company has already admitted that at least $28 million for the quarter and $41 million for

the six months ended June 30, 2001, respectively, of AOL advertising and commerce revenu e

was overstated based on its restatement of the quarter' s results in the SEC form 8-K filed

October 23, 2002 .

368. In addition, the Form 10-Q for the quarter ended June 30, 2001 contained a

footnote reclassifying certain revenue amounts, a year after they were first reported, resulting in

a decrease in "advertising, commerce and other" revenue for the quarter ended June 30, 2000 .

The SEC Form I0-Q failed to specify the origin of the reclassi fied revenue , continued to inflate

AOL's advertising, commerce and other revenue, and the reclassified revenue amount was

substantially less than the amount of the alleged overstatement. Thus, the reclassified

advertising revenue remained materially overstated, as set forth herein at 11297-298.

48184 155

1 . The Fiscal Ouarter Ended September 30, 2001

369. On September 24, 2001, aDow Jones News Service article titled, "AOL

Abandons Longstanding Financial Targets For Year" reported that AOL Time Warner, for the --

first time, acknowledged that the slowdown in the advertising market would affect its futur e

performance:

For more than 18 months , execu tives from AOL and its predecessor companies,America Online, Inc. and Time Warner inc., had insisted the merged entity wouldpost cash flow growth of 30% and revenue growth of more than 10%. Theprojections were among the proposed merger's se lling points to Wall Street.

But AOL said late Monday its cash flow growth in 2001 will be in the 20% rangeand revenue growth between 5% and 7%. AOL cited the [September 11 terrorist]attacks and the advertising market slowdown, becoming the latest company tosound a note of caution in the wake of the attacks .

While many analysts had lowered their AOL estimates in recent weeks, somewere surprised by the magnitude of the expected shortfall . . . . "These numbersare lower than what we had been projecting," said CIBC World Markets analystJohn Corcoran . "Me magnitude of the shortfall might surprise the Street ."

"The bottom line is - despite this tragedy and the resulting economic effects - ourunique mix of assets give us confidence that we can generate strong earningsgrowth next year and into the future." Chairman Steve Case said in the pressrelease.

Still, there was no disclosure of the fact that advertising revenue had already dec lined

significantly at AOL, and the illegal steps AOL had taken to artificially inflate its advertising

revenue in order to mask that fact .

370. On October 17, 2001, the Individual Defendants (except Keller) caused the

Company to issue a press release reporting its financial results for the quarter ended Septembe r

30, 2001 , including $624 mi ll ion in AOL advertising and commerce revenue, a 5% increase over

the year ago quarter .

48J84 156

371 . On November 14, 2001, the Individual Defendants (except Keller) caused the

Company to file its SEC Form 10-Q for the Company's fiscal qua rter ended September 30, 2001 .

The Form laQ contained substantially the same financial information as the October 17, 2001 --

press release, including advertising and commerce revenue of $624 million at the AOL unit for

the quarter, a 5% increase over the year ago quarter . The Form 10-Q also reported advertising

and commerce revenue for the AOL business segment for the nine months ended September 30 ,

2001 of $2 .051 billion, a 22% increase over the nine months ended September 30, 2000 .

372. In addition, the Form 10-Q assured investors that the Company financials wer e

prepared in accordance with GAAP:

The accompanying consolidated financial statements are unaudited but, in theopinion of management, contain all the adjustments (consisting of those of anormal recurring nature) considered necessary to present fairly the financialposition and the results of operations and cash flows for the periods presented inconformity with generally accepted accounting principles applicable to interimperiods.

373 .. In fact, AOL Time Warner' s reported AOL segment advertising and commerc e

revenue of $624 million for the quarter and $2 .1 billion for the nine months ended September 30,

2001, was overstated by at least $ 122.1 million, and $486.7 million, respectively, or an

overstatement of the actual advertising and commerce revenue by at least 24 % and 31%,

respectively, as a result of AOL Time Warner's improper accounting . The overstatement of at

least $122. 1 mi llion for the quarter was due to AOL Time Warner's improper accounting for the

Sun ($12.6 mi ll ion), eBay ($ 12.8 mill ion), Oxygen Media ($19 .8 m illion), Veritas ($4 mil lion),

WorldCom ($5.3 million), Homestore ($6.6 million), Monster.com ($6.2'million), Golf Channel

($15 million) and Bertelsmann ($39.8 mi ll ion) deals, as discussed above . The overstatement of

at least $486.7 million for the nine months ended September 30, 2001 was due to AOL Time

Warner's improper accounting for the Sun ($37 .8 million), eBay ($46.4 million), Homestore.com

48184 157

($28.8 million), Oxygen Media ($39 .6 million); Veritas ($12 million), Telefonica SA ($ 5

million), WorldCom ($15.9 million), Gateway ($130 million), Monster .com ($18.6 million) ,

PurchasePro ($16 million), Golf Channel ($15 million) and Bertelsmann ($121 .6 million) deals,

as discussed previously.

374. The Company has already admitted overstating $16 million,-and $57 mi llion of

AOL advertising and commerce revenue for the fiscal quarter and nine months ended September

30, 2001, respectively, based on its restatement of financial results in the SEC form 8-K filed

October 23, 2002 .

375-- In addition, the Form 10-Q for the quarter ended September 30, 2001 contained a

footnote reclassifying certain revenue amounts, a year after they were first reported , resulting in

a decrease in "advertising, commerce and other" revenue for the quarter ended September 30 ,

2000. The SEC Form 1D-Q failed to specify the origin of the reclassified revenue and continued

to inflate AOL's advertising, commerce and other revenue, and the reclassi fied revenue amount

was substantially less than the amount of the a lleged overstatement. Thus, the reclassified

advertising revenue remained materially overstated, as set forth herein at 11311-312 .

M. The Fiscal Quarter and Year Ended December 31, 200 1

376. On November 27, 2001, a Dow Jones News Service article titled , "AOL Co-COO

Backs `02 Double-Digit Cash Flow Growth View" reported that despite the economic downturn,

AOL Time Warner was holding to its ambitious targets for the year ended December 31, 2002:

AOL Time Warner Inc . (AOL) Co-Chief Operating Officer Bob Pittman said he'scomfortable with the company 's previous estimate of posting a "double-digit-cashflow growth rate in 2002 .

The media and Internet company said in late September it expected earningsbefore interest, taxes, depreciation and amortization, or EBITDA, to rise by adouble-digit percentage in 2002_ At the same time, AOL lowered its forecasts for

43184 158

this year, citing the weak economy and advertising market . It expects EBITDA torise 20% in 2001 .

"We're comfortable with the double'-digit EBITDA growth" i.n 2002, Pittman toldinvestors at the Credit Suisse First Boston technology conference in Scottsdale,Ariz. "We have enough control of our destiny to be comfortable ."

(Emphasis added . )

377. On January 30, 2002, the Individual Defendants (except Kelle) caused th e

Company to issue a press release with financial results for the fiscal quarter and year ended

December 31, 2001, which included a year-over-year increase in AOL advertising and commerce

revenue for the year of 13% to $2 .7 billion, and AOL advertising and commerce revenue of $637

million for the quarter.

378. On or about March 25, 2002, the individual Defendants (except Keller) caused th e

Company to file its Form 10-K for the fiscal quarter and year ended December 31, 2001 . The

Individual Defendants (except Keller) subsequently caused the Company to file a Form 10-K/A

on March 26, 2002 for the fiscal quarter and year ended December 31, 2001 . The Form 10-K

and Form 10-WA contained substantially the same financial information as the January 30, 2002

press release, including $637 mi llion and $2 .7 billion in AOL adver tising and commerce revenue,

and $2.2 billion and $8.5 billion in AOL Time Warner advertising and commerce revenue,

respectively, for the fiscal quarter and year ended December 31, 2001 . The Form 10-K and

Form 10-KJA was signed by, among others, Richard Parsons and Defendants Case, Levin, Pac e

and Pittman.

379. The Form 10-K and Form 10-K/A further stated :

While advertising revenues declined overall, certain segments and businesses ofAOL Time Warner experienced an increase in adver tising revenues . Specifically,and as discussed in more detail below under Business Segment Results ,advertising revenues increased at the AOL and Cable segments, and at The WBNetwork .

48194 159

380. The Form 10-K and Form 10-KA also incorporated, with the consent o f

Defendant Ernst & Young, the January 28, 2002 report of Ernst & Young which assure d

investors that the Company's financials were audited in accordance with GAAS and were

prepared in compliance with GAAP:

We conducted our audit in accordance with auditing standards generally acceptedin the United States . . . . We believe that our audits provide a reasonable basis forour opinion .

In our [Ernst & Young] opinion, the financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofAOL TimeWarner at December 31, 2001- and 2000, and the consolidated results of itsoperations and its cash flows for each of the three years in the period endedDecember 31, 2001 , in conformity with accounting principles genera lly acceptedin the United States. Also, in our opinion , the related financial statement scheduleand supplementary information, when considered in relation to the basic financialstatements taken as a whole, present fairly in a ll material respects the informationset forth therein.

381 . On March 27, 2002, AOL Time Warner issued its 2001 Annual Report in which

Richard Parsons and Defendants Case and Pittman emphasized the growth in advertising revenu e

compared to the previous year, noting there was "a 13% increase in AOL advertising and

commerce revenues from $2.369 billion to $2 .688 billion . "


revenue of $637 million for the quarter and $2 .7 billion for the year ended December 31, 2001

was overstated by at least $60 . 3 mil lion , and $547.2 million, respectively, or an overstatement of

the actual adver tising and commerce revenue by at least 10% and 26%, respectively, as a result

of AOL's improper accounting . AOL Time Warner 's reported advertising and commerce

revenue for the quarter and year ended December 31, 2001 was similarly overstated by at least

$60.3 million and $547 .2 million, respec tively, as a result of AOL Time Warner's improper

accounting. The overstatement of at least $60 .3 million for the quarter was due to AOL Time

48184 160

Warner's improper accounting for the Sun ($8.4 million), Oxygen Media ($ 19.8 mill ion),

Gateway ($3 million), Veritas ($4 million), WorldCom ($11 .8 million), Homestore ($6 . 6

million), Monster.com ($6.2 million) and Bertelsmann ($0 .5) deals, as discussed above. The --

overstatement of at least $547.2 million for the year ended December 31, 2041 was due to AO L

Time Warner's improper accounting for the Sun ($45 .2 million), eBay ($46 .4 million),

Homestore.com ($35.4 million), Oxygen Media ($59 .4 million), PurcbasePro ($16 million),

Gateway ($133 million), Veritas ($16 million), Telefonica SA ($5 million), WorldCom ($27 .7

million), Monster.com ($25 million), Golf Channel ($15 million) and Bertelsmann ($122 . 1

million) deals, as discussed above .

383 . The Company has already admitted overstating AOL advertising and commerc e

revenue for the quarter and year ended December 31, 2001 by $17 million, and $74 million ,

respcctively, based on its restatement of financial results in the SEC form 8-K filed October 23 ,

2002.

n. The Fiscal Quarter Ended March 31, 2002

384. By March 2002, the advertising market had become so bleak, that the Compan y

was forced to acknowledge a signi ficant impact on its AOL advertising business. Nevertheless,

AOL secretly continued to ar tificially inflate its advertising revenue .

385. Indeed, on or about May 5, 2002, the Individual Defendants (except Keller)

caused the Company to file its SEC Form 10-Q for the Company's fiscal quarter ended March 31 ,

2002. The Form l0-Q reported $501 million in AOL advertising and commerce revenue for the

quarter ended March 31, 2002 . In addition, the Form 10-Q assured investors that the Company's

financials were prepared in accordance with GAAP:

The accompanying consolidated financial statements are unaudited but, in theopinion ofmanagement, contain all the adjustments (consisting of those ofa

48184 161

normal recurring nature) considered necessary to present fairly the financialposition and the results of operations and cash flows for the periods presented inconformity with generally accepted accounting principles applicable to interimperiods .


revenue for the quarter ended March 31, 2002, of $ 501 mi ll ion was overstated by $130 .4 million,

or an overstatement of the actual advertising and commerce revenue by at least a stunning 35% ,

as a result of AOL's improper accounting, as discussed above. The $130.4 million

overstatement is due to AOL Time Warner's improper accounting for the Oxygen Media ($19 . 8

million), Gateway ($9 million), Monster .com ($6.2 million), Homestore ($6 .6 million),

WorldCom ($8.5 million)and Bertelsmann ($80 .3 million) deals, as discussed above. The

Company has already admitted an overstatement of at least $6 million in advertising an d

commerce revenue for the quarter in the SEC Form 8-K filed October 23, 2002 .

387. The Form 10-Q for the quarter ended March 31, 2002 also stated that th e

advertising and commerce revenue for AOL Time Warner the quarter ended March 31, 2001 was

$17 million less than originally reported a year previously, but failed to identify the origin of the

reduced revenue and whether the decrease related to AOL. The Form I0-Q again overstated the

Company's advertising and commerce revenue for the quarter ended March 31, 2001, a s

previously discussed in 1355.

o. The Fiscal Ouarter Ended June 30 2002

388 . On July 24, 2002, the last day of the Class Period, Richard Parsons and Defendan t

Pace held a conference call with market analysts after the Company issued a press release

announcing the Company's financial results for the quarter ended June 30, 2002 . The press

release was issued and the conference call took place after the stock market had closed on Jul y

24, 2002. During the conference call, Defendant Pace stated that the AOL division had $412

0-

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million in advertising and commerce revenue in the quarter ended June 30, 2002, $342 million of

which was advertising revenue. Pace also stated that the advertising and commerce backlog as

of June 30, 2002 was $860 million . Also during the call, Parsons stated that the SEC-was

conducting an investigation into the Company's accounting practices with respect to AOL

advertising revenue in reaction to allegations raised in articles published by The Washington Post

on July 18 and 19, 2402.

389. In fact, AOL Time Warner's reported AOL segment adver tising and commerce

revenue of $412 million and advertising revenue of $342 million for the quarter ended June 30 ,

2002, were both overstated by at least $126 million, or in comparison with actual advertising and

commerce revenue, by at least 44% and 58%, as a result of AOL's improper accounting.

390. The overstatement of at least $126 million for the quarter was due to AOL Tim e

Warner's improper accounting for the Oxygen Media ($19 .8 million), Homestore ($6 .6 million),

Monster.com ($6.2 million), Bertelsmann ($84.4 million) and Gateway ($9 million) deals, as

discussed above . Further, Pace's statement in the July 24, 2042 press release that AOL Time

Warner's AOL segment advertising revenue backlog as of June 30, 2002 was $860 million was

false because the actual backlog was overstated by at least $212 .8 million, or at least 33%, due to

the improper accounting of the Homestore .com ($132 million), Monster.com ($35.4 million),

Gateway ($51 million), and Bertelsmana ($113 .2 million) deals . Accordingly, notwithstanding

the extremely weak advertising market that left the Company no choice but to report decreased

advertising revenue, and acknowledgement by the Company of the SEC investigation, the

Company still artificially inflated its reported advertising revenue and backlog.

48194 163

391 . On July 24, 2002, AOL Time Warner stock closed at $11 .40 per share. Following

the Company's disclosure of the SEC investigation after the market closed on July 24, 2002, the

stock fell 15 .4% to close at $9 .64 per share at the end of trading on July 25, 2002. a-

392. Based on the foregoing, during the Class Period the Company, AOL, the

Individual Defendants and Defendant Ernst & Young, have made material misrepresentations

and omitted material facts, in SEC filings, press releases, financial statements, and AOL Tim e

Warner's consolidated pro forma financial statements referred to above, including the Merge r

Registration Statement, the Joint Proxy Statement Prospectus, and the financial statements an d

pro forma financial statements incorporated by reference in the Merger Registration Statemen t

and Joint Proxy Statement Prospectus as follows .

a. Materially overstated AOL and Company advertising and commerc e

revenue , AOL advertising and commerce backlog, and percentage increases of such amounts in

year over year comparisons in statements referenced above;

b. Materially overstated AOL advertising revenue in the conso lidated pro

forma financial statements in the documents referenced above ;

c. Failed to disclose that AOL and AOL Time Warner had engaged in sham

transactions and improper accounting, resulting in the overstated advertising revenue an d

backlog, and percentage comparisons referenced above ;

d. Failed to disclose in the documents referenced above the true current an d

anticipated condition of AOL's advertising revenue and advertising business, both before an d

after the Merger;

C. Falsely represented in the documents referenced above that the subjec t

financial statements were prepared in accordance with GAAP and Article 10 of Regulation S-X ;

48184 164

f Falsely represented in the documents referenced above that the audited

financial statements were audited in conformance with GAAS;

gn Falsely represented in the documents referenced above that the subjec

t financial reports fairly presented the results of the companies' operations, particularly with

respect to the adver tising and commerce revenue of AOL, including the advertising and

commerce revenue of the Company's AOL business segment; and

h. Falsely represented in the documents referenced above that results of th e

companies' operations, particularly with respect to the advertising and commerce revenue o f

AOL, including the advertising and commerce-revenue of the Company's AOL business segment.

393. AOL, the Company and Individual Defendant made numerous statements

described above in the companies ' press releases , and otherwise to market analysts and the

media, that materially overstated AOL and Company advertising revenue and falsely represented

or failed to disclose the effect on AOL and the Company of an industry-wide deterioration of th e

Internet advertising market. Such statements include those of Defendants Case, Pittman and

Kelly on October 18, 2000, to market analysts as detailed in IN 303-304 above. Other such false

and misleading statements include, as discussed above, the following :

1 . Kelly's statements reported by The Wall Street Journal on January 12,2001, as set forth in 1 315 above;

2. Pitt van's statements as reported by The Los Angeles Times on January 13,2001, as set forth in 1318 above;

3. Kelly's comments to market analysts on Janua ry 31, 2001 , as set forth in11324-325 above;

4. Pittman's comments at the Merrill Lynch Internet Conference on March 8,2401, as set forth in 1 328 above ;

5. Levin's statements to analysts on April 18, 2001, as set forth in ¶¶ 343-344 above;

48184 165

6. Pace's statements to analysts on July 24, 2002, as set forth in ¶ 388 above;and

7. The statements of Case, Pittman, Kelly and others in the AOL and,Company press releases announcing financial results throughout the ClassPeriod, as set forth above.

394. The longstanding and pervasive ar tificial infla ting ofAOL's advertising revenue,

including various sham deals, constituted devices, schemes or artifices to defraud investors an d

the marketplace. Indeed, the systema tic practices of AOL and the Company to materia lly

overstate advertising revenue operated as a fraud on the market and investors resulting in th e

purchase or acquisition of AOL and AOL Time Warner stock at artificially inflated prices .

395. In addition, AOL's artificially inflated advertising revenue caused the value of th e

Company's goodwill, created as part of the Merger, to be vastly inflated. As discussed in the

following section , the Company materially overstated the value of goodwill prior to and i n

conjunction with the Merger and improperly accounted for the goodwill after the Merger ,

causing it to continue to be greatly overstated .

IT. The Materially False and Misleading Statements , Omissions of Material Fact andDevices, Schemes or Artifices to Defraud Regarding AOL Time Warner's Goodwill

396. AOL and AOL Time Warner created a grossly overstated goodwill value of $127

billion, comprised of $94.705 billion of new goodwill and approximately $33 billion ofexisting

goodwill, in connection with the Merger. The Company, AOL and Time Warner before and in

conjunction with the Merger, falsely reported the Company's goodwill created by the Merger.

After the Merger, the Company continued to falsely report its goodwill . The representations i n

the Company's Merger Registration Statement , AOL's &Time Wa rner 's-Joint Proxy Statement-

Prospectus in connection with the Merger, AOL's SEC Form 10-K filings for the year ended

June 30, 2000 and the six-month period ended December 31, 2000, AOL's SEC Form 8-K filings

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on February 11, 2000, April 3, 2400 and May 23, 2000 and AOL Time Warner's SEC Form 8-

K/A filings on Janua ry 26, 2001 and March 30, 2001 vastly overstated the value of the pro forma

goodwill. The postMerger representations in Company financial statements continued to report

a greatly inflated goodwill valuation and failed to take appropriate write-downs of the goodwill

as required by GAAP .

397. Goodwill is defined by APB 16 as the premium paid by one company to acquire

another when the purchase price exceeds the fair market value of the acquired company' s

underlying identifiable tangible and intangible assets . Goodwill is intended to be the

quantification of the real and actual value of the unidentifiable intangible assets of a company .

Such assets include primarily the value of a business' reputation and customer patronage and

loyalty to be derived therefrom .

398. With respect to the pre-Merger misrepresenta tions , AOL incorporated by

reference in its SEC Fonn 10-K filed on September 22, 2000 for its fiscal year ended June 30,

2000, certain pro forma financial statements "which were presented to illustrate the effects of the

Merger." Those pro forma statements reported that, as a result of the Merger, an estimated

amount of $94.705 billion would be allocated to goodwill due to the excess purchase price over

identifiable tangible and other intangible assets. The pro forma statements also estimated a

ùseful life" for the goodwill of 25 years .

399. AOL's SEC Form 10-K filed on March 27 , 2001 for the period July 1, 2000

through December 31, 2000, incorporated by reference the same pro forma financial statements

which again estimated new goodwill attributable to the Merger of $94.745 billion with a useful

life of 25 years .

49194 167

400. AOL's SEC Form 8-K filed on February 11, 2000 contained a pro forma

consolidated condensed balance sheet of AOL Time Warner at September 30, 1999 to illustrate -

the effects of the Merger as if it occurred as ofthat date. That balance sheet estimated new 0-

goodwill attributable to the Merger to be $95 .842 billion, with an estimated useful life of 2 5

years .

401 . AOL's SEC Form . 8-K filed on April 3, 2000 contained a pro forma consolidated

condensed balance sheet of AOL Time Warner at December 31, 1999 to illustrate the effects o f

the Merger as if it occurred as of that date. That balance sheet estimated new goodwil l

attributable to the Merger to be $94 .736 million, with an estimated useful life of 25 years.

402. AOL's SEC Form 8-K filed on May 23, 2000 contained a pro forma consolidated

condensed balance sheet ofAOL Time Warner at March 31, 2000 to illustrate the effects of th e

Merger as if it occurred as of that date . That balance sheet estimated new goodwill attributable

to the Merger to be $94 .705 billion, with an estimated useful life of 25 years .

403 . AOL's 8-Ks filed on April 3 , 2000 and May 23, 2000 represented that :

AOL Time Warner will periodically review the carrying value of the acquiredgoodwill . . . for acquired businesses to determine whether an impairment mayexist . AOL Time Warner will consider relevant cash flow information, includingestimated future operating results, trends and other available information, inassessing whether the carrying value of goodwill .. . can be recovered. If it isdetermined that the carrying value of goodwill . . . will not be recovered from theundiscounted future cash flows of acquired businesses, the carrying value of suchgoodwill . . . would be considered impaired and reduced by a char a to operationsin the amount of the impairment .

(Emphasis added .) In addition, the Form 8-Ks represented that an "impairment charge i s

measured as any deficiency in the amount of estimated undiscounted cash flows of acquire d

businesses available to recover the carrying value related to goodwill . . . ."

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404. The Company' s Merger Registration Statement which incorporated by reference

AOL's and Time Warner's Joint Proxy Statement-Prospectus was filed with the SEC o n

February 11, 2000, as amended on March 24, 2000, April 25, 2000, May 18, 2400 and May 19, 0-

2000. The Merger Registration Statement and Joint Proxy Statement Prospectus incorporated by

reference the same pro forma financial statements "presented to illustrate the effects of the

merger" and previously referenced in 1398.

405. On or about May 23, 2000, the Joint Proxy StatementProspectus was mailed by

AOL and Time Warner, respectively, to their stockholders . The Merger Registration Statement

and Joint Proxy Statement-Prospectus represented that :

AOL Time Warner will eriodicall review the c value of the a uiredgoodwill for acquired businesses to determine whether an impairment may exist .AOL Time Warner will consider relevant cash flow information, includingestimated future operating results, trends and other available information, inassessing whether the carrying value of goodwill can be recovered . If it isdetermined that the carrying value of goodwill will not be recovered from theundiscountcd future cash flows of acquired businesses, the carrying value of suchgoodwill would be considered impaired and reduced bya charge to operations inthe amount of the impairment .

(Emphasis added .) In addition, the Merger Registration Statement and Joint Proxy Statement

Prospectus represented that an "impairment charge is measured as any deficiency in the amount

of estimated undiscounted cash flows of acquired businesses available to recover the carrying

value related to goodwill."

406. Following the Merger, on January 26, 2001, the Individual Defendants caused th e

Company to file its SEC Form 8-K!A amending its SEC Form 8-K filed January 12, 2001 . Form

8-K/A included as an exhibit the consolidated balance sheet of AOL Time Warner as of

December 31, 2000, which was subsequently updated as a pro forma consolidated condense d

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balance sheet in AOL Time Warner 's SEC Form 8-K/A filed on March 30, 2001 and set forth th e

amount allocated to goodwill as a result of the Merger .

407. The newly created $94.705 billion in goodwil l was predicated upon AOL's

overstated advertising revenue, and therefore a valuation of AOL that exceeded its true fair

market value. Indeed, as discussed-in this Complaint in great detail , AOL's advertising revenue

was artificially inflated to bolster the price of AOL's stock and to make certain the Merger that

Individual Defendants desperately wanted, was consummated. Accordingly, AOL's inflated

advertising revenue essentially created "counterfeit money" with regard to the inflated value o f

AOL stock, which in tam vastly overstated the value of goodwill . Therefore, the pro form a

financial statements incorporated by reference in AOL's Form 10-Ks for the year ended June 30 ,

2000, and the six-month period ended December 31, 2000 , AOL's SEC Form 8-K filings on

February 11, 2044, April 3, 2000 and May 23, 2040, the Company's Merger Registration

Statement, the Company's SEC Form 8-K/A filings on January 26, 2001 and March 30, 200 1

and AOL's and Time Warner's Joint Proxy Statement-Prospectus, falsely represented the tru e

value of goodwill . The Form I0-Ks, the Form 8-K the Form 8-KIAs, the Merger Registration

Statement and the Joint Proxy Statement-Prospectus also falsely represented the useful life of th e

goodwill to be an .estimated 25 years . As discussed below, the real useful life for the goodwill

was, in fact at best, two years .

408. In addition, the grossly overstated goodwill was not properly accounted for by the

Company in its financial . statements for each of the fiscal 2001 quarters and the year ende d

December 31, 2401, as well as the first two quarters of fiscal 2002 . For the quarter ended March

31, 2001 and until the quarter ended September 30, 2002, goodwi ll was the largest asset on AOL

Time Warner's balance sheet . Because goodwill was such a significant part of AOL Time

48184 170

Warner's financial statements, comprising more than half of total reported assets, its accounting

treatment was crucial to the proper and accurate determination of AOL Time Warner's earnings

and shareholders' equity. By failing to write-down this inflated, asset and thereby properly value

goodwill, Defendants materially overstated the Company's goodwill, shareholders' equity (the

Company's net worth) and net income in its financial statements for each of the fiscal quarters in

2001, the year ended December 31, 2001, and the first two quarters 'of2002.

409. Goodwill and other intangible assets were recorded in AOL Time Warner's SEC

Form 10-Q for the quarter ended March 31, 2001 (filed with the SEC on May 15, 2001) a s

$127.907 billion, which included the goodwill] created by the Merger and other goodwill and

intangible assets acquired by the Company after the Merger. The Company's reported goodwill

reflected a reduction since the-Merger for pro rata amortization of the goodwill over what the

Company represented to be the goodwill's useful life of 25 years . However, the Company failed

to take any write-downs of this vastly inflated asset . As a result of the inflated goodwill, the

Form I0-Q also contained a greatly overstated value of shareholders' equity in the amount of

$156.525 billion.

410. Goodwill and other intangible assets were recorded in AOL Time Warner's SEC

Form 10-Q for the quarter ended June 30, 2001 (filed with the SEC on August 14, 2001) as

$126.6 billion, reflecting a reduction since the Merger for pro rata amortization of the goodwill

over what the Company represented to be the goodwill's useful life of 25 years . However, the

Company failed to take any write-downs of this vastly inflated asset. The Company also

continued to report overstated shareholders' equity of $156 .1 billion.

411 . Goodwill and other intangible assets were recorded in AOL Time Warner's SEC

Form I0-Q for the quarter ended September 30, 2001 (filed with the SEC on November 14, 2001 )

48184 - 171

as $126.9 billion, including a reduction of the goodwill created by the Merger for pro rata

amortization of the goodwill over what the Company represented to be the goodwill's useful life

of 25 years . However, the Company failed to take any write-downs of this vastly inflated asset,

and accordingly also reported inflated shareholders' equity of $154 billion .

412. The Company's SEC Form 10-Q for each of the above-referenced financial

periods also stated :

The accompanying consolidated financial statements are unaudited but, in theopinion of management, contain all of the adjustments (consisting of those of anormal recurring nature) considered necessary to present fairly the financialposition and the results of operations and cash flows for the periods presented inconformity with generally accepted accounting principles applicable to interimperiods .

413 . The Company's SEC Form 10-K for the year ended December 31, 2001, (filed

with the SEC on March 25, 2002) reported goodwill and intangible assets of $128 billion, which

again reflects pro rata amortization of the original $94 .705 billion of goodwill over its supposed

useful life of 25 years . However, no write-downs of the overvalued asset were taken and the

Company again reported overstated shareholders' equity of $152 billion .

414. Jo addition , the Form 10-K represented that the Company "periodically review s

the carrying value of acquired intangible assets, including goodwill, to determine whether an

impairment may exist ." The Form l0-K also stated , with Ernst & Young's consent, that the

financial statements therein were prepared in comp liance with GAAP and were audited by and

given an unqualified opinion by Ernst & Young, who stated, "We conducted our audits i n

accordance with auditing standards generally accepted in the United States " (GARS). Ernst &

Young further stated as part of the Form 10-K: "In our opinion, [the Company's] financial

statements .._ present fairly, in all material respects, the consolidated financial position of AO L

Time Warner at December 31, 2001 and 2000, and the consolidated results of its operations and

48194 172

its cash flows for each of the three years in the period ended December 31, 2001, in conformit y

with accounting principles generally accepted in the United States ."

415. By failing to write-down the overstated goodwill in any of the fiscal 2001 quarters, +_

or the fiscal year ended December 31, 2041, the Company violated GAAP and thereby avoided

substantially reducing the carrying value of goodwill and shareholders' equity and reporting a

huge operating loss . GAAP, as set forth in FAS No. 121, which was applicable during the Class

Period, required that companies review long-lived assets, including goodwill, to determine

whether the assets are impaired . FAS No. 121, IN 5-6:

5. The following are examples of events or changes in circumstances thatindicate that the recoverability of the carrying amount of an asset shouldbe assessed :

a. A significant decrease in the market value of an asset ;

b. A significant change in the extent or manner in which . an asset isused or a signi ficant physical change in an asset;

c. A significant adverse change in legal factors or in the businessclimate that could affect the value of an asset or an adverse actionor assessment by a regulator,

d. An accumulation of costs significantly in excess of the amountoriginally expected to acquire or construct an asset ; and/or

e. A current period operating or cash flow loss combined with ahistory of operating or cash flow losses or a projection or forecastthat demonstrates continuing losses associated with an asset usedfor the purpose of producing revenue.

6. If the examples of events or changes in cir cumstances set forth inparagraph 5 are present or if other events or changes in circumstancesindicate that the carrying amount of an asset that an entity expects to holdand use may not be recoverable, the entity shall estimate the future cashflows expected to result from the use of the asset and its eventualdisposition. Future cash flows are the future cash inflows expected to begenerated by an asset less the future cash outflows expected to benecessary to obtain those inflows . If the sum of the expected future cashflows (undiscounted and without interest charges) is less than the carryin g

48184 173

amount of the asset, the entity shall recognize an impairment loss inaccordance with this Statement. Otherwise, an impairment loss shad notbe recognized; however, a review of depreciation policies may beappropriate .

(Footnote omitted.)

416. Individual Defendants were aware of several factors at the time of the Merger an d

thereafter which established that the goodwill was materially overstated as recorded by AO L

Time Warner in the financial statements referred to above. Individual Defendants knew of the

previously overstated AOL advertising revenue, which resulted in the inflated value of AO L

stock and therefore a huge overstatement of goodwill when the Merger was consummated .

Individual Defendants were also aware of a material decline in the advertising market and th e

increasingly dramatic decline in demand for AOL advertising, which had typically represente d

20%'of the Company's revenue. The fact that large amounts of existing AOL advertising

revenue were at signi ficant risk was known by AOL executives at least as early as August 2000 .

Indeed , in the months preceding the consummation of the Merger, ACL's senior management

was advised that the company faced the risk of losing more than $140 million in advertisin g

revenue the following calendar year.

417. Notwithstanding the material decline in the value of the previously inflated

goodwill, AOL Time Warner and the Individual Defendants failed to take required write-downs

so that the Company would not report a huge loss for thefiscal periods referenced above o r

admit that the value of AOL stock was greatly overvalued as part of the Merger . Moreover, the

Company repeatedly reported to the public that the estimated useful life of the goodwill was 2 5

years, when in fact, as discussed below, it was less than two years .

48184 174

418. Due to the accounting improprieties related to goodwill, the Company presented

its financial results and statements in a manner which violated GAAP , including the following

fundamental accounting principles :

1 .1 . Interim financial reporting should be based upon the same accounting principles an d

practices used to prepare annual financial statements (APB No. 28, 110);

1 .2.'Financial reporting should provide information that is useful to present and potentia l

investors and creditors and other users in making rational investment, credit and simila r

decisions (CON 1 134);

1 .3 . Financial reporting should provide information about the economic resources of a n

enterprise, the claims to those resources, and effects of 'transactions ; events and

circumstances that change resources and claims to those resources (CON 1140) ;

1 .4. Financial reporting should provide information about how management of an enterpris e

has discharged its stewardship responsibility to owners (stockholders) for the use o f

enterprise resources entrusted to it . To the extent that management offers securities of

the enterprise to the public, it vohintarily accepts wider responsibilities for

accountability to prospec tive investors and to the public in general (CON 1150);

1 .5.-Financial reporting should provide information about an enterprise 's financial

performance -during a period . Investors and creditors often use information about the

past to help in assessing the prospects of an enterprise . Thus, although investment and

credit decisions reflect investors' expectations about future enterprise performance ,

those expectations are commonly based at least partly on evaluations of past enterpris e

performance (CON 17 42) ;

._

48384 175

1 .6 . Financial reporting should be reliable in that it represents what it purports to represen t

That information should be reliable as well as relevant is a notion that is central t o

accounting (CON 2 7158-59);

1 .7. Completeness, which means that nothing is left out of the information that may b e

necessary to insure that it validly represents underlying events and conditions (CON 2 1

79); and

1 .8 . 'Conserva tism be used as a prudent reac tion to uncertainty to try to ensure that

uncertainties and risks inherent in business situations are adequately considered. The

best way to avoid injury to investors is to try to ensure that what is reported represent s

what it purports to represent (CON 2 IN 95, 97) .

419. The SEC's former Chief Accountant, Lynn Turner, remarked in a May 18, 200 1

speech that ". . . the staff wants to be very clear that if events occurring subsequent to th e

acquisition result in impairment . . . an impairment charge should be recorded in the appropriat e

period." (Emphasis added.) Clearly, the Company' s knowledge of the 'gross overstatement of

value both prior and subsequent to consummation of the Merger, as well as deteriorating marke t

conditions and Company . performance, should have caused it to evaluate and write down the

goodwill in the quarter ended March 31, 2001, and continue to do so in subsequent quarters t o

reflect the real value of goodwill.

420. Further, .the undisclosed adverse information concealed by Defendants during th e

Class Period is the type of information which, because of SEC regulations, regulations of th e

national stock exchanges and customary business practice, is expected by investors and securitie s

analysts to be disclosed and is known by corporate officials and their legal aid financial advisors

to be the type of information which is expected to be and must be disclosed.

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421 . On August 14, 2001, the Company's SEC Form 10-Q for the quarter ended rune

30, 2001 described changes in accounting standards for goodwill :

[t]hese standards change the accounting for business combinations by . .. prohibitingthe prospective use of pooling-of-interests accounting and requiring

companies to stop amortizing goodwi ll and certain intangible assets with anindefinite useful life created by business combinations accounted for using thepurchase method of accounting . Instead, goodwill and intangible assets deemedto have an indefinite useful life will be subject to an annual review for impairment.The new standards generally w il l be effective for AOL Time Warner in the firstquarter of 2002 and for purchase business combinations consummated after June30, 2001 . AOL Time Warner is in the process of quantifying the anticipatedimpact of adopting the provisions of FAS 142, which is deemed to be signi ficant.

Upon adoption, AOL Time Warner will stop amortizing goodwill, includinggoodwill in the carrying value of certain investments accounted for under theequity method of accounting . Based on the current levels of goodwi ll, this wouldreduce amortization expense and, with respect to equity investees , it would reduceother expense, net, by approximately $5.3 billion and $600 m illion, respectively.Because goodwi ll amortization is nondeductible for tax purposes , the impact ofstopping goodwi ll amortization included- in the carrying value of equi ty investeeswould be to increase AOL Time Warner's annual net income by approximately$5.9 billion. In addi tion, AOL Time Warner is in the process of evaluatingcertain intangible assets to determine whether they are deemed to have anindefinite useful life. As a result of this process, AOL Time Warner may stopamortizing an additional $25 billion to $40 billion of intangible assets . This couldresult in an additional reduction ofpretax amortiza tion of approximately $1 .0billion to $1 .5 billion, which will have a corresponding after-tax increase in AOLTime Warner's net income of 600 to $900 million.

(Emphasis added. )

422. AOL Time Warner's representation that earnings would increase under the "new"

accounting requirements for goodwill, FAS 142, by the amount of $5 .9 billion was materiall y

misleading and omitted material facts because AOL Time Warner was well aware that th e

goodwill figure was grossly overstated. The goodwill should have been adjusted due to it s

impairment before 2002, thereby greatly reducing the "plug figure" of goodwill that was far in

excess of the goodwill's true value. The required "impairment" test would have instantly

48184 177

revealed that an impairment loss had occurred which required reporting in the first quarter of

2001 and in the succeeding quarters to reflect the over-valuation of goodwill .

423. On January 7, 2002, Business Wire reported:

Effective January 1, 2002, all calendar year companies will be required to adopt

the new accounting standard "Goodwill and Other Intangible Assets" ("FAS

142"). FAS 142 eliminates amortiza tion of goodwill and other intangible assetswith indefinite lives, which is expected to reduce AOL Time Warner' s annual

amortization by over $7 billion.

FAS 142 provides new measurement techniques for goodwill and other intangible

assets resulting from business combinations . While its revaluation has not been

completed, the Company said it expects to record a one-time, non-cash charge in

its income statement for the first quarter of2002 in the 0-$60 bill ion range toreflect overall market declines since the AOL Time Warner merger was

,announced in Jana of 2000. This charge wi ll reflect the cumulative'effect of

adop ting, the accounting change and does not affect the Company's operations.

(Emphasis added.)

424. In the Company's 2001 SEC Form 10-K, for the year ended December 31, 2001 ,

the Company stated that it would be implementing FAS 142,'which superseded FAS 121, in the

first quarter of 2002 . FAS 142 requires an annual test for impairment in addition to interim test s

similar to FAS 121 . AOL-Time Warner stated:

As a result of this initial review for impairment, AOL Time Warner expects to

record a one-time, non-cash charge of approximately $54 bi llion upon adop tion of

the new accounting standard in the first quarter of 2002. Such charge is non-

operational in nature and will be reflected as a cumula tive effect of an accounting

change .

(Emphasis added.)

425. Under GAAP, AOL Time Warner could not wait until the first quarter of 2002 to

record any impairment of goodwill . In so doing, it improperly took advantage of a prospectiv e

change in accounting principles under FAS 142 to avoid a charge against operating income.

Under the prior accounting directive (FAS 121) that, as discussed above, should have been

48184 178

applied to the Company' s financial statements for the fiscal quarters and the year ended

December 31, 2001, the impairment would have been charged to operating income.

426. - The first impairment was ultimately reported in the Company's March 31, 2002 --

SEC Form 14-Q (filed on May 5, 2002) when AOL Time Warner announced, as reported by the

media, "the largest write-down in history ." This write-down reduced the Company's value b y

$54 billion in a massive charge against assets in its 2002 first quarter financial report, and left a

substantial remaining goodwill amount reported by the Company in the Form 1O-Q. The

Company represented in the Form 10-Q that the write-down of goodwill "is reflected as a

cumulative'effect of an accounting change. . . . "

427. The impairment, however, was neither caused by nor the result of new accountin g

regulations because the "old" accounting standard clearly required the same action, but at a n

earlier date. By ignoring the application of FAS. 121 (the "old" accounting directive), AOL Time

Warner did not acknowledge the immediate issue that the deal was improperly valued at th e

Merger date due to the artificially inflated advertising revenue, and thus the purchase price wa s

improperly calculated and recorded .

428. The Company's write-down,of goodwill in the first quarter of 2002 wa s

insufficient, resulting in a continued overstatement of goodwill value. Indeed, the Company' s

SEC Form 1 il-Q for the qua rter ended March 31, 2002 wrote down goodwill in the amount of

$54 bi ll ion, reducing outstanding goodwill to a reported $80.178 billion. The Form. 10-Q also

stated :

The accompanying consolidated financial statements are unaudited but, in the-opinion of management, contain all the adjustments (consisting of those of anormal recurring nature) considered necessary to present fairly the financialposition and the results of operations and cash flows for the periods presented inconformity with generally accepted accounting principles applicable to interim,periods .

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429. On July 24, 2002, the Individual Defendants (except Keller and Pittman) caused

the Company to issue a press release announcing its financial results for the quarter ended June

30, 2002, which did not include a write-down of goodwill .

430. As discussed. above, the pro forma financial statements included as part of AOL' s

SEC Form 10--Ks for the year ended June 34, 2000, and the six month period ended December 31 ,

2000, AOL Time Warner's SEC Form 8-K/A filings on January 26, 2001 and March 30, 2001 ,

the Company's Merger Registration-Statement and AOL's and Time Warner's Joint Proxy

Statement-Prospectus were materially false and misleading and omitted material facts because :

The pro forma financial statements materially overstated the real fairmarket value of goodwill ;

b. The pro forma financial statements, failed to disclose that the goodwill wasovervalued ; and

c. The useful life of the goodwill created by the Merger was far less than the25 years represented in the pro forma financial statements. -

431 . Similarly, the Company's financial statements for the quarters ended March 31 ,

2001, June 34, 2001 and September 30, 2001, and the year ended December 31, 2001, and fo r

the first fiscal quarter of 2002, as well as the Company's July 24, 2002 press release announcing

the Company's 2002 second quarter fi nancial results, were materially false 'and misleading

and/or omitted material facts because:

a. The failure to write-down or sufficiently write-down the goodwill, asdiscussed above, materially overstated the goodwill of the Company andits shareholders' equity,

b. The financial statements and July 24, 2002 press release failed to disclosethat the goodwill was materially overstated; -

c. The financial statements did not comply with GAAP P-or fairly present thegoodwill of the Company;

48184 - 180

d. The Company's Form 10-K for the year ended December 31, 2001 wasnot audited in conformity with GARS ; .

e. If the Company had properly written down the goodwill, it would havereported a huge operating loss, rather than the much smaller reportedlosses, for at least one of the fiscal 2001 quarters as well as for the entire2001 fiscal year,

f. If the Company had properly written down goodwill in 2002, it wouldhave reported a bigger net loss for the quarter ended March 30, 2402, andwhen it failed to do so, it would have reported a huge loss for the-second-quarter of 2002;

g: The useful life of the goodwill created by the Merger was far less than 25years ;

h. The Company's announcement that earnings would increase by $5 .9billion in 2002 following the effective date of SFAS 142 was misleadingbecause the goodwill should have been written down in 2001 based onSFAS 121; and

i. The Company's representation that SFAS 142 caused the impairment inthe value of outstanding goodwill was false because the prior accountingstandard, FAS 121, required the same action, but at an earlier time.

432. The gross overstatement of the true value of goodwi ll created by the Merger an d

failure to properly account for the goodwill also constitutes devices, schemes or artifices to

defraud the public. Indeed, the overstated goodwill masked the inflated advertising revenue an d

the real value of AOL stock and the Company.

I. Defendants ' Course of Conduct Is Revealed

433 . On July 18, 2002, The Washington Post published the first of two articles, based

on statements of former Company employees and confidential documents, which reporte d

allegations that the Company and AOL artificially inflated AOL's adver tising revenue, enabling

Defendants to report to the public materially false advertising revenue . The article reported that

the Company denied the allegations and quoted from a lawyer retained by the Company :

The accounting for all these transactions is appropriate and in accordance withgenerally accepted accounting principles . . . . The disclosures in AOL' s financial

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statements are approp riate and accurate . AOL's statements provide our investorswith all appropriate material information about our business.

(Emphasis added.) The article quoted Defendant Ernst & Young as stating that it "stands by its

original view that the accounting and disclosures were appropriate."

434. Within hours of the pub lication of The Washington Post article, Defendant

Pittman abruptly resigned from the Company .

435. The second of The Washington Post articles regarding the fraud, published the

next day, July 19, 2002, further detailed allegations of prior improper reporting of AO L

advertising revenues.

436. On July 24, 2002, the Company acknowledged that the SEC was investigating its

accounting practices in connection with AOL's advertising revenue . As The Washington Post

reported on July 25, 2402 :

AOL Time Warner Inc. disclosed yesterday that the Securities and ExchangeCommission has launched a probe into its accounting practices after ques tionswere raised about how the company generated revenue through a series ofunconventional deals.

The world's largest media company said that its accounting was proper and thatall the transactions were approved by its outside auditor. But its chief executiveand chief financial officer vowed to give investors a better understanding of thebusiness, beginning yesterday with more detailed disclosures about its onlinedivision, including its advertising and commerce revenue, as part of AOL TimeWarner's announcement of second-quarter financial results .

Pace said he is comfortable with the company's accounting and disclosurepractices, but he said he wants AOL Time Warner to be "on the leading edge" ofdisclosures.

(Emphasis added.)

437. On July 25, 2002, the San Jose Mercury News also reported on the Company' s

disclosure that the SEC was looking into the Company's accounting practices . The Company's

._

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Chief Executive Officer, Parsons; was quoted in the article as stating "In the current environment ,

any such allegations will necessarily and appropriately draw inquiry from the appropriate

regulatory authorities even where, as here, they are without merit ."

438. On July 25, 2002, after AOL Time Warner disclosed that the SEC had launched a

civil-investigation into its accounting practices, several Wall Street analysts immediatel y

downgraded the Company's stock.

439. Only after the existence of the SEC investigation regarding the imprope r

'recognition of AOL advertising revenue was revealed by the Company did Defendants' improper

conduct and its effect become clear to the marketplace . After the Company' acknowledged the

SEC investigation, AOL Time Warner shares declined by 15 .4% to close at $9 .64. Thus, AOL

Time Warner common stock had plummeted in value by more than 77% from its trading price of

AOL common stock at the beginning of the Class Period ($41 .38) to the Company's trading

price at the end of the Class Period ($9.64), as adjusted for stock splits and the Merger. The

value of AOL Time Warner stock from when it first started trading until the end of the Clas s

Period decreased by 79.9%.

440. On July 31, 2002, the Company confirmed that the DO] had opened a criminal

investigation into the Company's accounting practices .

441 . On or about August 9, 2002, the Company fired Defendant Colbum, the President

,of AOL's Business Affairs division , who had reported directly to Defendant Pittman .

442. On August 14, 2002, the Individual Defendants (except Ke ller, Pittman, and

Colburn) caused the Company to issue a press release, announcing the Company's certification o f

its Annual Report on Form 10-K for 2001 and all reports on Form IO-Q, all reports on Form 8-K,

all proxy materials and all amendments to the foregoing fi led with the SEC subsequent to the

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filing of its Form IO-IC for 2001 . In that release, the Company noted that it had disclosed in its

SEC Form I 0-Q for the second quarter 2002, which was filed with the SEC on August 14, 2002 ,

that based on information it claims to have learned in the previous 10 days: 0-

the Company had identified three transactions involving its AOL unit with respectto which the Company may conclude, after further investigation, thatconsideration received by AOL from third parties may have been inappropriately

-recognized as advertising and commerce revenues . The advertising andcommerce revenues recognized in connection with-these three transactions totaledapproximately $49 million occurring over a period of six quarters .

In the 10-Q filing, the Company noted that it may be necessa ry to restate the results of prior

fiscal periods.

443. On October 23, 2002, AOL Time Warner publicly stated that its previously

announced financial results for each of the quarters ended' September 30, 2000 through June 30,

2002 were incorrect and had to be restated . For the AOL division, the impact of the adjustments

reduced advertising and commerce revenue by $168 million dollars over the eight quarterl y

periods . The remaining $22 million dollars represented a reduction in revenues related to AO L

in which the advertising was delivered by other AOL Time Warner divisions . The Company

also announced that the review ofaccounting for advertising transactions was continuing.

444. On January 12, 2003, at the AOL Time Warner annual shareholder meeting ,

Chairman Case announced that he would step down in May, 2003 .

445. On January 20, 2003, A e Wall Street Journal reported :

Veritas Software Corp., Mountain View, Calif.-said it will restate-some financialresults to reflect changes in the accounting for two AOL Time Warner Inc_transactions, which the Securities and Exchange Commission is reviewing.Regulators are looking at whether AOL's America Online Internet business andVeritas had entered into transactions in which they bought products from each.other for legitimate business purposes or whether the deals were simply designedto inflate revenue on both sides.

(Emphasis added.)

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446. On January 30, 2003, The Wall Street Journal reported :

In an astonishing end to a disastrous year, AOL Time Warner Inc . reported a 2002net loss of $98.7 billion after taking a fourth-quarter charge of $45 .5 billion,mostly to write down the value of its troubled America Online unit . The write-down, creating the biggest annual corporate loss in history was more than twicewhat Wall Street had anticipated . AOL also announced the resignation of TedTurner as vice chairman.

(Emphasis added.)

447. On February 5, 2003, The Wall Street Journal reported :

In an indication that federal authori ties are expanding their criminal investigationof AOL Time Warner Inc.'s America Online wu the Federal Bureau ofInvestigation has sought to question several former PurchasePro .com Inc . officersin the past few weeks .

. . . People familiar with the situation said the Department of Justice and theSecurities and Exchange Commission are focusing on America Online and someof its former executives, including Eric Keller and David M . Colbum. Thesepeople said the investigation, which was launched last summer, is continuing andprosecutors are expected to decide whether to bring charges later this year .Simultaneously, federal prosecutors in Los Angeles are probing America Online'srelationship with Homestore Inc . Several former Homestore officials havepleaded guilty to fraud and are cooperating with prosecutors .

AOL declined to comment.

(Emphasis added . )

448. On March 12, 2003, The Washington Post reported:

The federal investigation of America Online Inc . and two of its former keexecutives has been broadened to include alleged "aiding and abetting:'ofschemes by other companies to artificially inflate reported revenue, sourcesfamiliar with the probe said yesterday.

Federal investigators are scrutinizing the roles that AOL and two dealrnakersDavid M. Colbwn and Eric Keller, may have played in enabling certaincompanies, including Homestore Inc., an online real estate firm, to im ro er1pump up financial results . At the core of the inves tigation, sources said,Securities and Exch ange Commission investigators are ex amining allegtA quidpro qua schemes in which AOL and other companies exchanged cash through

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sham transactions to falsely boost revenue, both before and after AmericaOnline's merger with Time Warner Inc . in January 2001 .

The expansion of the probe increases the potential exposure of AOL Time WarnerInc. and the individuals involved , because the could be found culpable not onlyfor the firm's own accounting irregulari ties but also for the financial misconductof others . sources said .

AOL Time Warner has been cooperating extensively with inves tigators in thehope that the company can avoid criminal charges. S till , insiders expect themedia giant to face civil sanctions from the SEC.

Investors in Homestore named AOL, Colbum and Keller as defendants in alawsuit filed last year in California, alleging that the company and its executivesmade it easier for Homestore to falsify financial results . Last week, a federaljudge said she was reluctantly removing the AOL defendants from the case, citinga Supreme Court decision that limits the ability of private parties to seek damagesfrom those who aid wrongdoing rather than perpetrating it themselves .

At the same time, U.S_ District Jude Marsha J. Pechman lashed out at AOL. Shenoted that the SEC has the ex licit legal authority to brie char es of "aiding andabetting" wrongdoing. "Me acts alleged . . . . which this Court must accept as truefor purposes of this motion, describe a massive conspiracy driven by pureavarice," Pechman wrote in her 41-page opinion .

***

While dropping the AOL defendants from the Homestore suit, Pechman said theyremain in the cross hairs of a federal probe.

"This decision does not mean that the wrongs of these aiders and abettors willnecessarily go unchecked : the law expressly ted the SEC the authori tobring civil actions against aiders and abettors of securities fraud, and it is thisCourt's understanding that some investigation is on oin " she wrote.

(Emphasis added .)

449. On March 28, 2003, the Company reported that it might have to restate as much

as an additional $400 million in AOL advertising revenue as a result of transactions with

Bertelsmann AG that were part of the SEC's investigation. At the same time, the Company

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acknowledged that further restatement may be necessary with respect to other transactions being

investigated by the SEC and DOJ.

450. On April 1, 2003, Reuters reported that Gateway "would delay filing its 2002

annual report by up to 15 days because of plans to restate 2000 and 2001 revenue and costs o f

goods sold as it reviews transactions with AOL."

J. Scienter of The Individual Defendant s

451 . The history of AOL is that they have pushed the envelope ever since SteveCase has been running the Company . The first time I wrote about AOLaccounting'was back in 1996 and then they were fessing up to playingaccounting games in the years before that . They were hiding expenses justlike WorldCom so that they could look profitable . They came clean, theystraightened things out, Steve Case gave a speech back then in which hepromised gold standard accounting. Three months later, he had to restateearnings again. There's a long history of this .

Jerry Knight, The Washington Post financial reporter, guest on CNBC television programKudlow & Cramer, Jan . 21, 2003 .

The Individual Defendants Knew, or Recklessly Disregarded, that AOL andAOL Time Warner Were Engaged in Fraud and Were Motivated to Use andCover Up the Use of Improper Accounting and Sham Tran sactions to

Artificially Inflate Advertising Revenue

452. As alleged herein, the Individual Defendants acted with scienter in that they knew,

or recklessly disregarded, that the public documents and statements issued or disseminated in th e

name of AOL and AOL Time Warner were materially false and misleading and omitted material

facts; were aware that such statements or documents would be issued or disseminated to th e

investing public; and knowingly, or recklessly, participated or acquiesced in the sham

transactions and improper accounting practices which led to the issuance or dissemination of

such statements or documents .

453. The Individual Defendants as a group, and separately , either knew, or recklessly

disregarded, the false and misleading statements or mate rial omissions referred to above. The

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types of accounting fraud engaged in during the Class Period were similar to earlier activit y

engaged in by AOL. Notwithstanding prior SEC actions against AOL, AOL and AOL Time

Warner maintained a culture of arrogance and greed geared solely toward maximizing reporte d

advertising revenue of AOL, inflating the value of AOL and the Company's stock, and ensuring

the consummation of the Merger. In addition, the Individual Defendants had both motive an d

opportunity to engage in the fraudulent activities Plaintiff a lleges .

a. The Individual Defendants Were Actively Engaged in the Company'sDaily Activities Such That They Were Aware Of, RecklesslyDisregarded Controlled and/or Culpably Participated in theFraudulent Activities of the Business Affairs Division

454. The organizational structures at AOL and AOL Time Warner were such that the

companies ' improper dealmaking and accounting practices , as well as the downturn in AOL's

advertising business, were known, or were recklessly disregarded , at the highest levels of AOI ,

including Stephen Case, its Chairman.

455. As a founder of AOL, its Chairman and Chief Executive Officer, and Chairman of

AOL Time Warner, Case had access to all significant corporate information possessed by th e

two companies . In addi tion , all of the key participants in the transactions at issue reported either

directly or indirectly to Case . According to a former Senior Manager in AOL 's Interactive

Marketing division , David M . Colburn and Robert Pittman reported directly to Case at AOL.

456. According to a former AOL Vice President for business development, AOL's

"Operating Committee" or "Op Corn", consisting of nine top members of senior management

chaired by Pittman, held weekly meetings to discuss matters of importance to the company . As a

result of these weekly meetings, the Operating Committee knew about the "BA Specials", the

rest ructuring of advertising deals for failing dot-corns, and the downturn in AOL's advertising

business . Members of the Operating Committee during 2000-2001 included, among others ,

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Defendants Pittman , Colbum and J. Michael Kelly . Case had the authority to sit in on the

Operating Committee's meetings .

457. As President and Chief Operating Officer ofAOL and Co-Chief Operating ,

Officer of AOL Time Warner, Robert Pittman was privy to all sign ificant financial and

operational information at the two companies . According to an Advertising Age article dated

May 7, 2001 entitled , "Crunchtime; Bob Pittman is Promising the World . AOL Time Warner

Better Deliver," Pittman was deeply involved with AOL's and the Company's advertising

business . He admitted to being the "Account Executive" on the biggest accounts and to fielding

client calls at home after hours . In addition, Pittman was one of Colbum's primary mentors,

promoting Colbum several times. According to The New York Times, Pittman promoted Colburn

to the head of the Business Affairs unit at AOL and at AOL Time Warner and personally worked

to support Colburn's efforts to push through the combined Company's major advertising deals,

including the agreement to sell advertising from both the AOL division and Time Warner t o

WorldCom .

458 . According to The Washington Post, David M. Colbum, who ran the Business

Affairs division, reported to Pittman , who reported directly to Case . In addition, Colburn is

reported to have been particularly close to Pittman . Colburn was heavily involved in all of the

transactions at issue in this Complaint-he reviewed and signed off on all deals . In addition to

his hands-on involvement with the subject deals, according to numerous witnesses and press

accounts, Colburn was also a major force in instilling the culture of greed and arrogance that

drove others within the companies to make sham deals or to take steps to engage in and cover up

the improper accounting used in connection with-the deals .

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459. J. Michael Kelly served as Executive Vice President and Chief Financial Office r

for AOL Time Warner and Senior Vice President and ChiefFinancial Officer for AOL. Kelly

joined AOL in June 1998 , and as its Chief Financial Officer, was the executive most directly

responsible for the accuracy of the Company's accounting. According to AOL Time Warner

executives, as reported in The New York Times article dated September 1, 2002 entitled "Ouster

at AOL, but Where Does Trail End?," it was Colburn's job to t ry and do everything possible to

post strong results , and Kelly's job to stop him at the limits of accounting rules . As Chief

Financial Officer, Kelly signed off on all of AOL and AOL Time Warner's major advertising

deals and its financial reports until December 2001, when he was demoted to Chief Operatin g

Officer of the AOL division.

460. Every advertising deal was reviewed and signed off by Colburn. A former

account manager in the account services unit of AOL' s Interactive Marketing division stated tha t

for big adver tising deals, Meyer Berlow, Barry Schuler or Defendant Pittman also signed off.

According to the former employee, the bigger the deal the more significant the list of peopl e

signing off on the deal. In anAdvertising Age ar ticle dated May 7, 2001, Pittman noted, with

regard to crossmedia advertising deals : "We generally do these issues at the COO or CEO leve l

within the Company . "

461 . Eric Keller, a Senior Vice President in the Business Affairs Division an d

purported number two dealmaker to his boss Colburn, was deeply involved in the creation an d

execution of the Company's advertising transactions, including the Homestore and PurchasePro

stock warrant deals.

462. Joseph Ripp, as Executive Vice President and Chief Financial Officer of AOL Inc.

(the online subsidiary of AOL Time Warner), had access to and was involved with .financia l

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matters relevant to the transac tions . In August 2001, Ripp along with Steven Rindner, a Senior

Vice President in AOL's Business Affairs and Development division, took over hand ling the

sham transactions with Homestore on behalf of the Company.

463 . Within Business Affairs, Keller and Rindner, as Vice Presidents, reported directl y

to Colburn who signed off on all deals emanating from that division .

464. Since November 2001 Wayne Pace has served as Execu tive Vice President and

Chief Financial Officer of AOL Time Warner . In this capacity, he played a pivotal role i n

driving value creation across AOL Time Warner and has overseen all of the Company's finance

functions, including tax, financial planning, mergers and acquisitions , treasury, accounting and

capital allocation. He has made numerous statements regarding the strength of the Company' s

advertising revenue despite knowledge that such revenue was materia lly overstated . As Kelly' s

successor, Pace took on Kelly's responsibilities and involvement in the Company .

465. Upon the Merger Date, Novack became Vice Chairman of the Company . As a

member of the Office of the Chairman, he provided strategic counsel and handled special

assignments for the Chairman, and assumed a leading role in major corporate transactions-

including taking a leading role in AOL 's joint venture with Bertelsmann . Formerly the Vic e

Chairman of AOL and a Director, Novack played a number of cri tical roles at that company. In

addition to broad strategic responsibilities , he oversaw AOL's Legal Department, as well as

AOL Investments, and was a key architect of the Merger between AOL and Time Warner. Prior

to joining AOL, Novack was outside counsel to the company .

466. Gerald Levin, as Chairman and Chief Executive Officer of Time Warner and

Chief Executive Officer of AOL Time Warner, had access to any and all corporate informatio n

possessed by the two companies . Levin was one of the primary driving forces behind the Merger .

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After the Merger, Levin made numerous misrepresentations regarding the Company's financia l

prospects and overruled internal efforts to disclose the true nature of the Company's advertising

revenues .

467 . As set out in detail below, the Individual Defendants were aware that AO L

advertising revenue was artificially inflated through sham transactions and improper accountin g

and that the advertising market was in a major downturn through regular company report s

tracking such revenue and several whistleblowers communica ting such issues to senior

management.

468. The Individual Defendants were insiders who were engaged in active daily role s

at the companies and were involved with or were aware of the relevant transactions at issue i n

this Complaint . Through their collective efforts, the companies issued pub lic filings, press

releases, and other group-published information containing false and misleading information.

469. Even in cases where Defendants were not personally engaged in such transactions,

they knew, individually or as a group, of the existence of improper accounting and eithe r

approved of it or failed to act to prevent it despite their ability to control the actions of the ke y

dealmakers .

470. As set forth elsewhere herein in detail , the individual Defendants , by virtue of

their receipt of informa tion reflecting the true facts regarding AOL and AOL Time Warner, their

control over, and/or receipt and/or modification of AOL's and AOL Time Warner 's allegedly

materially misleading misstatements and/or their associa tions with the AOL and AOL Tim e

Warner which made them privy to confidential proprietary information concerning AOL and

AOL Time Warner, participated in the fraudulent conduct alleged herein .

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b. The Nature of the Accounting Improprieties and Sham Transaction s

471 . Many of the subject transactions involved actions that demonstrate intentiona l

misconduct as the actions had no legi timate business purpose in AOL and AOL Time Warner' s

business other than to hide the true nature of the transactions so that advertising revenue could b e

artificially inflated. For example, in the fraudulent Homestore deals, Defendants set up sixteen

separate sham transactions in which the two companies generated bogus advertising revenu e

through the use of three-legged "round-t rip" deals involving third parties . . As part of the deal s

Defendants agreed with Homestore executives not to document the secret leg of the sha m

transaction in order to avoid their detection .

472. As set out more completely above, Keller was the architect of sixteen separat e

sham transactions with Homestore--all approved by Colburn-in which the two companies

generated bogus advertising revenue through the use of three-legged "round trip" deals involvin g

third parties . Once the deals were in effect, Keller worked with Homestore's top dealmaker ,

Peter Tafeen, in May 2001 to avoid detection by Homestore's auditing firm of the sham deals

that were to take place in the second quarter 2001 . Keller and Colburn also agreed with

Homestore executives not to document the secret leg of the sham transaction in order to avoi d

detection. In addition, Keller was directly involved in the fraudulent Homestore-House and

Home Deal in 2000 .

473. With the end of the 2001 second quarter rapidly approaching , Ripp and Rindner

participated in a conference call with Homestore CEO Stuart Wolff on June 29, 2001 and agreed

to carry on with the sham transactions despite their knowledge that the deals were corrupt. By

doing so, they were able to allow AOL Time Warner to inflate advertising revenue and avoid

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negative publicity for both AOL Time Warner and Homestore, in which AOL Time Warner ha d

a significant equity interest.

474. Similarly, Defendants' activities with regard to the PurchasePro warrants deal did

not serve any legitimate business purpose and shows intentional misconduct . That deal, which

according to The Washington Post was referred to as "science fic tion" by Colburn, involved a

purported revision of the terms of AOL's equity interest in PurchasePro, and AOL and the

Company fraudulently accounted for the transac tion by reporting $27.5 million in advertising

revenue .

475. Keller was involved with the PurchasePro transaction in which AOL received

PurchasePro stock warrants in exchange for distribu ting PurchasePro software. According to

Charles E. Johnson , Jr ., PurchasePro's CEO as reported by The Washington Post on July 19,

2002, "[tjhe warrants had nothing to do with ad revenue. They were directly related to selling

our marketplace software to our customers, supp liers and partners . "

476. Other types of fraudulently accounted for deals involved "round-tripping",

"jackpotting", conversion of settlement proceeds into advertising revenue, improperly booking

revenue in cases where AOL acted as an advertising broker, converting contract termination fees

from failing dot-corns into advertising revenue, and double-booking of advertising revenue

obtained in cross-platform deals .

477. In a classic "round-trip" transaction negotiated in 2000, AOL paid Veritas $50

million for $30 mill ion in software. Veritas, in turn, used the excess money paid by AOL to

purchase $20 million in AOL advertising. The Gateway deal also involved "round-tripping."

Both Gateway and Veritas have since restated their revenues based on the improper accounting

involved in their transactions with AOL demonstrating the fraudulent nature of the deals .

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478. By its "jackpotting" practices , AOL would run inordinate, and wholly ineffective,

amounts of advertising in the final few days before a quarter ended so that it could meet th e

number of advertising impressions required to realize all of the advertising revenue in tha t

quarter . Such behavior, which made no sense from an advertising or business standpoint, wa s

only done to commit fraud and produce improperly inflated advertising revenue .

c. Whistleblowers Provide Further Evidence of Individual Defendants'Knowled e

479. Several AOL and AOL Time Warner whistleblowers raised concerns with uppe r

management, including Pittman, about the propriety of the accounting methods being engaged i n

by the Company with regard to advertising revenue only to be dismissed for their efforts . Some

of these concerns were raised and summarily dismissed during the pendency of the Merger that

the Individual Defendants so badly wanted to be effectuated . The Individual Defendants,

particularly Case, Pittman, Kelly, Pace and Levin, in company press releases, continued t o

misrepresent to investors critical information relating to advertising revenue with full knowledge

that investors were relying heavily on such informa tion.

480. Numerous employees questioned the improper recognition of the advertisin g

revenue alleged herein, raising the matter with senior management. According to the July 18 ,

2002 Washington Post article entitled "Unconventional Transactions Boosted Sales: Amid Big

Merger, Company Resisted Dot-Corn Collapse" Robert O'Connor outlined his concerns in a

series of meetings in 2001 and 2002 with Pittman, Colburn, Kelly and other AOL executives .

According to O'Connor, "Clearly, a lot of what they were living on was revenue that was not of

the highest quality. I don't know if they're still in denial, but there was some pretty big busines s

issues they were not willing to face. For nine months I tried to get these guys out of denial . I

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tried to take the perfume off the pig ." O'Connor also told Company officials at some point that

he was concerned that AOL's accounting practices might lead to another SEC investiga tion.

481 . According to the July 18, 2002 Washington Post article, another former

employee, James Patti, a senior manager in AOL 's business affairs division told senio r

execu tives he was uncomfortable with some of the AOL advertising deals . He was laid off

shortly thereafter in 2001 even though he bad recently received a merit promotion . Patti said he

believes that his job termination was directly related to his unwillingness to go along with the

advertising deals. Patti said, "I had been asked to paper many of these questionable deals an d

was unwilling to cooperate, making my concerns known to management," and that "[t]he layoff

came exactly one week later . Ultimately, f was happy to leave the company with my integrity

and professional ethics intact . "

482. Recognizing that falling advertising rates would produce an inventory problem-

i .e ., AOL would be forced to sell so many additional ads to meet revenue targets that it woul d

run out of space to post additional ads-Robert O'Connor warned Company executives that thi s

would create a fundamental business problem . Told that he was not a team player, O'Connor left

the Company on March 29, 2002 without negotiating a severance package because he was n o

longer comfortable working in an environment where officials did not want to hear about interna l

business issues. According to O'Connor, as reported in the July 19, 2002 Washington Post

article entitled "Creative Transactions Earned Team Reward :" "Not only were they not willing t o

get out of denial, now they were going to actually punish those who were going to even rais e

issues."

483. Berlow, President of Interactive Marketing, commented on O'Connor in a March

8, 2042 e-mail obtained by The Washington Post. The e-mail, sent to Barry Schuler, at the time

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President of AOL' s Interac tive Services Group, noted that "[t]he only reason you know that there

is an inventory problem is that Bob [O'Connor] continued up the ladder with the inventor y

problem (Bobby-Ripp-Kelly-Mayo) and shot his career out the window." Berlow was referring

to Robert Friedman , then head of AOL's interactive marketing division ; Defendant Joseph A.

Ripp ,,Chief Financial . Officer of the AOL division of the Company ; Defendant J. Michael Kelly,

the ChiefOperating Officer for the AOL division ; and Mayo Stuntz , Jr., executive vice president

of AOL Time Warner 's cross divisional ini tia tives .

484. Soon after the Merger, Individual Defendants boldly projected a quick 30 percen t

profit increase. Defendants took this position despite fierce internal opposition from Joa n

Nicolais, Time Warner's chief contact with Wall Street . According to a December 9, 2002

Newsweek article entitled "How it All Fell Apart," one top executive stated that Nicolais

criticized AOL's approach as "basically an elaborate spin machine . . . . She didn't think the

numbers added up ."

d. The Prior Pattern of Improper Accountin Practice s

485. As noted in detail above, AOL has an extensive history of having engaged in, an d

been disciplined for, accounting improprieties by the SEC. Past SEC investigations of an d

actions against AOL occurred between 1997 and 2000 . On May 15, 2000, the SEC issued a

Cease and Desist Order against AOL requiring it to comply with accounting rules and the

securities laws. AOL agreed to comply with the Cease and Desist Order . In the same SEC

action, the SEC fined AOL $3 .5 million, the largest fine ever assessed at the time , and required

AOL to restate its financial statements for 1995-97 .

486. As a result of the multiple SEC ac tions, the Individual Defendants were wel l

aware of the importance of proper accounting and in fact Case had pledged to adopt "new gold-

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standard accounting practices ." Despite this knowledge, the Individual Defendants continued t o

intentionally ignore or recklessly disregard applicable accounting regulations and the securitie s

laws .

e. Defendants ' Restatement of AOL's Advertising-Revenue- and GAAPViola tions Provide Evidence of Scienter

487. Defendants ' GAAP violations, as presented in detail above, were not technical

viola tions of esoteric accounting rules, but conduct violative of basic GAAP principles that

further demonstrates the Individual Defendants' dishonesty .

488. Since the filing of the initial complaint, the Company has admitted that improper

accounting occurred over at least eight consecutive quarters with respect to almost $200 million

of advertising revenue. The biggest quarterly period of artificially inflated advertising revenu e

that the Company has admitted, $66 million, was for the quarter that commenced just one month

after the SEC issued the Cease and Desist Order and imposed a $3 .5 million civil penalty against

AOL.

489. By issuing a restatement over eight consecutive quarters of almost $200 million i n

advertising revenue, AOL Time Warner has admitted that its publicly-issued financial statements

for each of the restated periods were not prepared in conformity with GAAP , and that AOL Time

Warner materially misstated its financial condition and results of operations . Under GAAP, the

restatement of previously issued financial statements is reserved for circumstances where no

lesser remedy is available . Under APB 20, Accounting Changes, restatements are only permitted,

and are required only to correct material accounting errors or irregularities that existed at the

time the financial statements were originally prepared and issued .

490. The restatement of a company's previously issued financial statements becomes

necessary when it is discovered that previously issued financial statements contained errors o r

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irregularities in accounting which caused them to be materially misstated . Such misstatements

can be the result of errors or fraud, and once discovered, the company is obligated to notify al l

parties who may rely on the previously issuedfinancial statements that they should no longer

place reliance thereon. The restatement of a company's previously issued financial statement is ,

in fact, an admission that such financial statements contained material misstatements that -caused

them to be misleading to the reader.

f. The Individua l Defendants 'Awareness of Improper Deals andContinued Denial of Any Wrongdoing After the Truth is Revealed

491 . After the Company's accounting improprieties were revealed by The Washington

Post, the Individual Defendants admitted knowledge of the suspect deals but arrogantly denie d

any wrongdoing . Only after the allegations persisted and the SEC and DOJ investigation s

became public, did the Defendants acknowledge any wrongdoing .

492. According tone Washington Post July 18, 2002 article, a lawyer hired by the

Company responded : "The accounting for all of these transactions is appropriate and in

accordance with generally accepted accounting principles . The disclosures in AOL 's financial

statements are approp riate and accurate. AOL 's statements provide our investors with all

appropriate material information about our business." The attorney added that The Washington

Post's investigation was "not only grossly unfair and unwarranted in light of the exhaustive facts

we have presented to you, but is also reckless in the current highly-charged environment ."

493 . Within weeks of making these fervent denials, Pittman resigned, Colburn was

fired and locked out of his office, and the Company disclosed that government agencies wer e

conducting civil and criminal investigations into their accounting practices and that the Compan y

-itself was conducting an internal investigation of its accounting practices. As a result of this

internal investigation, the Company has thus far restated its advertising and commerce revenue i n

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the amount of $190 million for the eight consecutive quarters ended September 30, 2000 throug h

June 30, 2002 . The government's investigations are ongoing and reportedly were recentl y

broadened in scope. Most recently, the Company announced that it may further restate AO L

advertising revenue by reducing it in an amount of up to $400 million for 2001 and 2002 as a

result of the SEC's investigation into the Bertelsmann AG transactions .

2. Motive and Op ortunity of the Individual Defendants to Engage in ImproperAccounting, Sham Transactions and Reporting of Inflated AdvertisingRevenue

a. Salaries, Bonuses, Stock Sales -The Culture of Greed Begin s

494. Throughout the Class Period, the Individual Defendants all shared an overridin g

motive to enrich themselves through the considerable wealth that flowed to them from thei r

generous salaries and bonuses and the sale of stock at inflated prices. During the Class Period,

this motive became increasingly focused on the Merger between the two companies, the so-

called "deal of the century." Prior to the Merger, Individual Defendants engaged in fraud t o

inflate AOL's stock price and to initiate the Merger and ensure its ultimate consummation, alon g

with the corresponding acceleration of vesting of stock options and lifting of restrictions o n

restricted stock. After the Merger, the Individual Defendants engaged in fraud to keep the

illusion of growth, profitability and synergy of the merged entity alive-rand, correspondingly ,

keep the stock price up . After the Merger, the Individual Defendants also recognized that if th e

merger turned out to be a failure or was even perceived as such, they would be faced wit h

removal from their positions of power and access to corporate riches . In the end, this became the

reality for Individual Defendants Case, Levin, Pittman, Colbum and Keller. Such short-

sightedness and greed helped to produce the facts that are the subject of this Complaint .

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495 . Faced with these motivations and the knowledge of a general downturn in the

advertising market and a specific decrease in AOL advertising revenue, especially as a result o f

dot-corn failures, Defendants, individually and as a group, were highly motivated to engage i n

improper accounting and sham dealmakiug to inflate advertising revenue at the companies .

h. The Shift to Fiat Rate Pricing and the Increased Importance ofAdvertising Revenue to AOL's Bottom Lin e

496. Partly as a result of increased compe tition, in December 1996 AOL dropped its

pay-by- the-hour method of charging subscribers and adopted a " flat-rate" pricing plan .

497. Following the introduction of the flat rate plan for the AOL subscriber service in

December 1996, the company experienced a significant decline in its profit margins for revenu e

flowing from usage of its online service . As AOL began seeing its subscription revenue for the

online service drop, the company looked for ways to increase advertising revenue .

498. The growth of higher margin advertising revenue became increasingly importan t

to AOL's business objectives. Advertising revenue grew in importance as the company

continued to leverage its large, active and growing user base . For fiscal years 1997, 1998, an d

1999 AOL reported advertising and commerce revenue of $147 mill ion , $358 million, and $765

m illion , respectively. Advertising was the fastest growing part of AOL' s business .

499. AOL's SEC Form 10-K for the fiscal year ended June 30, 1997, described th e

importance of advertising revenue to AOL's success :

An important component of the company's business strategy is to increasenonsubscription based revenues, including from advertising sales and transactionfees associated with electronic commerce, and the sale of merchandise, which thecompany believes are increasingly important to its gEpwdi and success . Thecompany continues to establish a wide variety of relationships with advertisingand electronic commerce partners in order to grow its non-subscription basedrevenues and to provide AOL subscribers with access to a broad selection ofcompetitively priced, easy to order products and services .

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(Emphasis added.)

500. Beginning at least as-early as mid-1998 , many of these alliances and partnerships

enabled AOL, and later AOL Time Warner, to artificially inflate revenue through, among othe r

means, the use of improper accounting practices regarding "pound-trip" and barter transactions .

This was accomplished, in large part, through the emergence of AOL `portal ' deals described in

detail above .

501 . According to a former AOL Chief Technology Officer, Product Manager and

Senior Business Manager, as AOL became a portal with an increasing number of mi llions of

subscribers, the company had more power to demand what it wanted . It insisted that some of it s

adver tisers and content providers give AOL performance warrants or shares of their companies

for as little as a penny a share .

502. According to the same source, AOL used creative accounting when the company

began charging other companies for exposure to its subscribers .

c. A Culture of Recklessness and Gree d

503. The explosive growth in adver tising revenue at AOL, brought about in large pa rt

by the fraudulent accounting and dealmaking of the Business Affairs division, elevated tha t

division's and Colbum's importance at the company. As subscription revenues fell, advertisin g

growth was the only way the company could sustain its sky-high stock prices and ensure th e

company's long-term viability . The inflated stock value allowed AOL employees to becom e

increasingly wealthy as a result of stock options and large salaries . The Individual Defendants '

desire to maintain such wealth created a culture that expected and rewarded improper deal-

making in AOL's Business-Affairs unit through the use of a mix of lavish perks and financial

rewards and the threat of verbal abuse .

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504. For example, a September 1, 2002 New York Times article entitled "duster at

AOL, but Where Does the Trail End?" reported that Pisan "lavishly rewarded executives who

did meet their quarterly goals ." The article proceeds to note that Colburn earned enough fro m

AOL stock op tions to hire popular music groups `N Sync and the Dave Matthews Band to play at

par ties for his children .

505. Colburn, as the leader of the Business Affairs division, has been described as a

"larger than life figure." The Washington Post, in a July 19, 2002 article, described Colbum' s

tactics as follows :

He burnished his imposing reputation on Sundays at 9 a.m. on theregulation basketball court outside his large, clapboard and stone country-stylehouse in Potomac .

There, he gathered his loyalists-a group of deal makers who wanted tomove up the corporate ladder. Attendance was de rigueur. What he taught hisdisciples was his way of playing sports-and doing business . He played aferocious game, breaking down his opponents with rough elbows, blatant foulsand name-calling, attendees said .

"It's the way he gets people to love him and fear him," said an AOLofficial . "You don't go to play, you go there to be abused ."

Colbum could be rougher on his troops at work, said several sources,many of whom declined to speak for attribution for fear- it would hurt their careeror jeopardize their benefits .

Once Colbum beckoned Ted Rogers, then a new member to his team-and a former Washington Redskins player and gave him a dressing downoutside AOL's fifth-floor boardroom during a meeting of "Op Com," theoperating committee of senior executives, chaired by Pittman .

Witnesses said Colbum screamed at Rogers for a paperwork mistake-getting the wrong AOL executive's signature on a particular deal . The beratingbecame water-cooler legend : If Colburn could decimate Rogers, a 250 pound, 6-foot-2 112 former linebacker, what about the rest of his crew?

***

Every couple of weeks, AOL sources said, Colburn would pick otherpeople, poke fun at them, yell at them, break them apart, and build them back up.

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"He'd put an arm around you, and say, `Things are going to be all right, Ireally love you,"' said an AOL source. "He'd say a kind word, and it'd makeyour day. It's like an abusive father. "

Colburn also bestowed financial rewards on his minions . He would sendfavored underlings and their spouses on weekend getaways to places like NewYork, all expenses paid, including limousine service and lavish dinners, AOLsources said .

Colburn helped decide who got stock options, another powerful incentiveto keep employees in line, especially when AOL shares were on the rise, sourcessaid. During the height of the Internet boom, employees recalled logging on totheir computers in the morning, checking their portfolio and staring in amazementat their growing assets .

"It was like, `Tow, I just made a few thousand dollars just by sleeping,"'said an AOL official .

But in exchange for such largess , Colburn demanded loyalty, AOL sourcessaid, and .never was that more clear than when AOL was at the pinnacle of itspower.

"He created these foot soldiers who went to war for him," said an AOLsource. "These were heady times ."

506. Colburn's efforts to create loyalty in his Business Affairs division were successful .

As described in the Industry Standard article "AOL Rough Riders" dated October 30, 2000 :

[Colbum] has a posse of imitators at AOL who show up at work dressed inHawaiian shirts and needing a shave. They'll plunk a pair of cowboy boots up onthe table during a meeting no matter who's present because that's somethin gColburn would do . Some even borrow his strange accent . "Every guy workingon deals inside AOL wants to be just like Colburn," [ex-AOL dealmaker Phillip]Zakas says . "So you'd have these people walking around trying to sound likeColbum: Ìf you don't sign this deal, you're f*#ldng crazy; this is a great deal .'That kind of stuff happened all the time even though it was frowned upon-unlessof course it was Colburn or a vice-president, because they .had the charisma to getaway with it."

507. In January 2000, when AOL announced its anticipated merger with Time Warner,

Colburn's Business Affairs division was at the height of its power, making huge deals with start-

up Internet companies desperately seeking the type of business legitimacy that only AOL could

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offer them. The Business Affairs division' s successes enriched those in the division and

employees throughout the Company . The Washington Post reported on July 19, 2002 :

The transactions, in turn, helped enrich AOL. Everyone, it seemed, wasbecoming an instant millionaire at the company's Dulles headquarters . Therewere a lot of Ferraris . And twenty somethings and secretaries retiring with seven-figure bank accounts after a few years on the job, thanks to the incredible windfallfrom stock options .

At business affairs, almost anything seemed possible . Hard work begotwealth. Wealth begot parties . And parties, on occasion, became part of that work .

That included a spontaneous excursion from Dulles to San Francisco by ahandful ofAOL officials on the corporate jet. They called it a "team-building

lp,trip.

It took place in the Gold Club topless bar on Howard Street , said sourceswho were present, and both men and women from AOL attended .

"The lavish parties, the crazy antics-it really socialized you," saidanother AOL source. "You had to toe the line . "

508. The importance of the Company's stock price was instilled in every facet of

corporate culture at AOL and AOL Time Warner. For example, according to. a former employee,

even securi ty issues were presented in terms of stock value . At a security session, AOL's head

of security, a former FBI agent, began his presentation by saying "Everything we do around her e

is related to one word ." Then he stopped and wrote on the blackboard the word "stock" H e

then went on to explain that "the main reason to practice good corporate security was .that

security leaks and problems could affect AOL's stock price."

509. On a monthly basis, Colburn would present `Sammy Awards"-to the to p

performers of the 100 or so employees of AOL 's Business Affairs division. A takeoff on

television 's Emmy awards , the Bammys were presented by Colbum to those employees who had

put together deals most favorable to AOL .

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510. At one such ceremony in December 2000, just prior to the Merger, Colburn

awarded the Bammy gold star plaque to Kent Wakeford and Jason Witt, who had put togethe r

the sham transaction with PurchasePro .Com described herein. According to The Washington

Post, Colburn praised Wakeford and Witt for what he called a "science fiction" deal to generat e

advertising revenue, a comment some attendees took for the aggressive way the Company ha d

constructed the transaction .

511 . One attendee at the ceremony said , "The sheer arrogance , the feeling of being

untouchable, was amazing."

512. In light of the important role played by the Business Affairs division in helpin g

AOL and AOL Time Warner meet its revenue targets and the fact that its work was approved b y

executives at the highest level, it is not surprising that Business Affairs employees believed they

could do no wrong.

d. The Importance of Initiating, Consummating and Successful)Implementing the Merger

513 . Case and Levin may have had different motives in merging their two companies ,

but the strength of their desire to merge was the same .

514. "Case had been searching for a big acquisi tion for a year. Time Warner was

exactly what he longed for, a traditional company rich in assets and history . Gerry Levin had

been searching for something entirely different . In a career that encompassed the history of the

modern media, Levin held fast to a vision of an interactive world . For him, AOL was the

fulfillment of that vision ." CNBC television program The Big Heist: How AOL Took Tim e

Warner, CNBC, January 9, 2003, transcript at 3 ("Big Heist Trans . at "D.

515 . According to John Malone, a longtime business associate of Steve Case and

Chairman of Liberty Media (one of AOL 's largest shareholders) stated : "Case was ready to

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marry anybody that would have hard assets and liquidity ." Id. at 3. Richard Beanie. AOL's

lead deal attorney, confirmed this observation: "We spent a good amount of time, I believe in the

spring and summer leading up to [the Merger], looking at a lot of different strategic choices ." Id .

at8 .

516. The Newsweek article, dated December 9, 2002 entitled "How it All Fell Apart, "

noted: "Case was also increasingly worried that customers would dump his snail's-pace dial-up

service for faster connections offered by cable companies . His hot stock was burning a hole in

his pocket . "

517. In addition to a desire to meet the market's continued expectations of increased

advertising revenue to keep the company's stock price artificially inflated, the Individual

Defendants were under tremendous pressure to keep advertising revenue up so as to no t

jeopardize AOL's pending Merger with Time Warner.

518. After the Merger agreement was announced in Janua ry 2000, the pressure to

generate advertising revenue became even more intense. According to the July 19, 2002

Washington Post article, in August 2000, employees in the Business Affairs division were

meeting regularly in a conference room between the office of Case and Pittman to discuss wha t

to do with a growing list of failing dot-com customers which were pleading with AOL to

restructure their advertising deals. Colburn and Berlow conducted the meetings with their

employees, oftentimes screaming at them to get AOL's business partners to pay up . According

to AOL sources, Colbum was constantly reminding people that pressure was on because of the

Merger and would say "Are you guys crazy? Are you forgetting what we have to accomplish? "

519. As reported in The Washington Post article on July 18, 2002, according to former

AOL employee, James Pat ti : "The bubble had clearly burst, but senior management was under

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enormous pressure to hit the [financial] numbers and close the Time Warner transaction, whic h

would diversify the revenue base and lower the risk profile of the company ."

520. Not surprisingly, the Company's largest quarterly restatement of advertisin g

revenue was for the last publicly reported quarter prior to the co nsummation of the Merger .

521 . There was also a strong motive at Time Warner to consummate the Merger,

especially on behalf of Levin. Michael Fuchs, former HBO Chairman and CEO who worked

with Gerry Levin for nearly 20 years, stated that Levin "has an enormous drive to be seen as a

visionary. It started back in 1975 when HBO went up on the satellite. It became Gerry's calling

card . And replicating that visionary situation was driving motivation for him throughout hi s

career. Every deal was the transforming deal ." Big Heist Trans . at 4.

522. Levin was so intent on consummating the Merger that he reportedly told few

Time Warner colleagues of the deal's existence . According to a reporter who covered the story

for Time, "People who reported directly to Levin, you know, heads of huge divisions who had no

idea, they found out about it, I believe it was the Sunday night before the Monday mornin g

announcement." Big Heist Trans . at 9 .

523 . Once implemented, Time Warner individuals such as Levin were mo tivated to see

the Merger succeed in order that they not be viewed as failures for having agreed to merge wit h

an Internet company such as AOL.

524. Perhaps recognizing that his vision would not be fulfilled, Levin retired from the

Company unexpectedly in May 2002 . On January 12, 2003, Levin' s partner in the Merger, Case

announced his resignation from the Company effective May 2003, noting that, among other

things, the Merger had been a "disappointment ."

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e. Defendants' Financial Incentives Related to the Merge r

525. In addition, certain Individual Defendants had enormous financial incentives t o

complete the merger due to the accelerated vesting of their stock options and lifting o f

res trictions on stock sales . AOL Time Warner's 2002 Proxy Statement noted : "All options

awarded prior to 2000 held by Messrs . Levin, Turner, and Parsons became immediately

exercisable in full upon the approval of Time Warner 's board of directors of the AOL-TW

Merger on January 9, 2000. All options awarded prior to 2000 held by Messrs . Case and Novack

became immediately exercisable in full on the Merger Date and a ll such options held by Mr.

Pittman became immediately exercisable on the first anniversary of the Merger Date . "

Restricted shares of stock at both companies similarly became vested and unrestricted .

526. Once the Merger was completed, part of Defendants' motivations for the Merger

became clear. As set out in detail below, the Individual Defendants engaged in extensive inside r

selling in the months immediately following the Merger with numerous sales taking plac e

between January and May 2001, when the combined company's stock hit its all-time high .

During this period the Individual Defendants (whose information is publicly available) sold ove r

11 .4 mill ion shares of AOL Time Warner stock for proceeds of nearly $270 million.

527. This massive insider sell-off occurred while the Company was engaged in a $ 5

billion repurchase of its stock . During the first six months of 2001, the Company repurchased 3 0

million shares of its stock for $1 .3 billion serving to further inflate the stock price while the

Individual. Defendants sold 11 .4 million of their own shares for proceeds of $270 million during

the same period .

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f. The Individual Defendants Deny and Cover Uu Problems Associatedwith Shrinking Advertising Revenue

528. Due to the critical importance of advertising revenue to AOL , such revenue was

tracked closely by the companies and their top executives . According to one former AOL Vice

President, Robert O'Connor (Vice President of Finance for the Business Affairs unit) prepared

reports that showed "every adver tising deal that AOL had and the amount of annual revenu e

recognition expected from each deal ." The reports would show the amount of revenue initiall y

expected from a deal and would show a lower amount than initially expected if that advertiser

were experiencing financial difficulties . According to The Washington Post ar ticle dated July 18 ,

2002, AOL tracked on a weekly basis the health of the dot-corns, how much they owed AOL,

what AOL was doing to get its money , how the dot-corns were responding and how much mone y

AOL could lose if the dot-corns did not pay their b il ls .

529. In addi tion, according to a former employee AOL used a "pipeline report"

prepared by the Interactive Services unit that showed what advertising deals were in the pipelin e

and could be expected to turn into revenue producers .

530. As reported in The Washington Post on July 18, 2002, according to sources a t

AOL, the Company considered suing failing dot-corns in order to get them to pay for ads tha t

they had agreed to buy. But sources said that AOL decided against such a strategy because th e

public court filings would publicize the weakness in the business .

531 . In September 2000, internal company documents indicated that AOL was "at

risk" to lose more than $108 million in advertising revenue in fiscal 2001 (July 2000 to June

2001) with most of the jeopardized revenue coming from failing dot-corns .

532. According to the July 18, 2002 The Washington Post article, approximately two

weeks before AOL released its first quarter results on October 18, 2000, Pittman and several o f

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the Individual Defendants were told in a meeting at-AOL's Dulles headquarters by Rober t

O'Connor that AOL faced the risk of losing more than $140 million in adver tising revenue in

calendar year 2001 . This came at a time when the market-was aware of the downward trend

facing the industry. For example, just a week before the AOL's October 18, 2000 statements, th e

common stock of Yahoo Inc., plunged 21 % after the company reported that its advertising

revenue growth could no longer be sustained.

533. According to the July 18, 2002 The Washington Post article, AOL's top

executives were already holding weekly emergency meetings to discuss the status of advertisin g

agreements with failing dot-corns .

534. Not only did Pittman , Case and Kelly not communicate the Company's

advertising revenue problem to analysts during an October 18, 2000 conference call, the y

actually touted the strength of AOL's advertising and commerce revenues .

535. When asked whether AOL was feeling a slowdown in advertising , Pittman

responded "I don ' t see it, and I don 't buy it."

536. At the same conference, Case said "AOL's advertising growth is right on target"

and noted that "[t]he current advertising environment benefits us because it will drive a flight t o

quality "

537. Similarly, Kelly told analysts that AOL' s advertising and commerce revenu e

growth was "very healthy" and emphasized, "I can 't say that strongly enough . "

538. Despite his vehement denial of any problems with AOL advertising, J . Michael

Kelly later sought to disclose problems related to the decline in advertising revenue to investors

just months after the Merger, but was overruled by Levin and Pittman. On October 14, 2002 ,

The New York Times reported the following :

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Six months after America Online bought Time Warner, the merged company'sto executives rejected ar ents from its chief financial officer that the shouldback down from their ambitious promises to Wall Street, three senior executivesinvolved in the company's deliberations now sa . . . . Instead, the executiveswaited two more months, until September 2001, to publicly acknowledge that thecompany would badly miss their financial projections made at the time of th e

merger.

The chief financial officer, J . Michael Kelly, made his case while r arias AOLTime Warner's second-quarter earnings report in July 2001, arguing that aprolonged downturn in the advertising market was jeopardizing the company'spromise of an annual operating profit, excluding certain charges, of $11 billion inthe merger's first year, the senior executives said .

But Mr. Kelly's boss, Gerald M . Levin, the former chief executive, and Robert W .Pittman, the former co-chief operating officer, overruled him, arguing that thecombination of new company-wide advertising deals and deep cost cuts could-stillmake up for any shortfalls, the senior executives said .

Mr. Kelly eventua lly signed off on the company's public statements . But hiscaution in July 2001 suggests that AOL Time Warner's top executives mgy have

been more aware of the risks to the company's results than the have previouslyacknowledged .

Mr. Kelly was the execu tive most directly responsible for the company 's, financialreports and the chief financial officer of AOL before the merger, giving him aunique familiarity with its books as well as those of the merged company.

The Securi ties and Exchange Commission and the Justice Department areinvestigating the possibility that AOL temporarily inflated its advertising revenuearound the time it acquired Time Warner , and one ques tion they are asking is howmuch Mr. Kelly and his co lleagues knew about the precariousness of AOL'sfinances , people involved in the inves tiga tions have said .

New information emer ' in light of the investigations suggests that even by thetime the merger was com lete . AOL's advertising and marketing revenue-themost crucial component of the combined com an_R's profits and growth-alLeadd Mended on a varie of unusual deals creating the temporary but unsustainableappearance of strong demand for its services . More than $500 million of AOL'sadvertising, marketing and other revenue between June 2000 and July 2001derived from anomalous soon-to-Mire deals .

A company spokesman said that the company consistently gave investors its bestinformation and its executives worked hard to fulfill their promises .

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And yet, AOL had always declined to answer questions about who its biggestadvertisers were or exactly where its revenue came from, even to other executivesat its sister companies like AOL Europe, two executives involved said . After themerger closed in January 2001, AOL Time Warner disclosed even less . Thecom an for the first time stopped revealing AOL's backlog of future advertisingrevenue under contract . As a resuk investors had no way of knowing daring thenext 18 months that the backlog was declining to $800 million, from $3 billionbefore themer er.

(Emphasis added . )

539. Despite his earlier denials of the possibility of a slowdown in advertising at AOL,

Pittman abruptly resigned from AOL Time Warner following the two Washington Post articles

published on July 18 and 19, 2002.

540. Soon after publication of the same two articles, Colbum was fired and locked ou t

of his office .

3. Individual Defendants' Compensation Incentives

541 . Although scienter ofthe Individual Defendants is described in the immediatel y

preceding paragraphs and throughout this Complaint, the following is a summary of publicly

known compensation information regarding the Individual Defendants .

Stephen M. Case

542. According to publicly available data, Case made the most money from his inside

sales of stock of all the Individual Defendants .

543 . All stock options awarded prior to 2000 and held by Case became immediatel y

exercisable in full on the Merger Date, providing a s trong personal motive for him to ensure the

Merger went through at all costs . During the Class Period Case sold over 6 million shares of

AOL and AOL Time Warner stock for total proceeds of over $555 m il lion. In the four months

immediately following the Merger, Case sold 2 million shares for total proceeds of over $100

million.

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544. Case's eitecutive compensation during the Class Period provides further evidence

of his motive. During 2001 and 2002 he received an annual salary of $1 million . In 2002, Case

also received "other annual compensa tion" of $277,555 consis ting of "financial services" of

$99,213 and transportation-related benefits of $178,342 . For July 1, 2000 through December 31 ,

2000 (the "Transition Period") Case received a salary of $383,333, for AOL fiscal year 200 0

(July 1, 1999-June 30, 2000) he received a salary of $725,000 and a bonus of $1 .125 million, and

for AOL fiscal year 1999 he received salary of $575,000 and a bonus of $1 million. Moreover,

Case received option grants of 4 million shares in 2001, 1 .75 million shares during the Transition

Period, 3 million shares for AOL fiscal year 2000, and 1 .8 million shares during AOL fiscal year

1999 .

Robert W. Pittman

545. All stock options awarded prior to 2004 and held by Pittman became immediatel y

exercisable on the first anniversary of the Merger Date providing a strong personal motive fo r

him to-ensure the Merger went through at all costs . During the Class Period Pittman sold over

3 .3 million shares of AOL and AOL Time-Warner stock for proceeds of over $262 million . He

sold 1 . 5 million shares for over $72 mi llion in the four months immediately following th e

Merger. Bloomberg, in a July 30, 2002 article entitled "AOL Time Warner Pay Dilemma Goe s

Beyond Pittman ," suggests that Pittman sold an unusually large percentage of his AOL and AOL

Time Warner stock: "Pittman seems to have been a far more savvy investor than an executive.

He clearly didn't believe in the notion that one ought to hold a lot of shares in one's company, a s

he owned just 13 ,388 shares as of Jan. 31 [2002] ."

546. Pittman's executive compensation during the Class Period provides further

evidence of his motive. Up until his departure in July 2002, Pittman received a salary o f

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$769,230. During 2001 he received a salary of $1 million . In 2002, Pittman also received "other

annual compensation" of $288,837 consisting of, inter alia "financial services" of $100,000 and

$161,192 for reimbursement for the payment of taxes related to life insurance coverage provided

in 2001 . In 2001, Pittman also received "other annual compensation" of $399,611 consisting of,

inter alia, $100,000 for financial services and $286,346 for the payment of taxes related to life

inkwmee coverage. For July 1, 2000 through December 31, 2000 (the "Transition Period")

Pittman received a salary of $358,333 and a bonus of $550,000, for AOL fiscal year 2000 (July 1 ,

1999-June 30, 2000) be received a salary of $683,334 and a bonus of $1 .05 million, and for AO L

fiscal year 1999 he received salary of $591,667 and a bonus of$1 million . In addition, Pittman

received option grants of 210,000 shares in 2002, 3 .5 million shares during 2001, 1 .5 million

shares during the Transition Period, 2 .5 million shares for AOL fiscal year 2000, and 1 .44

million shares during AOL fiscal year 1999 .

J. Michael Kelly

547. During the Class Period Kelly sold over $42 mi ll ion in AOL and AOL Time

Warner stock. Kelly sold 400,000 shares for proceeds of over $19 million in the three month s

immediately following the Merger . Kelly's executive compensation provides further evidence of

his motive. In 1999 Kelly received a base salary of $450,000 and a minimum bonus of 75% of

base salary or greater if certain personal and corporate goals were met. In addition, he received a

stock option package consisting of an initial reward of 250,000 shares vesting over 4 years an d

the option to purchase 225,000 additional options per year during years 4, 5, and 6 .

David M. Colburn

548. During the Class Period Colbum sold at least 150,000 shares of AOL and AOL

Time Warner stock for proceeds of over $7 .5 million-all during the four months following the

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Merger. Colburn's stock sales while an employee at AOL are not publicly available because he

was not required to notify the SEC of sales due to his level of employment with the company .

However, according to the the Industry Standard article of Oct. 30, 2000 entitled "AOL' s

Rough Riders," it is likely that he had very substantial sales during this period as the article

reported that he had an es timated net worth of $250 million .

Joseph A. Ripp

549. During the Class Period Ripp sold at least 20,000 shares ofhis AOL and AO L

Time Warner stock for proceeds of over $1 .7 million .

Gerald M.' Levin

550. A ll stock op tions awarded prior to 2000 and held by Levin became immediately

exercisable in full upon the approval by Time Warner's board of directors of the Merger o n

January 9, 2000 providing a strong personal motive for Levin to ensure the Merger was approve d

at Time Warner.

551 . Levin's executive compensa tion during the Class Period provides furthe r

evidence of his motive. In 2002, Levin received a salary of $769,230 and other annual

compensa tion of $285,058 consisting of, inter ali a, $100,000 in financial services and $178,342

in transportation-related benefits . During 2001 he received a salary of $1 million and other

annual compensation of $237,602 consisting of, inter alia, of $97,500 in financial services and

transportation related benefits of $127,446 . In 2000 Levin received a salary of $1 million, a

bonus of $10 million, and other annual compensation of $226,620 from Time Warner . In

addition, Levin received option grants for 4 million shares during 2001 and 750,000 share s

during 2000 .

48194 216

Wayne H. Pace

552. During a large portion of the Class Period Pace held positions that did not require

him to publicly report his insider transac tions .

Eric Keller and Steven Rindner

553 . Due to these Defendants' positions with the companies, they were not required to

file forms with the SEC related to insider sales and therefore that information is not publicly

available .

4. Additional Allegations and Discussion ReiZarding Scienter and 10 Viola tions ofStephen M. Case

554. By at least November, 1999, Defendant Case was aware that AOL's real

advertising revenue was decreasing significantly . Alec Klein, Stealing Time: Steve Case, Jerry

Levin, and the Collapse of AOL Time Warner 105-106, 186 (Simon & Schuster ed . 2003)

(hereinafter "Stealing Time"). (The author of Stealing Time, Alec Klein, also investigated and

wrote the July 18 and 19, 2002 Washington Post articles that reported on the impropriety of AOL

advertising revenue). As a result, Case knew, no later than November 1999, that the AO L

advertising revenue stream was considerably more imperiled than was being reported to

shareholders and the public. In fact, investors had no idea that AOL advertising revenue was in

jeopardy. Rather, they were told of huge AOL advertising revenue growth . At the same time,

however, Case knew the substantially endangered condition of that critically important revenu e

source.

555. Indeed, by November 1999, "Case began receiving internal company report s

pointing to a stark reversal of fortune on the horizon . Investors didn't know it, but suddenly

AOL's backlog - its pipeline of ad deals - was showing a disturbing downward trajectory ." Id .

at 186. The internal AOL advertising revenue reports received by Case include the following :

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A confidential report dated November 4, 1999, showed just how badthe situation was: The company had signed forty-seven deals valuedat $694 million from July to September 1999, but in the next three-month period, from October to December, so far only fourteen dealshad been signed, valued at $457 million. Less than a week later, onNovember 10, another internal report showed the same weakness .And by January 14, 2000, four days after the AOL-Time Warnermerger was announced, a further report indicated there was still nopickup .

Id. The November 4 and 10, 1999 and January 14, 2000 internal confidential AOL reports

received by Case were all entitled "Interactive Marketing Key Deals Summary ." Id. at 313 .

556. Not coincidentally, at the very time Case received the November reports revealing

deteriorating AOL advertising revenue, he first approached Defendant Levin about a merger wit h

Time Warner. As Klein reveals in Stealing Time:

[Sligns of financial weakness were beginning to blip on AOLspreadsheets . Internal AOL documents show that as early as the fallof 1999, just as Case made his ini tial approach to Levin, AOL'spipeline of future, big adver tising deals was projected to slow involume and revenue. That, combined with AOL' s greatest asset, itsstock price, gave Case all the incentive he needed to pu ll off theTime Warner deal .

"It was," said a company executive, "Steve's masterstroke . "

Id. at 106.

557. Case, by his own admission, was able to st rike the merger deal only afte r

convincing Time Warner that the value of AOL stock was "real." ( supra ¶ 78.) As the

January 11, 2000 Los Angeles Times reported:

Levin and Case said they had worked carefully to strike a reasonablecompromise on the values of their two companies .

"One of the creative breakthroughs was in the valuation" Case toldThe Times in a joint interview with Levin. He said the key tocoming to a final deal was Time Warner's "reco 'lion that theseInternet values are real ."

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(id .) (Emphasis added.) The extremely high value placed on AOL as part of the Merger was

principally based on AOL' s reported advertising revenue and the huge historical and projected

continued growth in the company's advertising revenue. (supra ¶ 79.)

558. However, at the same time Case persuaded Time Warner that the value of AO L

stock was "real ," and publicly represented in the Los Angeles Times that the value of the

company's stock was "real," Case knew that the purported value of AOL stock was not, in fact,

real. Case knew by at least November 1999, and failed to disclose to the marketplace, tha t

AOL's advertising backlog was deteriorating substan tially.

559. Case continued to sign AOL's SEC filings , including the following :

• SEC Form 10-Q for the fiscal quarter ended December 31, 1999• SEC Form 10-Q for the fiscal quarter ended March 31, 200 0■ Joint Proxy Statement-Prospectus mailed to shareholders on or about May 23,

2000• SEC Form 10-K for the fiscal quarter ended June 30, 200 0■ SEC Form 10-K/A for the fiscal quarter ended June 30, 2000+ SEC Form 10-Q for the fiscal quarter ended September 30, 200 0

SEC Form 10-K for the transi tion period from July 1, 2000 to December 31, 2000

Scree supra IN 275, 284, 405, 295, 310, & 332 .) All of these SEC filings reported substantially

inflated AOL advertising revenue and backlog (see supra 11276-277,285-286,392,297-298 ,

311-312 & 335) and gave the false impression of huge continuing AOL advertising revenue

increases on a quarter-to-quarter basis . Yet Case continued to fail to disclose to AOL

shareholders and the investing public the adverse company information of which he ha d

knowledge or, at the very least, recklessly disregarded, j, that the real AOL advertisin g

revenue was decreasing significantly. Instead, he touted AOL's financial results to ensure that

the Merger was consummated and to inflate the value of AOL' s stock price . For example, on

April 18, 2000, the same day Case signed AOL's financial statement for the quarter ending

March 31, 2000, AOL issued a press release announcing "record" financial results and inflated

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AOL advertising revenue and backlog of at least 57% and 73%, respectively, for the quarter

ending March 31, 2000 . See pra ¶¶ 285-285 .) In that press release, Case stated :

This quarter's results underscore the tremendous strength ofAmerica Online's operations, and demonstrate that we are on a clearpath to continued strop growth and increased rofiitab ili . Sincewe announced our landmark merger with Time Warner, we haven'tmissed a beat .

(Lee su ra ¶ 280.) (Emphasis added . )

560. On May 15, 2000, Case, on behalf of AOL , agreed wi th the SEC to cease & desist

from violating applicable accounting standards, and AOL paid a $3 .5 million fine to the SEC.

See, supra ¶ 19.) This SEC action came after previous SEC actions against AOL and Case's

earlier commitment to scrupulously adhere to applicable accounting standards. (supra ¶ 18 .)

Accordingly, Case was aware of the urgent need for AOL to comply with applicable accountin g

practices .

561 . On or about May 23, 2000, the Joint Proxy Statement Prospectus, signed by Cas e

and Levin, was mailed by AOL and Time Warner to their stockholders . The Joint Proxy

Statement-Prospectus was incorporated into the Merger Registration Statement, which in turn

incorporated financial statements and pro forma financial statements that materially overstated

AOL advertising revenue and backlog and omitted material facts regarding the real condition o f

AOL advertising revenue .

562. On July 20, 2000, AOL's financial statement for the quarter ending June 30, 2000 ,

which was signed by Case, announced more "record" financial results and inflated advertising

revenue and backlog by at least 48% and 52%, respectively . (S supra ¶¶ 297-298.) Also on

July 20, 2000, Case was interviewed by the Dow Jones News Service, which reported on that

same day as follows :

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Case said "all our numbers were at or above consensus estimates."AOL's earnings of 13 cents a share, excluding items, beat theconsensus by 2 cents a share . Case said AOL's fourth-quarter [forthe quarter ending June 30, 2000] results were helped by strongadvertising and electronic-commerce revenue, a development thatshould reassure investors who had feared that a "dot-com" shakeoutwould hurt the online advertising market.

(aee sum ¶ 294.) (Emphasis added .) Case again failed to tell the public the true condition o f

AOL's advertising revenue, backlog and growth, which he was aware of at least as early as

November 1999. Case continued to have access to_periodic AOL advertising revenue reports ,

including those titled "Interactive Marketing Key Deals Summary" dated March 21, 2000 ,

August 18, 2000 and August 24, 2000 . See Stealing Time at 313 . Other AOL internal

documents available to Case, which reported the true state of AOL 's adver tising revenue, such

as an "Interactive Marketing FY02 Budget Analysis-Ad Forecast," dated September 26, 2000

and documents titled "Interactive Marketing Deal Restructuring," dated August 18 and 24, 2000.

Id. These reports in the fall of 2000 confirm the same information that Case was aware of in

November 1999 - AOL was continuing to lose substantial amounts of actual adver tising

revenue. (eee supra % 7, 75, 301 & 313 .)

563 . On October 18, 2000, AOL again reported "record" financial results and inflated

advertising revenue and backlog by at least 41 % and 51%, respectively, for the quarter endin g

September 30, 2000 . (Lee supra IN 311-312 .) The quarterly statement, signed by Case, covered

the first full quarter after Case agreed to the SEC's Cease & Desist order and the last publicl y

reported quarter before the Merger was consummated. This AOL financial statement involves

the biggest quarterly restatement of AOL advertising made thus far by the Company . (See supra

¶ 236.) On October 18, 2000, following the release of these quarterly results, Case, along with

Levin, Pittman and Kelly, held a conference call with analysts to tout AOL's purported financial

48184 221

performance . (See supra ¶ 304) ; Stealing Time at 195. In response to an analyst's question of

whether AOL was affected by the industry-wide slowdown in advertising, Case stated that

"AOL's advertising growth is right on target . . . . The current advertising environment benefi ts

us because it will drive a flight to quality." id.

564. The Dow Jones Business News also reported on October 18, 2000, as follows :

AOL's first-quarter ad revenue,' however, was "very much ontare " and should be strong in future qua rters, Chairman and ChiefExecutive Steve Case said Wednesday. In an interview after AOLreported first-quarter [for the quarter ending September 30, 2000]results, Mr . Case said the company 's advertising revenue showed ithas weathered an overall slump in the online ad market .

As for AOL's sharp drop Tuesday [October 17, 2000], Mr. Casesaid, "I do not think people generally are concerned about Inte rnetadvertising. Our results show there's no reason to be concernedwhen it comes to AOL . "

(Emphasis added .)

565. In addition, according to Nina Munk's book, Fools Rush In: Steve Case, Jerry

Levin, and the Unmaking of AOL Time Warner (HarperCollins ed. 2004) (hereinafter "Fools

Rush In"), Case and Levin spent the day on October 18, 2000 promoting the Merger wit h

analysts, investors and journalists . Munk's book relates what Case told analysts, investors and

journalists on October 18, 2000 :

[F]ar from hurting AOL, he said, the so -called dot-corn shakeoutwas encouraging advertisers to spend more money on AOL ."Mere 's a lot of swirl about the advertising market, [but] AOL'sadvertisin wth is right on tare" Case told everyone . "Thecurrent advertising market benefits us because it drives a fl ight toquality."

All day on October 18, reporters analysts, and investors kept baitingLevin and Case. One television reporter asked incredulously:"Everybody has been hurt by the crashing dot-corn advertising . Youhave not?" Case replied: "Maybe we're a little bit different than

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everybody else . We've always felt that we were, maybe, a cutabove. I don't say that arrogantly, but we have been doing this forover fifteen years and we've kind of emerged as the blue-chip. Andwe have a little different business model - a different approach . Ithink we benefit from that ."

Fools Rush In 204-205. (Emphas is added.)

566. Based on Case's knowledge dating back to at least November 1999 regarding the

precipitous decline in AOL advertising revenue, on October 18 , 2000 he knowingl y

misrepresented the state of AOL advertising revenue in an effort to consummate the Merger and

inflate the value of AOL stock. At a minimum, on October 18, 2000 , Case was reckless i n

touting AOL 's advertising revenue and fa iling to disclose the true state of AOL advertising

revenue if, before making such statements , he failed to review the post-November 1999 an d

January 2000 internal AOL documents which revealed the real condition of that source o f

revenue. (Lee supra IN 7, 75, 301 & 313 .) Indeed, in light of his prior knowledge of decreasing

AOL advertising revenue dating back to at least November 1999 , Case's misrepresentations on

October 18, 2000 regarding the condition of AOL advertising revenue were either knowingly or

recklessly false.

567. Case continued to have access to AOL's periodic internal reports regarding AOL

advertising revenue, including documents entitled "Interactive Marketing Key Deals Summary, "

dated November 6 and 16, 2000 and January 4, 2001, and a report entitled "Interactiv e

Marketing Q2 Deals at Risk Potential Exposure," dated December 2000 . See Stealing Time at .

313 .

568. Nonetheless, AOL issued on March 27, 2000, and Case signed, AOL's SEC Form

10-K for the transition period from July 1, 2000 to December 31, 2000 . (supra ¶ 332.) This

SEC Form 10-K continued to report substantially inflated AOL advertising revenue by at least 3 7

48184 223

% of the actual amount of AOL advertising revenue, and failed to disclose the declining

condition of real AOL advertising revenue. {Id} Significantly, with the filing of the SEC Form

10-K for the transition period, AOL and the Company abruptly ceased the reporting of AOL

advertising and commerce revenue backlog . (Id . )

569. With his knowledge of the actual condition of AOL advertising revenue, shortl y

after the Merger was consummated on January 11, 2001, Case caused the Company to initiate a

$5 billion stock repurchase program that propped up the value of AOL Time Warner stock.

Fools Rush In at 214. At the same time, within a four-month period immediately after th e

Merger, Case sold 2 million shares of his Company stock for total proceeds of $100 million .

See supra 1543.) See also Fools Rush In at 229.

570. After the Merger, Case continued to sign SEC filings , including the SEC Form

IO-K for the fiscal quarter and year ended December 31, 2001 and SEC Form 10-K/A for th e

fiscal qua rter and year ended December 31, 2001 . [See supra ¶ 378.) These SEC filings reported

substantially inflated AOL advertising revenue and did not disclose the true condition of thi s

important revenue source. (supra 382, 286-287.)

5 . Additional Allegations and Discussion Regarding Scienter and & 10 (b) Violations ofGerald M. Levin

571 . Shortly after Case and Levin announced the Merger , AOL Time Warner was

incorporated in February 2000, at which time Defendant Levin was appointed Chief Executiv e

Officer of AOL Time Warner . See supra ¶ 38(h) . )

572. On or about May 23, 2000, the Joint Proxy Statement-Prospectus, signed b y

Levin and Case, was mailed by AOL and Time Warner to their stockholders . The Joint Proxy

Statement-Prospectus and the Merger Registration Statement which also was signed by Levin ,

incorporated financial statements and pro forma financial statements that materially overstate d

48184 224

AOL advertising revenue and backlog . In addition, these documents did not disclose material

facts regarding the true condition of AOL advertising revenue. (ace supra ¶[ 36(a), 38(h), 392 &

405 .)

573. On October 18, 2000, AOL reported "record" financial results and inflate d

advertising revenue and backlog by at least 41 % and 51%, respectively, for the quarter ending

September 30, 2000 . (See supra IN 311-312.) This quarterly statement involved the bigges t

restatement of AOL advertising revenue issued thus far by the Company. ( sum 1236.)

574. As indicated above , on October 18, 2044, Levin spent the day with Case

promoting the Merger with analysts, journalists and investors . Levin, on October 18, 2000,

described the condition ofAOL advertising revenue to analysts, journalists and investors a s

follows: "There's been a lot of swirl around the advertising market, particularly related to the so-

called dot-corn shakeout . I don't get it and I don't buy it." Fools Rush In at 205. (Emphasis

added.) Levin also referred to any concern regarding a decline in AOL advertising revenue as "a

kind of nervous Nellie, manufactured issue . . . ." Id. at 204 .

575. According to an October 18, 2000 article in the Dow Jones News Service, during

the conference call with analysts on that day Levin also stated, "[w]e think there is no dot-cam

advertising issue as it relates to Time Warner or AOL."

576. Similarly, in an October 19, 2000 article in the Hollywood Report er, Levin -stated

that fears of slowing advertising revenue from Internet companies were misguided . "There is no

advertising issue," he said .

577. By his statements on October 18 and 19 , 2000 , Levin misrepresented the real state

of AOL' s advertising revenue and failed to disclose the truthful information to the public. As

Chief Executive Officer of AOL Time Warner, Levin sought to dispel any concerns about AO L

48184 225

advertising revenue in an effort to promote the Merger. In so doing, Levin acted knowingly or

recklessly in making such false statements regarding the advertising revenue because he eithe r

knew the truth from AOL' s internal reports or recklessly disregarded AOL internal documents

which showed the substantial deteriora tion of AOL advertising revenue . (supra ¶f 7, 75, .301

& 313 .) Indeed, since Levin assumed responsibility to describe the state of AOL advertising

revenue, he was, at a minimum , reckless in failing to first review pertinent internal company

reports which disclosed the true condition of that important revenue source .

578. After the Merger, Levin signed company SEC filings including AOL's. SEC Form

10-K for the transition period from July 1, 2000 to December 31, 2000, AOL Time Warner' s

SEC Form 10-K for the fiscal quarter and year ended December 31, 2001, and SEC Form 10-

KJA for the fiscal quarter and year ended December 31, 2001 . (See supra ¶ 332.) These SEC

filings reported substantially inflated AOL advertising revenue and did not disclose the rea l

condition of AOL advertising revenue. Significantly, with the issuance of the AOL SEC Form

14-K for the transition period from July 1, 2000 to December 31, 2001, AOL and the Company

discontinued the reporting of AOL advertising and commerce backlog . C&e supra ¶ 332 .)

579. In July of 2001, Levin and Defendant Pittman rejected the efforts of their ow n

CFO to disclose the true nature of AOL' s advertising revenue. While preparing the Company' s

second-quarter earnings report, AOL Time Warner's Chief Financial Officer, J . Michael Kelly,

finally sought to divulge publicly that the Company would be unable to meet financia l

projections . As The New York Times reported on October 14, 2002 :

The chieffinancial officer, J. Michael Kelly, made his case while pireparing AOL TimeWarner' s second-quarter earnin r rt in Jul 2001, gKgWpg that a prolongeddowntu rn in the advertising market was jeopardizing the company's promise of anannual operating profit, excluding certain charges, of $ 11 bi llion in the merger's firstyear, the senior executives said .

48184 226

But Mr. Kelly's boss, Gerald M. Levin, the former chief executive, and Robert W .Pittman, the former co-chief operating officer, overruled him . . . .

supra ¶ 538.) (Emphasis added.)

580. Levin refused, after his Chief Financial Officer's warning, to disclose the real

condition of AOL advertising revenue:

[B]y July 2001, AOL Time Warner's situation was becoming untenable . Even withunconventional deals, the newly merged company could not reach the lofty financialgoals it had set for itself in its first full year. The ad market was that bad . . . . Then thechorus began to mount [within AOL Time Warner],_becoming more hostile : Why iscorporate sticking to these ridiculously high targets? Why is Levin working so hard to

justify the merger to Wall Street?** *

Then an internal caution came from AOL Time Warner's top financial man, J . MichaelKelly. As he was preparing the public release of the company's second-quarter financialnumbers that July, the chief financial officer could not ignore how the anemic ad marketwas threatening to scuttle AOL Time Warner's promises to Wall Street, includingachieving a revenue increase of 12 to 15 percent in the merger's first year .

It was time, Kelly argued to his bosses, for the company to go bat in hand to Wall Streetand publicly lower its financial goals . This was a matter of maintaining AOL TimeWarner's credibility with investors . They deserved to know. It was a compellingargument. But Kelly was overruled [by Levin and Pittman] .

Stealing Time at 266 . (Emphasis added .) Kelly's immediate boss at the time was Gerald Levin .

581 . Accordingly, by at least July 2001, Levin knew from the Company's own Chie f

Financial Officer that the industry-wide Internet advertising downturn was adversely affectin g

AOL and was not disclosed to the investing public . However, Levin refused to disclose such

information to shareholders and the public so that the Merger looked like a success . Instead,

Levin caused the Company to issue a financial statement for the quarter ending June 30, 2001

which reported inflated AOL advertising revenue by at least 27 % compared to AOL's actual

advertising revenue and did not reveal the subst antial deteriorating condi tion of AOL's real

advertising revenue. See supra 1367.) Levin therefore knew by at least July 2001 that the AO L

48184 227

advertising revenue stream was considerably more imperiled than was being reported t o

shareholders and the public .

6. Additional Allegations and Discussion Regarding Scienter and 14 Violations ofJoseph A. Ripp and Steven E. Rindner

582. The void left in the wake of Keller's departure in June 2001 was quickly filled by

two of AOL's senior officers . One was AOL's Chief Financial Officer, Defendant Ripp, whos e

position gave him complete access to all of the accounting that reflected any transactions that

brought AOL revenue, whether real or illusory, and imposed on him the duty to ensure that the

transactions were properly documented and reported. (su~ra ¶ 36(f) .) The other was

Defendant Rindner, who succeeded Keller as AOL's Senior Vice President for Business Affairs

and Development, a position that made him responsible for creating and monitoring the deal s

that generated revenues for AOL. ( supra ¶ 36(g) . )

583 . In tandem, Ripp and his accomplice Rindner immediately stepped in to shepher d

the sham Homestore deal that Keller and Colburn had devised . In so doing, both of them knew

about the fraudulent structure of the circular transactions that had brought AOL fictitious

revenue during the first quarter of 2001 and the additional ones contemplated for the secon d

quarter. The two men wasted no time ensuring that AOL captured the remaining revenue fro m

the secret Homestore vendors before the second quarter ended .

584. Beginning in mid-June 2002, Rapp and Rindner had a number of phon e

conversations with Joseph J . Shew, Homestore's Vice President of Finance, during which they

made sure that AOL would actually receive its money from the secret par ties in time to

artificially inflate its revenue for the then-current quarter. ( First Amended Consolidate d

Class Complaint $ 358, filed in In re Homestore . com Securi ties Li tigation., 41-CV-11115 MJP,

U.S. Dist. Court, Central Dist . of Cal . ("Homestore Complaint"). They pushed Homestore to

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accelerate its payments to the secret parties so that AOL would receive its phony revenue by the

quarter 's end. See i They also told Homestore that unless those parties furnished letter s

con firming they would purchase advertising, AOL would not feed any more money into the

circuit of deceit. (Lee Lid .) In other words, Ripp and Rindner were so aware of how the sha m

transactions worked, that they wanted written confirmation that AOL would receive its part o f

the fraudulent funds .

585. Motivated by their desire to ensure receipt of the round-tripped payments, Ripp

and Rindner asked Homestore to prepare a list of its secret vendors, ultimately titled "Potentia l

Referral Advertisers ." The purpose of the list was to document which vendors wer e

participating-or, stated from Ripp and Rindner's perspective, from whom AOL would be

receiving the money from. Ripp and Rindner 's request for the list evinces their knowledge tha t

the transac tions were essentially circular between AOL and Homestore, and not independent

deals between AOL and the secret vendors . See id . 11356-57.)

586. Homestore told Ripp and Rindner that it did not want to create a list identifyin g

the secret vendors participating in the fraudulent scheme. However, in a phone conversation

with Jeff Kalina, Homestore's Director of Transactions, and Stuart Kim, a member o f

Homestore' s legal department, in the latter part of June 2002, Ripp and Rindner insisted that th e

vendors be identified to ensure AOL would receive the money . When Homestore suggested as a

compromise that the list also include names of vendors with whom it never intended to d o

business, Ripp and Rindner agreed to a merged list having full knowledge of which named

vendors actually participated in the triangular transactions and which names were merel y

dummies . See, id . 1357 .)

48184 - 229

587. To address AOL's desire to recognize advertising revenue during the then -current

quarter, Shew had a series of meetings with Peter B . Tafeen, Homestore's Executive Vice

President of Business Development and Sales, and Jeff Kalina, its Director of Transactions . (See

id. ¶ 358.) The outcome was Homestore's agreement to pay the secret vendors in time for them

to buy advertising from AOL before the quarter expired . See id.) But by June 29, the final

business day of the quarter, AOL still had not received all the confirmation letters, so Ripp and

Rindner withheld AOL's authorization of the transactions . Worried that the funds it advanced to

the vendors would not come full circle, Homestore made sure that AOL had all the letters later in

the day. See id . 1359; supra 1133.)

588. That evening Ripp and Rindner, now AOL's point men on the Homestore deal ,

participated in a conference call with Homestore's Chief Executive Officer, Stuart Wolff, which

consummated the transactions. See id. ¶ 359; supra ¶ 133 .) With Shew and Tafeen in his office,

Wolffsummarized the transactions and articulated Homestore 's perspective, delving into detail

with the help of a written schedule of the transactions that Kalina and Taffeen had prepared for

him. (Stt Homestore Complaint ¶ 359.) Wolff and Taffeen both expressed their concern that

AOL might renege by not reimbursing Homestore for the front money it had already paid to the

hidden vendors . See i Shew also told Ripp and Rindner in no uncertain terms that because

Homestore had fronted money so AOL could get its purported advertising revenue, AOL was

obligated to complete the round trip by paying Homestore, less the commission due AOL on the

transactions . See id.) A ll three legs of the deal were laid out for Ripp and Rindner to see . If

they had lacked knowledge about any facets of the deal before that conference, after it they were

every bit as educated as Coeburn and Keller about the illicit workings of the transaction .

48184 230

589. Later that evening, AOL sent Homestore confirmation that it was going forward

with the deal-in the precise manner discussed during the conference . See id. ¶ 360; supra ¶

134.)

590. In addition to the facts evidencing the actual knowledge Ripp and Rindner had

about the Homestore transactions, the surrounding circumstances compel the conclusion that

they must have known the deal was corrupt. The fraudulent nature of the transactions could not

have been more transparent to AOL's Chief Financial Officer and the man in charge of

developing business . There was no conceivable explanation for the deal's triangular structure

other than using a clandestine leg that allowed AOL to derive illusory advertising revenue from

the funds it then passed on to Homestore . At the very least, instead of vigilantly performing their

duties, Ripp and Rindner recklessly allowed the illegal transactions to take place on their watch,

turning a blind eye to what were, at the very least, red flags that clearly disclosed the fraudulent

nature of the transactions. Instead, Ripp and Rindner let the transactions proceed, allowing AOL

to claim $45.1 million of fraudulent revenue from these transactions during the-first two quarters

of 2001 . (Lee supra ¶ 127.) All the while, Ripp and Rindner were keenly aware that they would

benefit personally from stock price inflation caused by the fraud they helped perpetrate . (Lee

supra IN 549, 553.)

591 . Despite their oversight of the deal they knew to be fraudulent, neither Ripp no r

Rindner did anything to expose it . Just as Keller had done before them, they concealed the

deal's structure so that AOL could further inflate the advertising revenue it reported and avoid

the consequences of bringing the facts to light. And like Keller, each of them was complicit in

the fraud by doing what it took to make the deal work .

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592. In short, Ripp and Rindner knew of or recklessly disregarded the blatantl y

fraudulent nature of the Homestore scheme . Both were fully aware of how the scheme operate d

and that there could be no legitimate reason for its machinations . Indeed, the scheme has already

resulted in seven Homestore officers and management personnel, including the ones dealing wit h

Ripp and Rindner, pleading guilty to criminal charges stemming from the DOJ's investigation of

Homestore . (Heins Decl. in app . to Mot. to Dismiss, Exs. E , G-J.) The scheme is still being

scrutinized as part of the ongoing_ SEC and DOJ inves tigations of AOL' s advertising revenue .

593. As recognized by the court presiding over the securities class action brought b y

Homestore's shareholders, the scheme Ripp and Rindner helped orchestrate was "a massiv e

conspiracy driven by pure avarice." In re Homestore Sec. Litig., No. C01-11115 MJP, 2003 WL

1227643, at *24 (C .D. Cal . March 7, 2043). (Lee supra ¶ 137.) Because of Ripp and Rindner's

acts, they were targeted, along with Colburn and Keller, by the Homestore court's apt commen t

that "the detailed allega tions describing the role of AOL and its agents in helping Homestore

please Wall Street and in boosting its own revenues through bogus commissions give this Court

great pause." ld_ ( sera $ 137.)

K. Scienter of Ernst & Youn g

594. In addition to the facts alleged above, the following facts, among others, sho w

that Ernst & Young acted with scienter.

1 . Ernst & Young's Work for AOL, Time Warner and AOL Time Warner

595. Ernst & Young was retained by and had served as independent auditor to both

AOL and Time Warner for many years prior to the Merger, and AOL Time Warner since th e

Merger. Ernst & Young performed annual audits on AOL's and AOL Time Warner's financial

statements during the Class Pe riod , as well as quarterly review work for AOL since at least the

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first quarter 2000, and as to AOL Time Warner, for every quarter since the Merger, to date . As

such, Ernst & Young was heavily involved in the regular accounting practices of the companies .

For each fiscal year 1999, 2000 and 2001 and transition period ended December 31, 2000, Erns t

& Young issued "clean" opinions as set forth in AOL and AOL Time Warner's SEC Form 10-Ks ,

-opining that AOL and AOL Time Warner' s financial statements were prepared in conformity

with GAAP, that the financial statements "present fairly in all material respects" the financial

condition of the companies and that Ernst & Young had planned and performed its audits i n

accordance with GAAS. Each of these representations was untrue . Ernst & Young also

consented to the incorporation of its reports containing its unqualified opinions, and to th e

reference to itself as "Experts" in the Merger Registration Statement .

2. Ernst & Young's Close Relationship with AOL Time Warner

596. AOL and AOL Time Warner were huge clients for Ernst & Young . For example,

Ernst & Young billed AOL Time Warner $49 .05 million in 2002 and $52.7 million in 2001 . Of

the 2002 amount, $32.5 mi ll ion, or 66%, was for services other than AOL Time Warner's U.S .

Audit. Of the 2001 amount, $42.1 million, or 80%, was for services other than AOL Time

Warner's U.S . Audit . The addi tional fees in 2002 included $ 19.2 mil lion for tax compliance and

planning , $5 .9 million for internal audit services, and $4 .2 million for subsidiary an d

international audits . The additional fees in 2001 included $25.9 million for tax compliance and

planning, $8.2 million for internal audit services, and $3 .6 million for subsidiary an d

international audits .

597. For 2000 (prior to the Merger), Ernst & Young was paid by the two companies a

combined $59 million (AOL $3 .5 mil lion and Time Warner $55.4 million) . Of this amount, only

$8 mi llion was for the U.S. audits of AOL and Time Warner. The rest was for consulting

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services provided by the Ernst & Young consulting group (prior to its sale on May 23, 2000 t o

the French company, Cap Gemini) .

598. In addition , former Ernst & Young alumni were employed at AOL and AOL Time

Warner during the Class Period. James W. Barge, a Senior Vice President and Controller at

AOL Time Warner, came from Ernst & Young . Barge is responsible for overall internal and

external financial reporting functions, financial planning and analysis and Board-leve l

communications . Barge came to Time Warner from Ernst & Young in March of 1995 as

Assistant Controller. At Ernst & Young, be was the Area Industry Leader of the Consumer

Products Group and a Partner in the West Region Accounting Auditing Department. During that

period he had regional responsibility for consultations on a wide variety of accounting and

auditing issues managing SEC related matters .

599. John Martin, AOL Time Warner's Vice President of Investor Relations and the

Company's principal day-to-day contact with the investment community, is also an Ernst &

Young alumnus. Before joining Time Warner in 1993 as a Manager of SEC financial reporting,

he was a Senior Accountant in the Business Assurance Group at Ernst & Young in New York .

3. Ernst & Young's Auditing Expertise and Industry Knowled e

600. Ernst & Young is a sophisticated multinational accounting and tax firm ranking a s

the fourth largest such firm in the world with annual revenues of $4.4 billion according to a 2002

survey .

601 . In addition, Ernst & Young promoted itself as having expertise specifically suited

for internet and e-commerce companies through its Technology Communications an d

Entertainment division (TCE) . In their brochure, Ernst & Young boasted "Ernst & Young helps

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technology, communications, and entertainment companies operate more efficiently, profitably ,

and successfully . "

602. Ernst & Young, along with the Massachusetts Institute of Technology an d

Inter@a ctive Week, studies the companies involved in the internet economy to produce the

Internet 500 which ranks the top 500 businesses by their revenue generated from onlin e

operations.

603. In addition to AOL Time Warner, Ernst & Young lists numerous technology

companies on its roster of clients including several entities with which AOL had agreements a s

to which it engaged in improper accounting practices . Such entities include eBay and Sun

Microsystems. Ernst & Young also served as auditor for Veritas before being replaced following

that company's year 2000 audit .

4 . Ernst & Young's Actual Knowledge of Specific Transactions and AccountingThereof

604. In the wake of SEC actions against AOL Time Warner and in response to the July

18 and 19, 2002 Washington Post articles, the Company has stated that it had relied on Ernst &

Young's approval of not only the accounting methods used, but many of the particula r

transactions at issue as well . In addition, Ernst & Young has stated that its audits were properly

performed when it knew that they were not.

605. Prior to the July 18, 2002 Washington Post article, H . Stephen Hurst, Ernst &

Young partner , released a statement at AOL Time Warner' s request saying the firm stood by its

original view that the accounting and disclosures were appropriate .

606. In July 2002, then AOL Time Warner CEO Richard Parsons said in a conference

call following The Washington Post articles that "They [Ernst & Young] have confirmed in

writing, without qualification, that the accounting for each and every one of the transaction s

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mentioned in [The Washington] Post articles and the related financial statement disclosures for

those transactions were approp riate and in accordance with Generally Accepted Accounting

Principles ."

607. In a July 29, 2002 article in Advertising Age, Defendant Pace also reassured

investors that AOL Time Warner and its auditor Ernst & Young stood by the accounting .

608. Regarding the Homestore transactions in particular, AOL Time Warner

spokesman John Buckley stated in an August 6, 2002 Los Angeles Times article that "AOL's

accounting for all transactions with Homestore .com were appropriate and signed off by our

outside auditors Emst & Youn ." (Emphasis added .)

609. One of the transactions described in The Washington Post articles involved

AOL's deal with PurchasePro in the fall of 2000 , a deal AOL Time Warner said was approved

by Ernst & Young .

610. However, PurchasePro's auditor, Arthur Andersen , disagreed with the way

PurchasePro accounted for revenue from reseller agreements . PurchasePro's SEC Form 8-K

dated November 29, 2001 states:

During Andersen's review of the Company's interim financial statements for thethree-month period ended September 30, 2000, Andersen expressed disagreementwith prior members of the Company's management regarding propose drecognition of revenue derived from reseller agreements between the Companyand its business partners . This issue was the subject of discussion betweenAndersen and the Company's Audit Committee and was resolved to Andersen'ssatisfaction.

As a result of this disagreement, Arthur Andersen resigned as PurchasePro 's auditor on

November 21., 2001 .

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5. The Restatement of AOL's and AOL Time Warner' s Financial Statements

611 . Despite Ernst & Young's immediate and unequivocal denial of any improper

accounting when The Washington Post first reported on July 18, 2002 on the accountin g

improprieties, both the Company and Ernst & Young acknowledged only three weeks later that

at least $49 million of advertising revenue had been improperly reported when the allegations

persisted and the SEC and DO] started their investigations . Two months later, the Company

reported that $190 million in advertising revenue was improperly reported and that th e

Company's internal investigation was continuing. Then, on or about March 28, 2003, the

Company reported that the SEC may require it to restate an additional $400 million in revenue

based on the Company's improper accounting for an advertising deal with Bertelsmann AG .

612. Ernst & Young issued unqualified audit reports, which were published in th e

companies Forms 10-K and Annual Reports to shareholders for, inter alia, the years ended

December 31, 2001 and December 31, 2000 .

613 . However, by restating its financial results, AOL Time Warner has admitted that

its and AOL's publicly-issued financial statements for each of the restated periods were not

prepared in conformity with GAAP, and that AOL and AOL Time Warner materially misstated

its financial condition and results of operations . Thus, Ernst & Young's opinions that the

financial statements for the years ended December 31, 2000 and 2001, had been prepared i n

conformity with GAAP were false and misleading . Under GAAP , the restatement of previously,

issued financial statements is reserved for circumstances where no lesser remedy is available .

Under APB 20, Accounting Changes, restatements are only permitted , and are required to :

correct material accounting errors or irregularities that existed at the time the financial statement s

were originally prepared and issued.

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614. The restatement of a company's previously issued financial statements becomes

necessary when it is discovered that previously issued financial statements contained errors or

irregularities in accounting which caused them to be materially misstated . Such misstatements

can be the result of errors or fraud, and once discovered, the company is obligated to notify all

parties who may rely on the previously issued financial statements that they should no longer

place reliance thereon. The restatement of a company's previously issued financial statements is,

in fact, an admission that such financial statements contained material misstatements that cause d

them to be misleading to readers .

6. Ernst & Young's Past Involvement with Previous Accountinc Fraud s

615. Ernst & Young has been involved in accounting fraud in the past . Recently, Erns t

& Young paid $335 million to settle claims arising from its auditing role in a securities frau d

case involving Cendant Corp., a record amount paid by an auditing firm in such a case .

616. On November 23,1992, The Office of Thrift Supervision fi led a No tice of

Charges against Ernst & Young stemming from its improper audit practices with regard to som e

of the most notorious failed financial institutions of the 1980's savings and loan crisis, including

Continental Illinois. To resolve these charges and numerous related lawsuits filed by the FDIC ,

Ernst & Young paid $400 million in settlement, and agreed to a cease and Desist Order

restricting its future work for insured depository institutions .

617. In May 1999, Ernst & Young settled claims that it failed to publicly disclose

accounting irregularities by paying $34 million in a securities case involving Informix .

618. In a complaint filed in 2002 by the Federal Deposit Insurance Corporatio n

("FDIC"), the FDIC alleged "Ernst & Young has a long history of breaching duties owed to the

FDIC and other regulatory agencies overseeing financial institutions . "

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7. Ernst & Young's Responsibilities as AOL's and AUL__ Time Warner'sIndependent Auditor

619. The duty owed by an independent auditor to a company's shareholders is wel l

established . As the United States Supreme Court explained in a case involving a predecessor

firm of Ernst & Young :

By certifying the public reports that collectively depict a corporation's financialstatus, the independent auditor assumes a public responsibility transcending anyemployment relationship with the client . The independent public accountantperforming this special function owes ultimate allegiance to the corporation'screditors and stockholders, as well as to the investing public . This "publicwatchdog' function demands that the accountant maintain total independencefrom the client at all times and requires complete fidelity to the public trust .

United States v Arthur Young & Co ., 465 U.S. 805, 817-18 (1984) .

620. In addition, the responsibilities and functions of an independent auditor includ e

the following :

The objective of the ordinary audit of financial statements by the independentauditor is the expression of an opinion on the fairness with which they present, inall material respects, financial position, results of operations and cash flows, inconformity with generally accepted accounting principles . (AU § 110.01) .

The auditor has a responsibility to plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement,whether caused by error or fraud. (AU § 110.02) .

The professional qualifica tions required of the independent auditor are those of aperson with the education and experience to practice as such . (AU § 110.04) .

621 . The independent auditor must also comply with professional training and

proficiency rules, including the following:

The audit is to be performed by a person or persons having adequate technicaltraining and proficiency as an auditor. (AU Section 150.02) .

In the performance of the audit which leads to an opinion , the independent auditorholds itself out as one who is pro ficient in accounting and auditing. (AU § 210.03).

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The independent auditor's formal education and professional experiencecomp liment one another, each auditor exercising authority upon an engagementshould weigh these at tributes in determining the extent of his or her supervision ofthe subordinates and review of their work. It should be recognized that thetraining of a professional person includes a continual awareness of developmentstaking place in business and in his or her profession . (AU § 201 .04) .

In the course of his or her day-to-day practice, the independent auditor encountersa wide range of judgment on the part of management, varying from true objectivejudgment to the occasional extreme and deliberate misstatement . He or she isretained to audit and report upon financial statements of a business because,through training and experience, he or she has become skilled in accounting andauditing and has acquired the ability to consider objectively and to exerciseindependent judgment with respect to the information recorded in books ofaccount or otherwise disclosed by his or her audit. (AU § 21 0.05) .

622. Ernst & Young, in contracting to perform its -audit of AOL' s and AOL Tim e

Warner's financial statements, assumed all of the responsibilities and obligations set forth in the

preceding paragraphs .

8. Ernst & Young's Violations of Accounting and Auditing Standards

623 . As discussed below , Ernst & Young violated its professional responsibilities-and

knowingly or recklessly participated with AOL and AOL Time Warner in improper revenue

recogni tion practices , policies, and procedures in order to artificially boost AOL's and AOL

Time Warner's reported advertising revenue. Although Ernst & Young was aware that the

revenue recognition prac tices of AOL and AOL Time Warner were in violation of GAAP, Erns t

& Young provided unqualified audit opinions in order to continue earning lucrative fees for th e

audi ting and other services that it provided for AOL and AOL Time Warner.

624. As part of its planning for and implementa tion of various audit engagements for

AOL and AOL Time Warner, Ernst & Young was required under GAAS to be thoroughly

familiar with the nature of AOL's and AOL Time Warner's business, the manner in which senio r

management ran the companies, the internal control environment at the companies, and the area s

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of audit risks at AOL and AOL Time Warner. As AOL and AOL Time Warner' s auditor, Erns t

& Young had unfettered access to the Company's books and records throughout the Class Period .

Ernst & Young, as a world-renowned "Big 4" public accounting firm, had knowledge of the

requirements of GRAS, and, as described below, knew of the audit risks inherent in AOL, AOL

Time Warner and in the industry.

625. Ernst & Young knew, or except for its reckless disregard of the facts would hav e

known, that (i) it had not performed its audits of AOL's and AOL Time Warner's financial

statements in comp liance with GAAS ; (ii) it never should have issued an "unqualified" audi t

report on AOL's and AOL Time Warner's financial statements for the fiscal/calendar year s

ended 1999, 2000, 2001 and the transition period for AOL ended December 31, 2000 ; and (iii)

its audit reports on AOL's and AOL Time Warner's financial statements for the years ended

1999, 2000, 2001 and transition period for AOL ended December 31, 2000 were not in

conformity with GAAS when opining that the financial statements were in accordance wit h

GAAP and that the "financial statements . . . present fairly in all material respects," the financial

condition of the companies . This conclusion may be expressed only when the auditor h as

formed such an opinion on the basis of an audit performed in accordance with GAAS. (AU §

508.07). Ernst & Young failed to do so .

626. As set forth above, AOL and AOL Time Warner repeatedly violated GAAP with

respect to its accounting for the deals at issue . Yet, Ernst & Young failed to identify and correc t

those violations despite its admitted awareness of many of the deals . In fact, Ernst & Young' s

audits of the financial statements were so woefully inadequate that Ernst & Young repeatedl y

violated GARS. Ernst & Young utterly failed to perform the most fundamental of procedures to

provide a basis for its unqualified reports . As described herein, Ernst & Young repeatedly an d

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materially violated GAAS in each of its audits of AOL and AOL Time Warner during the Class

Period, failed to plan or to perform its audits to obtain reasonable assurance that AOL and AOL

Time Warner' s financial statements were free ofmaterial misstatement , and, therefore, had n o

basis on which to state that the financial statements were presented in conformity with GAAP,

GAAS violations include :

a. Ernst & Young Failed to Properly Consider Fraud .

627. Ernst & Young knowingly or recklessly failed to plan its audits to evaluate th e

risk factors relating to management's characteristics, their influence over the contro l

environment and the company's accounting and internal control policies. "The auditor should

specifically assess the risk of material misstatement of the financial statements due to fraud an d

should consider that assessment in designing the audit procedures to be performed ." AU §

316.12; AU § 316 .05 {"The auditor should assess the risk that fraud may cause the financial

statements to contain a material misstatement ."). When examining risk factors provided in AU

Section 316, it is obvious that Ernst & Young should have identified risks for fraudulen t

reporting virtually everywhere . Among the conditions that should cause the auditor to consider

that a client has attempted financial fraud are discrepancies in the accounting records, such as

transactions not properly recorded as to amount, or unsupported or unauthorized balances o r

transactions ; conflicting or missing evidential matter, such as significant unexplained items o n

reconciliations ; or denied access . to records . AU §§ 316.25, 317.09, AU §§ 316.21, 317.09. To

limit the risk of financial statement misstatement as a result of fraud, the auditor should perform

procedures, including a detailed review of the client's quarter-end and year-end adjusting journal

entries and an investigation of.any entries that appear unusual as to nature or amount and of

significant and unusual transaction, particularly those occurring at or near quarter-or year-end .

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AU § 316 .29. Ernst & Young violated GAAS because it failed to properly consider the risk that

AOL and AOL Time Warner' s financial statements would be materially misstated as a result of

fraud .

628. In its role as auditor, starting at least as early as the quarter ended December 31 ,

1998, and throughout the Class Period, Ernst & Young knew of extraordinary audit risk factors

("red flags") at AOL and AOL Time Warner which Ernst & Young intentionally ignored or

recklessly disregarded, allowing AOL and AOL Time Warner to artificially inflate their

advertising revenue. Significant audit risk factors which existed at AOL and AOL Time Warne r

throughout the Class Period and Ernst & Young audit failures include the following :

a. Ernst & Young knowingly or recklessly failed to design its audits to

consider that a significant portion of management 's compensation was represented by bonuses,

stock options, or other incentives , the value of which was contingent upon AOL and AOL Time

Warner achieving . unduly aggressive revenue or earnings targets . Ernst & Young was aware of

the overwhelming mo tivation for management to engage in fraudulent financial repor ting, which

included the personal mo tive that Individual Defendants had to maintain a high stock price,

AOL's need to maintain its stock price in order to consummate the Merger.

b. Ernst & Young knowingly or recklessly failed to properly consider the

excessive interest by management in maintaining or increasing AOL and AOL Time Warner' s

stock price or advertising revenue growth trends through the use of unusually aggressiv e

accounting practices . Ernst & Young was aware that AOL and AOL Time Warner entered int o

many complex and aggressive transactions, and that material amounts of the advertising revenu e

that came in at the end of the qua rters which a llowed AOL and AOL Time Warner to hit its

advertising revenue targets were based on such practices . Many deals entailed reciprocal or

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round- trip transactions whereby AOL and AOL Time Warner's own money was cycled back to

them as revenues, or barter instruments that were difficult to value, while others, lik e

PurchasePro, improperly converted cash flows of an entirely different nature into advertising

revenues

c. Ernst & Young was aware of the significant p roblems that AOL

experienced with the SEC on several - occasions in connection with its accounting practices ,

including the May 2000 imposition of a cease and desist order and $3 .5 million fine against AOL

and the requirements on several occasions that AOL restate prior financial statements . Ernst &

Young was therefore aware of the SEC's sign ificant concerns with AOL' s accounting practices,

as well as with internet companies generally . Further, Ernst & Young knew of the importanc e

the SEC attached to making sure that AOL and AOL Time Warner's financial statements did not

"reflect the desire of management rather than the underlying financial performance of th e

company"' and did not "stretch the rules through aggressive accounting."

d. Ernst & Young knowingly or recklessly failed to design its tests or execute

its audits properly to investigate the nature, timing and amount ofrevenues which Ernst &

Young knew were being recorded at the eleventh hour at AOL and AOL Time Warner . Ernst &

Young knew that AOL and AOL Time W arner management had a practice of promising analysts ,

creditors, and other third parties that the companies would achieve what appeared to be undul y

aggressive or clearly unrealistic forecasts -- AOL and AOL Time Warner were touted as th e

industry powerhouse primarily because of their ability to meet and generally exceed undul y

aggressive forecasts . When the online adver tising market was weakened , AOL and AOL Time

Warner communicated their superiority and insulation from any risk of loss . Ernst & Young

knew the positive impact the announcement of a large advertising deal would have on the AOL

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and the AOL Time Warner share price, and knew that AOL and AOL Time Wa rner were

extraordinarily intent on hitting adve rtising revenue targets . Ernst & Young knew that AOL' s

"BA Specials" that would come through near the end of a reporting period consistently aide d

AOL and AOL Time Warner in meeting or exceeding the market 's high expectations .

e. Ernst & Young did not adjust its audit procedures despite a failure b y

AOL and the Company's management to display and communicate an approp riate attitude

regarding internal controls in the financial reporting process . As the long-term auditing and

accounting firm of AOL and AOL Time Warner, Ernst & Young was very aware that AOL an d

AOL Time Warner placed signi ficant emphasis on hitting earnings targets and analys t

expectations at the expense of fiscal responsibility and proper accounting practice . In this regard,

Ernst & Young knew of the high pressure and focused environment at the companies to report

revenue, especially advertising revenue , as high as possible. This included AOL and AOL Time

Warner's senior management continuously setting unduly aggressive and unattainable revenu e

targets and expectations for operating personnel, as opposed to targets and expectations based on

the operational reali ties at the companies and within the intemnet industry, thereby setting up

enormous pressure on the AOL and AOL Time Warner management to employ improper

advertising revenue recognition practices. Despite this attitude and corporate culture, Ernst &

Young failed to address the risks of overstated revenues .

f. Ernst & Young knowingly or recklessly failed to inquire of all partie s

involved in the complex barter/roundtrip transactions, did not perform substantive tests t o

determine proper valuation (such as present value analyses or comparable market pricing t o

estimate fair market value) and did not investigate whether advertising revenue was truly earne d

or realizable. In order to determine such, investigations as to the value of deals touted in AOL

48194 245

and AOL Time Warner's SEC filings, specifically the co llectibility of receivables or restricted

stock transactions should have been examined .

g. Ernst & Young did not appropriately design or execute its audits t o

properly address the impairment of AOL Time Warner's tangible and intangible assets. AOL

Time Warner ignored the requirements in the then present literature regarding goodwil l

impairment, choosing to wait to apply subsequent standards and claim the impairment loss was a

result of new accounting literature .

h. Ernst & Young knowingly or recklessly failed to increase its substantiv e

testing to determine how or why AOL and AOL `Time Warner continued to show growth of

large proportions when competitors and the indust ry as a whole was declining . Additional

testing should have included comprehensive tracking of relationships (to expose the

roundtripping/barter transac tions , procedures should have been put in place to identify the

reciprocal patterns of purchases and sales) and examina tion of pricing (including discounts) of

counterparties ' bartering instruments (AOL and AOL Time Warner paid inflated p rices for

customer goods or services to generate inflated sales for itself) . Ernst & Young knew that AOL

and AOL Time Warner faced a high degree of competition in a market facing declining margins .

Not only this , but the indust ry as a whole was suffering with increasing business failures and

signi ficant declines in customer demand . Ernst & Young was aware that AOL and AOL Time

Warner faced the reality that their adver tising revenue was a critical indicator of performance ,

while the industry was experiencing declining advertising demand .

i. Ernst & Young knowingly or recklessly failed to audit the controls aroun d

the disclosures, classification and timing for advertising revenue, allowing classification a s

revenues rather than gains/losses on contracts . As AOL and AOL Time Warner's dot-corn

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customers were failing and the related revenue streams were drying up, Ernst & Young wa s

aware that AOL and AOL Time Warner began to reduce commitments and accelerate co llections

from these customers and that AOL and AOL Time Warner would allow the dot-corns to pa y

their way to a shortened or terminated deal, saving the dot corn years of payments and-generatin g

immediate cash flow for the companies .

629. Ernst & Young was also aware of significant audit risks ("red flags") relating t o

the operating characteris tics and financial stability of the AOL and AOL Time Warner, yet failed

to plan and perform the nature, timing and extent of its audit procedures, including :

a. Ernst & Young was aware of and knowingly or recklessly failed to

examine the nature, timing and classification of round-tripping and barter transactions . In order

to appropriately account for the transac tions , further investiga tion beyond reading the contracts

was required . Ernst & Young knew that AOL and AOL Time Warner regularly entered into

roundtripping or barter transactions that generated gains or earnings growth while the amounts of

cash transacted were simply exchanges of like amounts .

b. Ernst & Young knowingly or recklessly failed to plan its audits to consider

the fact that AOL and AOL Time Warner ' s financial reporting was based on significant

estimates that involved unusually subjective judgments or uncertainties, or that were subject to

potential signi ficant changes in the near term that were financially disrup tive on the entity (e.g.

ultimate co llectibility of receivables , timing of revenue recogni tion , or realizability of financial

instruments based on the highly subjective valuation of collateral or difficult-to-assess repayment

sources) . Ernst & Young knew that AOL and AOL Time Warner entered into barter transac tions

on a regular basis that included goods and services of an estimated value. Ernst & Young failed

to design substantive tests to determine the reasonableness of these estimated values . Ernst &

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Young failed to examine the counterparties' competitive pricing and standard discounts for

similar transactions - there were cases where AOL and AOL Time Warner overpaid for goods

and services to provide incen tive to the counter-party to purchase from AOL and AOL Tim e

Warner and valued the transactions at the inflated amounts .

c. Ernst & Young did not properly ascertain materiality as it related to AOL

and AOL Time Warner and its transactions . Materiality applies to both the quantitative and

qualitative factors Ernst & Young knowingly or recklessly failed to consider the impact o f

overstated advertising revenue on the stock price and investors' decision-making . Ernst &

Young was aware that AOL and AOL Time Warner had significant, unusual, and highly

complex transactions, especially those close to quarter or year end, that posed difficul t

"substance over farm" questions . Most of AOL and AOL Time Warner's barter/roundtrippin g

transactions, in addition to advertising deals with companies who were obligated to remi t

litigation settlements to the company, fell into this risk category.

d. Ernst & Young knowingly or recklessly failed to examine transactions fo r

substance over form, proper valuation and business use. Ernst & Young was aware that AOL

and AOL Time Warner bad contractual anangements without apparent business purpose. AOL

and AOL Time Warner entered into deals with companies who had no business purpose for

advertising online .

e. Ernst & Young knew, but knowingly or recklessly failed to ascertain why ,

AOL and AOL Time Warner outperformed everyone in the marketplace, accepting the easy

answer that the proof was in the numbers . Ernst & Young had the responsibility to exercise

skepticism in investigating the revenue recognition policies, including valuation, timing and

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collectibility of the barter transactions, and the "multi-million dollar" deals with companies with

questionable futures. It did not carry out its responsibility.

630. Given Ernst & Young's actual knowledge and disregard of such significant audi t

risk factors ("red flags") at AOL and AOL Time Warner, particularly in the context of ho w

sensitive advertising revenue recognition issues were, and are, for internet-based companies ,

Ernst & Young either knew of or recklessly disregarded, the various sham and improperl y

accounted for AOL and AOL Time Warner transactions described in this Complaint. Ernst &

Young's total abdication of professional skep ticism in not challenging the economic substanc e

and reality of the subject transactions resulted in the issuance of a "clean" or unqualified audi t

opinion on financial statements that were known or would have been known had Ernst & Youn g

conducted its audits in accordance with GAAS, to be materially misstated .

b. Ernst & Young Failed to Maintain Independence

631 . Ernst & Young violated GARS General Standard No . 2, which requires the

auditor to maintain an independence in mental attitude in all matters relating to the aud it. The

independent auditor must comply with the rules of independence, including AU § 150.02 which

provides that. Similarly, AU § 220 .02 states :

"In all matters relating to the assignment, an independence in mental attitude is to be maintaine d

by the auditor or auditors ." AU § 220.02 states :

[T]he auditor must be independent . . . .he must be without bias with respect to theclient since otherwise he would lack that impartiality necessary for thedependability of his findings, however excellent his technical proficiency may be .However, independence does not imply the attitude of a prosecutor but rather ajudicial impartiality that recognizes an obligation for fairness not only tomanagement and owners of a business but also to creditors and those who mayotherwise rely (in part, at least) upon the independent auditor's report, as in thecase of prospective owners or creditors .

AU § 220.02 .

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632. Ernst & Young knew that its various other business dealings with AOL and AOL

Time Warner through which it earned enormous fees presented conflicts of interest for Ernst &

Young, which motivated it to appease the companies rather than perform its auditin g

responsibilities for the benefit of the companies' shareholders .

c. Ernst & Young Violated GARS By Reporting That The FinancialStatements Were Presented in Accordance With GAAP When TheWere Not

633. Standard of Reporting No . 1 states :

The report shall state whether the financial statements are presented in accordancewith generally accepted accounting principles . AU § 150 .02 .

Professional standards set forth the following requirements with respect to this standard :

The term "generally accepted accounting principles " as used in reportingstandards is construed to include not only accounting principles and practices butalso the methods of applying them . AU § 410.02 .

The phrase "generally accepted accounting principles" . . . includes not onlybroad guidelines of general application , but also detailed practices andprocedures . . . AU § 411 .02 .

The auditor' s opinion that financial statement present fairly an entity's financialposi tion, results of operations , and cash flow in conformity with generallyaccepted accounting principles should be based on his or her judgment as towhether (a) the accounting principles selected and applied have generalacceptance; (b) the accounting principles are appropriate in the circumstances . . . .(e) the financial statements reflect the underlying transactions and events in amanner that presents the financial position, results of operations, and cash flowsstated within a range of acceptable limits , that is, limits that are reasonable andpracticable to attain in fi nancial statements. AU § 411.04.

634. Ernst & Young violated GAAS Reporting Standard No. 1, which requires the

audit report to state whether the financial statements are presented in accordance with GAAP, as

Ernst & Young's audit opinions falsely represented that the AOL and AOL Time Warner

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financial statements complied with GAAP when, in fact, those financial statements were

materially misstated .

d. Ernst & Young Failed to Obtain Sufficient and Competent EvidentialMatter.

635. "Most of the independent auditor's work in forming his or her opinion o n

financial statements consists of obtaining and evaluating evidential,matter concerning th e

assertions in such financial statements ." AU § 326 .02. "The independent auditor 's direct

personal knowledge, obtained through physical examination, observation, computation, and

inspection, is more persuasive than information obtained ind irectly." AU § 326 .21 .

Representations from management "are not a subs titute for the application of those auditing

procedures necessary to afford a reasonable basis for an opinion regarding the financial

statements under audit ." AU § 333 .02; AU § 333 .02. "The books of original entry, the general

and subsidiary ledgers, related accounting manuals, and records such as work sheets and

spreadsheets supporting cost alloca tions, computations , and reconciliations all cons titute

evidence in support of the financial statements." "[W]ithout adequate attention to the propriety

and accuracy of the underlyiig accounting data, an opinion on financial statements would not be

warranted ." AU § 326 .16, AU § 326 .15 . Ernst & Young violated GARS by failing to obtain

sufficient and competent evidential matter .

636. For example, Ernst & Young failed to obtain stifficient competent evidentia l

matter with respect to AOL and AOL Time Warner's excessive valuation and comple tion of

earnings process in connection with barter transactions . Ernst & Young failed to :

a. Perform an adequate test of the fair market value of the goods ,

services and equity exchanged for advertising ;

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b. Inquire of lower level staff responsible for putting goods int o

serv ice to determine the benefit received by AOL and AOL Time Warner, and

c. Inquire of customers as to the value received by the customer .

637. Further, Ernst & Young failed to obtain sufficient competent evidential matter

with respect to AOL and AOL Time Warner's overpayments for goods or services in order to

generate reciprocal sales . Ernst & Young failed to :

a. Obtain standard price lists, large customer and volume discounts ,

etc. from vendors to determine the reasonableness of p rices being paid by AOL and AOL

Time Warner, and

b. Compare such transactions with similar purchases made in the pas t

to determine whether an overpayment was made .

638. Ernst & Young also failed to gather sufficient competent evidential matter t o

corroborate AOL and AOL Time Warner's management representations as to the earnings

process completed in connection with "jackpotting ." Ernst & Young failed to :

a. Examine the times and sites on which ads ran which would have

demonstrated the lack of a true earnings process and in turn revealed a mechanism used simpl y

to generate revenue;

b. Inquire of lower level staff responsible for placing the

advertisements on AOL's web site; and

c. Inquire of customers who expressed dissatisfaction ove r

"j ackpotting."

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e. Ernst &Young Failed to Exercise Due Professional Care andProfessional Skepticism .

639. "Due professional care requires the auditor to exercise professional skepticism ."

This requires the auditor to "diligently perform, in good faith and with integrity, the gatherin g

and objective evaluation of evidence." "In exercising professional skepticism, the auditor should

not be satisfied with less than persuasive evidence because of a belief that management i s

honest." AU §§ 230 .07-09, AU § 316 .16-21 (professional skepticism is required in planning an d

performing an audit) . The auditor also "must be without bias with respect to the client sinc e

otherwise he would lack [the] impartiality necessary for the dependability of his findings ." AU §

220.02. Notwithstanding these requirements, in connection with its planning and performing

audit procedures concerning, among other things, recognition of advertising revenue, and certai n

other matters described herein, Ernst & Young relied almost exclusively on representations fro m

AOL and AOL Time Warner management and failed to exercise professional skepticism, faile d

to maintain an independent mental attitude and failed to exercise due professional care in th e

exercise of its audits.

C Ernst &,Young Failed to Properly Plan and Supervise .

640. The auditor must adequately plan its audit and properly supervise the work of

associates so as to establish and carry out procedures reasonably designed to search for and

direct the existence of fraud that could have a material effect on the financial statements . AU §§

310, 320, 327. The auditor must also obtain a level of knowledge of its clients' businesses

sufficient to enable it to "obtain an understanding of the events, transactions , and practices that,

in his judgment , may have a signi ficant effect on the financial statements ." AU § 311 .06 .

. . . The auditor may decide to consider further management's selec tion andapplica tion of signi ficant accounting policies , particularly those related to revenuerecogni tion , asset valua tions, or capitalizing versus expensing . In this respect, the

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auditor may have a greater concem about whether the accounting principlesselected and policies adopted are being applied in an inapprop riate manner tocreate a material misstatement of the financial statements. AU § 316A.27.(Emphasis added.)

641 . For example, Ernst & Young failed to obtain sufficient knowledge, and plan its

audit accordingly, with respect to AOL and AOL Time Warner' s accounting and reporting

systems to recognize, among other things :

a. The methods AOL employed to generate substantial advertising

sales activities near the end of reporting periods along with any weaknesses of failures within th e

internal control system that would ensure such sales' validity. AOL had "BA specials" - that

were generated at the eleventh hour of a given reporting period and provided revenue figures

necessary to hit earnings targets, but later would be deemed uncollectible or impaired ;

b. Weaknesses associated with AOL' s accounting policies related to

revenuetgain classification. AOL renegotiated deals for a buy-out or early termination with

failing dot-cons which were const rued as sales revenues rather than a gain or other revenues ;

and

c. Litigation settlements that were converted to advertising revenu e

on more than one occasion. There appeared to be little or no internal controls governing such

classification practices, nor did Ernst & Young plan their audits accordingly based on thes e

weaknesses within the internal control system . In connection with planning and supervising it s

audit procedures, Ernst & Young violated GAAS .

642. In addition, Ernst & Young failed to obtain sufficient knowledge upon which t o

assess the environment under which AOL and AOL Time Warner' s accounting data, wer e

produced and processed :

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a. Revenues/profitability were not consistent with indust ry trends (AOL was

able to show increased advertising revenues in an industry facing significant decline) ;

b. The rate of change within the indust ry was rapid;

c. AOL and AOL Time Warner operated within a highly compe titive

environment;

d. Direction of change within industry was declining with business failures ;

e. Management demonstrated an attitude toward financial reporting that wa s

unduly aggressive;

f. Management placed undue emphasis on meeting revenue/earnings

projections ;

g. Management's compensation was tied to meeting aggressive targets ;

h. Many contentious or difficult accounting issues were present; and

Significant difficult-to-audit transactions or balances were present .

g. Ernst & Young Failed to Properly Evaluate Audit Findings .

643. "The risk of material misstatement of the financial statements is generally greater

when account balances and classes of transactions include accounting estimates rather tha n

essentially factual data because of the inherent subjectivity in estimating future events ."

Estimates are subject "to misstatements that may arise from using inadequate or inappropriat e

data or misapplying appropriate data ." AU § 312 .36 . "Even when management's es timation

process involves competent personnel using relevant and reliable data, there is potential for bia s

in the subjective factors." Accordingly, the auditor should consider estimates "with an attitude

of professional skep ticism ." AU § 342.04. "{T]he auditor should obtain an understanding of

how management developed the estimate ," AU § 342 .10, and should "obtain sufficient

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competent evidential matter to provide reasonable assurance" that, among other things , es timates

are reasonable in the circumstances and are presented in conformity with GAAP, AU § 342 .07 .

Ernst & Young violated GAAS , because it failed to obtain sufficient competent evidential matter

concerning, and, therefore , failed to properly evaluate , AOL and AOL Time Warner's estimates

of, among other things, round -t ripped transac tions, bartered goods and services , and goodwill

impairments .

h. Ernst & Young Failed to Properly Consider AOL and AOLTime Warner 's Lack of Internal Control .

644. "In all audits , the auditor should obtain an understanding of internal control

sufficient to plan the audit ." AU § 319 .02. The auditor should obtain sufficient knowledge of

the information system relevant to financial reporting to understand," among other things, the

classes of significant transactions , "the accounting records, supporting information and specific

accounts in the financial statements involved in the processing and reporting of transactions, the

accounting processing involved in recording , processing , accumulating and reporting

transactions , and the financial reporting process used to prepare financial statements." AU §

319.49. Ernst & Young violated GAAS because it knowingly or recklessly failed to learn or to

consider that AOL and AOL Time Warner had grossly deficient internal controls and procedures .

For example, Ernst & Young failed to develop or plan its audits to consider :

a. that AOL Time Wainer had grossly deficient revenue recognition

disclosure controls, including the lack of an appropriate system for determining amount,

timing and classification of revenues/gains, policies governing the calculation of fair

market value in the complex barter transactions, and integrity of revenue disclosures to

report the true substance of transactions rather than their form which were many time s

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quite different . This included a lack of control over a few key employees ' abili ty to

influence the accounting for advertising revenue ; and

b. that efforts were not made to assure that all necessary adjustments to

correctly and fairly present AOL and AOL Time Warner's quarterly financial posi tion

and results of operations.

L. The Materially False and Misleading Statements and Omissions of Material Facts Inthe Merger Registration Statement and Joint Proxy Statement Prospectus

645. On February 11, 2000, AOL Time Warner filed with the SEC and disseminated to

the public the Merger Registration Statement, which included the Joint Proxy Statement-

Prospectus. AOL Time Warner made four amendments to the Merger Registration Statement,

the last of which was filed with the SEC on May 19, 2000 .

646. The Merger Registration Statement was signed by J . Michael Kelly, Executive

Vice President and Chief Financial Officer, Gerald M. Levin, Chief Execu tive Officer, and Pau l

T. Cappuccio, Vice President and Director .

647. The Joint Proxy Statement-Prospectus was signed by Defendant Case, as

Chairman and Chief Executive Officer of AOL, and Defendant Levin, as Chairman of Tim e

Warner, and sent to shareholders of both companies on or about May 23, 2000 .

648. The Merger Registration Statement and Joint Proxy Statement-Prospectus

included the Second Amended and Restated Agreement and Plan of Merger (the "Merge r

Agreement") . The Merger Agreement was attached as Annex A to the Merger Registration

Statement and Joint Proxy Statement-Prospectus. In the Merger Agreement, AOL represented

and warranted as follows :

4.1 Representations and Warranties of America Online . . .

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(d) Reports and Financial Statements .

(i) America Online has filed all required registration statements,prospectuses , reports, schedules, forms, statements and other documents requiredto be filed by it with the SEC since July 1, 1997 (collec tively, including allexhibits thereto , the "America Online SEC Reports") . . . . None of the AmericaOnline SEC Reports, as of their respective dates (and, if amended or supersededby a filing prior to the date of this Agreement, then on the date of such filing),contained or will contain any untrue statement of a material fact or omitted or willomit to state a material fact required to be stated therein or necessar t o to make thestatements therein , in light of the circumstances under which they were made, notmisleading. Each of the financial statements (including the related notes)included in -the America Online SEC Reports presents fairly, in a ll materialrespects, the consolidated financial position and consolidated results of operationsand cash flows of America Online and its consolidated Subsidiaries as of therespective dates or for the respective periods set forth therein , all in conformitywith United States generally accepted accounting principles "GAAP")consistently applied during the periods involved except as otherwise noted therein,and subject, in the case of the unaudited interim financial statements, to theabsence of notes and normal year -end adjustments that have not been and are notexpected to be material in amount . All ofsuch America Online SEC Reports, asof their respective dates (and as of the date of any amendment to the respectiveAmerica On line SEC Report), complied as to form in all material respects withthe applicable requirements of the Securities Act and the Exchange Act and therules and regulations promulgated thereunder .

***

(e) Information Supplied .

(i) None of the information supplied or to be-supplied by AmericaOnline for inclusion or incorporation by reference in (A) the Form S-4 (as definedin Section 6.1) will, at the time the Form S-4 is filed with the SEC, at any time itis amended or supplemented or at the time it becomes effective under theSecurities Act, contain any untrue statement of a material fact or omit to state anymaterial fact required to be stated therein or necessary to make the statementstherein in light of the circumstances under which they were made, not misleadingand (B) the Joint Proxy Statement/Prospectus (as defined in Section 6.1) will, onthe date it is first mailed to Time Warner stockholders or America Onlinestockholders or at the time of the Time Warner Stockholders Meeting or theAmerica Online Stockholders Meeting (each as defined in Section 6 .1), containany untrue statement of a material fact or omit to state any material fact requiredto be stated therein or necessary in order to make the statements therein,in lightof the circumstances under which they were made, not misleading . The Form S-4and the Joint Proxy Statement/Prospectus will, comply as to form in all materialrespects with the requirements of the Exchange Act and the Securities Act and therules and regulations of the SEC thereunder .

481sa 258

(Emphasis added.)

649. The Joint Proxy Statement-Prospectus included the following message to

shareholders : "Me boards of directors of both America Online and Time Warner have approved

the merger and recommend that their respective stockholders vote FOR the merger proposal .

Informa tion about the merger is contained in this joint proxy statement prospectus . "

650. The Joint Proxy Statement-Prospectus continued :

Your vote is v important, regardless of the number of shares you own .Whether or not you plan to attend the special meeting, please vote as soon aspossible to make sure that your shares are represented at the meeting . If you donot vote, it will have the same effect as voting against the merger . We stronglysupport this combination of our companies and join with our boards of directorsin enthusiastically recommending that you vote in favor of the merger .

(Emphasis added . )

651 . The Joint Proxy Statement Prospectus explained that the record date of eligibility

to vote on the Merger was May 18, 2000, and that the Special Stockholder Meetings for AO L

and Time Warner shareholders would both take place on June 23, 2000.

652. The Merger required and received the affirmative vote of the AOL and Time

Warner shareholders at the respective Special Stockholder Meetings .

653. The Merger Registration Statement and Joint Proxy Statement-Prospectu s

included selected historical financial data of AOL, including the audited consolidated financial

statements of AOL for the year ended June 30, 1999 and unaudited consolidated financia l

statements for the nine months ended March 31, 1999 and 2000 .

654. In addition, the Merger Registration Statement and Joint Proxy Statement-

Prospectus included unaudited pro forma conso lidated financial data of AOL Time Warner. The

pro forma financial results were presented on two different bases due to AOL's and Time

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Warner's different fiscal years - a June 30 fiscal year basis and a December 31 calendar yea r

basis . The AOL Time Warner pro forma financial data included revenue data for the nine

months ended March 31, 2000, the year ended June 30, 1999, the three months ended March 31 ,

2000 and the year ended December 31, 1999 .

655. The Merger Registration Statement also included the pro forma consolidated

condensed balance sheet of AOL Time Warner as of March 31, 2000 which purported to reflect

the historical financial position ofAOL at March 31, 2000 and also set forth the amount

allocated to goodwill as a result of the Merger.

656. The Merger Registration Statement and Joint Proxy Statement -Prospectus also

incorporated by reference, inter alia, the documents set forth below, each of which included

some or all of the materially untrue and misleading financial statements and information referred

to herein :

a. America Online's Annual Report on Form 10-K for the fiscal year endedJune 30, 1999 (filing date August 13, 1999) ;

b. America Online's Quarterly Report on Form 14-Q, for the quarterly periodended September 30, 1999 (filing date November 2, 1999) ;

G . America Online's Quarterly Report on Form 1 O-Q, for the quarterly periodended December 31, 1999 (filing date February 14, 2000) ;

d. America Online 's Quarterly Report on Form 10-Q/A, for the quarterlyperiod ended March 31, 2000 (fi ling date May 17, 2000), which contains financialstatements and related information that restate and supersede the financial statements andrelated information in America Online's Annual Repo rt on Form 10-K for the fiscal yearended June 30, 1999, fi led August 13, 1999 ;

e. America Online's Current Report on Form 8-K dated January 19, 2000(filing date January 24, 2000) incorporating AOL's press release, dated January 19, 2000,announcing AOL's financial results for the quarter ended December 31, 1999;

f. America Online 's Current Report on Form 8-K dated January 10, 2000(filing date February 11, 2000) incorporating AOL Time Warner pro forma consolidatedcondensed financia l statements for the three months ended September 30, 1999, the year

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ended June 30, 1999, nine months ended September 30, 1999 and year ended December31; 1998;

g. America Online's Current Report on Form 8-K dated April 3, 2000 (filingdate April 3, 2000) incorporating AOL Time Warner pro forma consolidated condensedfinancial statements for the six months ended December 31, 1999, the year ended June 30,1999, and the year ended December 31, 1999 ;

h. America Online's Current Report on Form 8-K dated Apri l 18, 2000(fi ling date Apri l 2 1, 2000) incorpora ting AOL's press release, dated April 18, 2000,announcing AOL's financial results for the quarter ended March 31 , 2000; and

i . The Joint Proxy Statement and Prospectus filed with the SEC on or aboutMay 19, 2000 and sent to Time Warner and AOL shareholders on or about May 23, 2000relating to the Merger of AOL and Time Warner .

657. Ernst & Young consented to the incorporation by reference in the Merge r

Registration Statement and Joint Proxy Statement-Prospectus of its unqualified audit report ,

dated July 21, 1999 , on AOL's 1999 consolidated financial statements as set forth in AOL's

1999 SEC Form 10-K for the year ended June 30, 1999 and consented to all references to Erns t

&Young in the Merger Registration Statement and Joint Proxy Statement-Prospectus, which

included a reference to it under the caption "Experts ." In a subsequent amendment to the Merger

Registration Statement, Ernst & Young consented to the reference to itself as "Experts" and to

the use of its report dated July 21, 1999, except for Note 3, which is dated May 12, 2000, wit h

respect to the consolidated financial statements of AOL for the three years ended June 30, 1999

incorporated by reference as Exhibit 99 to AOL's SEC Form 10-Q/A for the qua rterly period

ended March 31, 2000 , incorporated by reference and made a part of the Merger Registra tion

Statement and Joint Proxy Statement Prospectus . In that amendment, Ernst & Young als o

consented to the incorporation by reference in the Merger Registration Statement and Joint Prox y

Statement-Prospectus, and to the reference to itself as "Experts," of its May 19, 2000 report wit h

respect to the consolidated balance sheet of AOL Time Warner as of March 31, 2000 . Finally,

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Ernst & Young consented to the incorporation by reference in the Merger Registration Statemen t

and Joint Proxy Statement-Prospectus of its report dated July 20, 2000, with respect to th e

consolidated financial statements of AOL included in its SEC Form 10-K for the year ended Jun e

30, 2000. These reports were incorporated in the Merger Registration Statement and Joint Prox y

Statement-Prospectus "in reliance on Ernst & Young's report, given on their authority as expert s

in accounting and auditing ."

658 . AOL Time Warner further represented in the Merger Registration Statement an d

Joint Proxy Statement-Prospectus that Ernst & Young had audited the consolidated balance shee t

of AOL Time Warner at March 31, 2000 and audited the consolidated financial statements o f

AOL for the three years ended June 30, 1999 and that such fi nancials were incorporated in th e

Merger Registration Statement and Joint Proxy Statement-Prospectus under "Experts" "i n

reliance on Ernst & Young LLP's report, given on their autho rity as experts in accounting an d

auditing. "

659. The pro forma consolidated condensed financial statements included in the

Merger Registra tion Statement and Joint Proxy Statement-Prospectus were "presented to

illustrate the effects of the Merger ." The pro forma financial statements represented that as a

result of the Merger an estimated amount of $94.705 billion would be allocated to goodwi ll due

to the excess purchase price over identifiable tangible and other intangible assets . The pro forma

financial statements also estimated a useful life of 25 years for the goodwill .

660. The Company ' s Merger Registration Statement and AOL 's and Time Warner' s

Joint Proxy StatementProspectus represented that :

AOL Time Warner will periodically review the carrying value of the acquiredgoodwill for acquired businesses to determine whether an impairment may exist .AOL Time Warner will consider relevant cash flow information, includingestimated future operating results, trends and other available information, i n

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assessing whether the carrying value of goodwill can be recovered . If it isdetermined that the carrying value of goodwill will not be recovered from theundiscounted future cash flows of acquired businesses, the carrying value of suchgoodwill would be considered impaired and reduced by a charge to operations inthe amount of the impairment.

(Emphasis added.) In addition, the Merger Registration Statement and Joint Proxy Statement-

Prospectus represented that an "impairment charge" would be "measured as any deficiency in the

amount of estimated undiscounted cash flows of acquired businesses available to recover th e

carrying value related to goodwill ."

661 . All of the financial statements of AOL contained or incorporated by reference i n

the Merger Registration Statement and Joint Proxy Statement-Prospectus were untrue becaus e

they materially overstated AOL advertising and commerce revenue, and/or AOL advertising and

commerce backlog, and/or percentage increases in such amounts in year over year comparisons ,

for various fiscal periods as set forth in ¶J 240-357 and 392 .

662. All of the pro forma financial statements for AOL Time Warner, including the

Company's pro forma consolidated condensed balance sheet as of March 31, 2000, contained o r

incorporated by reference in the Merger Registration Statement and Joint Proxy Statement-

Prospectus were untrue because they materially overstated AOL advertising and commerc e

revenue, as set forth in $1235-357 and 392, and because they materially overstated the real valu e

of goodwill and its useful life, as set forth in IN 395-432 .

663 . All of the financial statements and pro forma financial statements contained o r

incorporated by reference in the Merger Registration Statement and Joint Proxy Statement-

Prospectus failed to disclose the sham transactions and improper accounting that resulted in th e

overstated advertising revenue and backlog, and percentage comparisons referred to above ; the

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true current and anticipated condition of AOL's adver tising revenue and business ; and the true

fair value of goodwill created by the Merger and its useful life was materially overstated .

664. All of the financial statements of AOL contained or incorporated by reference in

the Merger Registration Statement and Joint Proxy Statement-Prospectus falsely represented tha t

they were prepared in accordance with GAAP and Article 10 of Regulation S-X .

665. With respect to the audited financial statements of AOL included or incorporated

by reference in the Merger Registration Statement and Joint Proxy Statement Prospectus, Ernst

&Young falsely represented that they were audited in conformance with GARS.

666. All of the financial statements of AOL contained or incorporated by reference in

the Merger Registration Statement and Joint Proxy Statement-Prospectus falsely represented tha t

they fairly represented the results of AOL operations, particularly with respect to the advertising

revenue and business of AOL.

667. For the same reasons set forth above, AOL's representations and warranties in the

Merger Agreement attached as Annex A to the Merger Regis tra tion Statement and Joint Prox y

Statement-Prospectus that: (1) AOL's financial statements were prepared in conformity with

GAAP; and (2) AOL's SEC filings were free of material misstatements and omissions wer e

similarly untrue and misleading.

VII. APPLICABILITY OF PRESUMPTION OF RELIANCE :FRAUD-ON-TEDE-NLARIKET DOCTRINE

668. At all relevant times, the market for AOL and AOL Time Warner stock, was an

efficient market for the following reasons, among others :

a. AOL's and the AOL Time Warner 's stock met the requirements for listing ,

and were listed and ac tively traded on the NYSE, a highly efficient and automated market;

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b. As regulated issuers , AOL and AOL Time Warner filed periodic publi c

reports with the SEC and the NYSE ;

c. AOL and AOL Time Warner regularly communicated with publi c

investors via established market communica tion mechanisms, including through regular

dissemination of press releases on the national circuits of major newswire services an d

through other wide-ranging public disclosures, such as communications with the financia l

press and other similar reporting services and regular periodic conferences with groups of

market analysts ; and

d . AOL and AOL Time Warner were followed by numerous securities

analysts employed by major brokerage firms who wrote reports which were distributed to

the sales force and certain customers of their respective brokerage firms . Each of these

reports was publicly available and entered the public marketplace .

669. As a result of the foregoing, the market for AOL's and the Company's stock

promptly digested current .information from all publicly available sources and reflected such

information in AOL's and the Company's stock. Under these circumstances, all purchasers of

AOL and the Company's stock during the Class Period suffered similar injury through their

purchase of such stock at artificially inflated prices and/or through their purchase or sale o f

options on AOL and/or Company stock, and a presumption of reliance applies .

VIII. NO SAFE HARBOR

670. The statutory safe harbor provided for forward-looking statements under certain

circumstances does not apply to any of the allegedly false statements pleaded in this Complaint .

Many of the specific statements pleaded herein were not identified as "forward-looking

statements" when made, nor was it stated that actual results could differ materially from those

48194 265

projected, nor did meaningful cautionary statements identifying important factors that could

cause actual results to differ materially from those in the forward-looking statements accompany

those forward-looking statements. Alternatively, to the extent that the statutory safe harbor does

apply to any forward-looking statements pleaded herein, defendants are liable for those fals e

forward-looking statements because at the time each of those forward-looking statements was

made, the particular speaker knew that the particular forward-looking statement was false, and/or

the forward-looking statement was authorized and/or approved by an executive officer of

America. Online and/or the Company who knew that those statements were false when made.

IX. COUNTS

COUNT ONE

(Against AOL Time Warner for Violations of § 11 of the Securities Act in Connection with

the Merger Registration Statement)

671 . Plaintiffrepeats and realleges each and every allegation contained above as if

fully set forth herein, except that this Count does not sound in fraud , and Plaintiff does not

incorporate herein any allegations of fraud in connection with this Count . This Count is asserted

against AOL Time Warner for violation of Section 11 of the Securities Act, 15 U.S .C. § 77k, on

behalf of all Class members who acquired AOL Time Warner common stock pursuant and/or

traceable to the Merger Registration Statement, including in exchange for Time Warner common

stock .

672. The Merger Registration Statement contained untrue statements of mate rial facts

and omitted to state material facts necessary to make the statements made therein not misleading .

As referenced in this Complaint, the untrue statements of material fact contained in, and th e

material facts omitted from the Merger Registration Statement include :

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a. AOL's untrue financial statements which artificially inflated AOLadvertising revenue;

b. AOL Time Warner' s untrue pro forma financial statements whichcontained artificially inflated AOL advertising revenue;

c. AOL Time Warner's untrue pro forma financial statements which falselyrepresented the true value of goodwill created in connection with theMerger, and the useful life of the goodwill ;

d. Failure to disclose that the AOL advertising revenue in the financialstatements and pro forma financial statements was based on shamtransactions and improper accounting, the true current and anticipatedcondition of AOL's advertising revenue and business; and that the true fairvalue of goodwill created by the Merger and its useful life was materiallyoverstated; -

C. The untrue representa tion that AOL's financial statements had beenprepared in conformity with GAAP; and

f. . AOL's untrue representations and warranties in the Merger Agreement .

673 . AOL Time Warner is the registrant for the shares issued pursuant to the Merger

and fi led and signed the Merger Regis tration Statement as the issuer of its common stock. AOL

Time Warner is therefore absolutely liable under Section 1 I of the Securi ties Act, 15 U .S.C . §

77k, to Plaintiff and other members of the Class for the material misrepresentations or omission s

contained in the Merger Registration Statement .

674. At the time Plaintiff and other Class members acquired AOL Time Warner

common stock pursuant and/or traceable to the Merger Registration Statement, they did no t

know of the facts concerning the untrue and misleading statements and omissions alleged herein .

675 . In connec tion with issuing the Merger Registration Statement, AOL Time Warner

used the means and instrumentalities of interstate commerce and the U . S. mails .

676. By reason of the foregoing , AOL Time Wa rner is absolutely liable for violations

of Section 11 of the Securities Act to Plaintiff and the other members of the Class who acquire d

AOL Time Warner common stock pursuant and/or traceable to the Merger Registratio n

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Statement, including in exchange for Time Warner common stock, each of whom has been

damaged by reason of such violations .

COUNT TWO

(Against Defendants Case, Levin, Kelly, Cappuccio, Novack, and Pittman for Violation ofSection 11 of the Securities Act in Connection with the Merger Registration Statement)

677. Plaintiffrepeats and realleges each and every allegation contained above as if

fully set forth herein, except that this Count does not sound in fraud, and Plaintiffdoes not

incorporate herein any allegations of fraud in connection with this Count . This Count is asserted

against Defendants Stephen Case, Gerald M . Levin, J . Michael Kelly, Paul T. Cappuccio,

Kenneth J . Novack, and Robert W . Pittman for violations of Section I 1 of the Securities Act, 1 5

U.S .C. § 77k, on behalf of all Class members who acquired AOL Time Warner common stock

pursuant and/or traceable to the Merger Registration Statement,, including in exchange for Tim e

Warner common stock .

678. The Merger Registration Statement contained untrue statements of material facts

and omitted to state material facts necessary to make the statements made therein not misleading ,

as referenced in ¶ 672 .

679. Defendant Stephen Case signed the Joint Proxy Statement-Prospectus which wa s

incorporated into the Merger Registration Statement . Defendant Gerald Levin, signed the Join t

Proxy Statement-Prospectus and the Merger Registration Statement . Defendants J . Michael

Kelly and Paul Cappuccio signed the Merger Registration Statement. Defendants Stephen Case,

Kenneth J. Novack and Robert W. Pittman, all consented to being named in the Merger

Registration Statement as being or about to become directors of AOL Time Warner . All are

therefore liable under Section 11 of the Securi ties Act, 15 U.S.C. § 77k(a)(1) and (3), to Plaintiff

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and other members of the Class for the material misrepresentations or omissions contained in th e

Merger Registration Statement .

680. At the time Plaintiff and the other Class members acquired AOL Time Warner


know of the facts concerning the untrue and misleading statements and omissions alleged herein .

681 . In connection with issuing the Merger Registration Statement, the individua l

Defendants named in this Count used the means and instrumentalities of interstate commerce and

the U . S. mails .

682. By reason of the foregoing, the Defendants named in this Count violated Sectio n

11 of the Securities Act and are liable to Plaintiff and the other members of the-Class who

acquired AOL Time Warner common stock pursuant and/or traceable to the Merger Registration

Statement, including in exchange for Time Warner common stock, each of whom has bee n

damaged by reason of such violations .

COUNT THREE

(Against Ernst & Young for Violations of § 11 of the Securities Act in Connec tion with theMerger Registration Statement)

683. Plaintiff repeats and realleges each and every allegation contained above as i f

fully set forth herein, except that this Count does not sound in fraud, and Plaintiff does no t

incorporate herein any allegations of fraud -in connection with this Count . This Count is asserted

against Ernst & Young for violations of Section 11 of the Securi ties Act, 15 U.S.C. § 77k, on

behalf of all Class members who acquired AOL Time Warner common stock pursuant and/o r

traceable to the Merger Registration Statement, including in exchange for Time Warner commo n

stock .

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684. Ernst & Young consented to the incorporation by reference in the Merger

Registration Statement of its unqualified audit report, dated July21, 1999, on AOL's 1999

consolidated financial statements as set forth in AOL's 1999 Form 1 Q-K for the year ended June

30, 1999 and consented to all references to Ernst & Young in the Merger Registration Statement,

which included a reference to it under the caption "Experts ." In a subsequent amendment to the

Merger Registration Statement, Ernst & Young consented to the reference to itself as "Experts"

and to the use of its report dated July 21, 1999, except for Note 3, which is dated May 12, 2000,

with respect to the consolidated financial statements of AOL for the three years ended June 30,

1999 incorporated by reference as Exhibit 99 to AOL's Form 10-Q/A for the quarterly period

ended March 31, 2000, incorporated by reference and made a part of the Merger Registration

Statement and Joint Proxy Statement-Prospectus . Ernst & Young also consented to the

incorporation by reference in the Merger Registration Statement of its report dated July 20, 2000,

with respect to the consolidated financial statement of AOL included in its Form 10-K for th e

year ended June 30, 2000. Ernst & Young opined that AOL's financial statements for fiscal year

ended June 30, 1999 and 2000, which were incorporated in the Merger Registration Statement,

were prepared in conformity with GAAP. Further, as set forth under the caption "Experts,"

AOL's financial statements were included "in reliance on Ernst & Young's report, given on their

authority as experts in accounting and auditing ." Ernst & Young is therefore liable under

Section 11 of the Securities Act, 15 U.S.C. § 77k(a)(4) .

685. In the Merger Registration Statement, the parts that Ernst & Young prepared and

incorporated within the document, specifically, its audit reports dated July 21, 1999, except Note

3 which is dated May 12, 2000 and July 20, 2000, and the parts that it audited, specifically,

AOL's annual financial statements, contained untrue statements of material facts and omitted to

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state material facts necessary to make the statements made therein not misleading . In particular,

as discussed in 240-357, 392 and 396-432 abode, the untrue statements include the

overstatement of advertising revenue, and backlog, and percentage increases in the amounts and

the overstatement of the value of goodwill created in the Merger for the various fiscal periods as

set forth in ¶ 657, and the statements in Ernst & Young's audit reports that : (i) it had audited

AOL's financial statements for each of the three years ended June 30, 1999 and the year ended

June 30, 2000 in accordance with GAAS ; (ii) it had planned and performed those audits "t o

obtain reasonable assurance about whether the financial statements are free of materia l

misstatements ;" (iii) in its opinion , AOL's financial statements "present fairly, in all material

respects , the consolidated financial position" of AOL at June 30, 1999 and 1998 and June 30,

2000 in conformity with "generally accepted" accounting principles ; and (iv) its audits provided

"a reasonable basis for [Ernst & Young's] opinions ."

686. At the time Plaintiff and the other Class members acquired AOL Time Warner


know of the facts concerning the untrue and misleading statements and omissions alleged herein.

687. In connection with the issuance of the Merger Registration Statement, Ernst &

Young directly or indirectly, used the means and instrumentalities of interstate commerce and th e

U.S. mails .

688. By reason of the foregoing, Ernst & Young violated Section 11 of the Securities

Act and is liable to Plain tiff and the other members of the Class who acquired AOL Time

Warner common stock pursuant and/or traceable to the Merger Registra tion Statement, including

in exchange for Time Warner common stock , each of whom has been damaged by reason of such

violations .

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COUNT FOUR

(Against Defendants Case, Pittman, Ke11y, Coxbu rn, Ripp and Levin for Liability Under §15 of the Securities Act For Violations of § 11 of the Securities Act )



incorporate herein any allegations of fraud in connection with this Count. This Count is asserted

against Defendants Stephen M . Case, Robert W. Pittman, J . Michael Kelly, David M. Colburn,

Joseph A . Ripp and Gerald M. Levin for violations of Section 15 of the Securities Act, 15 U.S .C .

§ 770, on behalf of all Class members who acquired AOL Time Warner common stock in

exchange for Time Warner common stock, pursuant to and/or traceable to the Merge r

Registration Statement.

690. As alleged in Count One, AOL Time Warner violated Section 1 I of the Securitie s

Act .

691 . The Defendants named in this Count acted as controll ing persons of AOL Time

Warner within the meaning of Section 15 of the Securities Act as alleged herein . These

Defendants had the power and authority to cause the Company to violate Section I I of th e

Securities Act.

692. By virtue of their high-level positions as executives and/or directors at AOL and

AOL Time Warner during the Class Period and members of the Company 's management team,

and/or their ownership and contractual rights , participation in and/or awareness of AOL's and

AOL Time Wa rner's opera tions, the Defendants named in this Count had the power to influenc e

and control and did influence and control , directly or indirectly, the decision-making of AOL

Time Warner, including the content and dissemination of the various statements which Plaintif f

contends are false and misleading . Each of the Defendants named in this Count, by virtue of hi s

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responsibilities and activities as a senior officer and/or director of AOL and/or AOL Tim e

Warner was privy to and participated in the creation , development and reporting of AOL's and

AOL Time Warner' s internal budgets, plans, projec tions and/or reports . These Defendants were

provided with or had unlimited access to copies of the reports, press releases, public filings and

other statements alleged by Plaintiff to be misleading prior to and/or shortly after thes e

statements were issued and had the ability to prevent the issuance of the statements or cause the

statements to be corrected .

693. Because of their positions of control and authority as senior officers and directors

of AOL and/or AOL Time Warner, these Defendants were able to,-and did, control the contents

of the Merger Registration Statement which contained materially false financial information and

omitted facts necessary to make the facts stated therein not misleading.

694 . At the time Plaintiff and other Class members acquired AOL Time Warner

common stock pursuant and/or traceable to the Merger in exchange for AOL and Time Warner

common stock, they did not know of the facts concerning the untrue and misleading statement s

and omissions alleged herein .

695. By reason of the foregoing, these Defendants are jointly and severally liable a s

control ling persons pursuant to Sec tion 15 of the Securities Act for the Company' s violations of

Section 1 i to Plaintiff and the other members of the Class who acquired AOL Time Warner

common stock pursuant and/or traceable to the Merger Registration Statement, including in

exchange for Time Warner common stock.

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COUNT FIVE

(Against AOL, Time Warner, and AOL Time Warner For Violations of § 14(a) of theExchange Act, and Rule 14a-9 Promulgated Thereunder In Connec tion With the Joint

Proxy Statement-Prospectus)

696. Plaintiff repeats and realleges each and every allegation contained above as if


incorporate herein any allegations offraud in connection with this Count . This Count is asserted

against AOL, Time Warner, and AOL Time Warner in its own right and as successor to AO L

and Time Warner for viola tions of Section 14(a) of the Exchange Act, 15 U .S .C. § 78n(a), an d

Rule 14a-9 promulgated thereunder, 17 C.F.R'240 .14a-9, on behalf of all Class members who

held Time Warner common stock at the close of business on May 18, 2000, the record date o f

eligibility to vote, and on June 23, 2000, the date of the Special Meetings in which the Merge r

was voted upon and approved .

697: The Joint Proxy Statement-Prospectus described herein was a "proxy solicitation"

within the meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated

thereunder.

698. The Joint Proxy Statement-Prospectus contained untrue statements of materia l

facts and omitted to state material facts necessary to make the statements made therein no t

misleading, as referenced in ¶ 672 .

699. AOL and Time Warner sought to secure AOL and Time Warner shareholder

approval of the AOL Time Warner Merger by means of the materially false and misleading Joint

Proxy Statement-Prospectus and solicited proxies from Plaintiff and other members of the Class .

48194 274

700. AOL and Time Warner, at the time it issued the Joint Proxy Statement-Prospectus ,

acted negligently and without due care in distributing or causing to be distributed the Joint Prox y

Statement-Prospectus containing the false and misleading statements and omissions .

701 . The Merger required and received the affirmative vote of the AOL and Time

Warner shareholders at the respective Special Stockholder Meetings held on June 23, 2000 .

Accordingly, the materially false and misleading Joint Proxy Statement-Prospectus was an

essential link in the accomplishment of the Merger.

702. In connection with issuing the Joint Proxy Statement-Prospectus , AOL Time

Warner used the means and instrumentalities of interstate commerce and the U.S. mails .

703 . By reason of the foregoing, AOL, Time Warner, and AOL Time Warner are liable

to Plaintiff and other members of the Class who held Time Warner common stock on May 18 ,

2000 and June 23, 2000 for violations of Section 14(a) of the Exchange Act and Rule 14a- 9

promulgated thereunder, each of whom has been damaged by reason of such violations.

COTTN T SIX

(Against Defendants Case, Levin, Kelly, Cappuccio, Novack and Pittman For Violations of§ 14(a) of the Exchange Act, and Rule 14a-9 Promulgated Thereunder In Connection With

the Joint Proxy Statement Prospectus)


fully set forth herein , except that this Count does not sound in fraud , and Plaintiff does not


against Defendants Stephen Case, Gerald M. Levin, J . Michael Kelly, Paul T. Cappuccio,

Kenneth J . Novack, and Robert W. Pittman for violations of Section 14(a) of the Exchange Act,

15 U.S .C. § 78n(a), and Rule 14a-9 promulgated thereunder, 17 C .F.R. §240.14a-9, on behalf of

all Class members who held Time Warner common stock at the close of business on May 18 ,

48184 275

2000, the record date of e ligibility to vote, and on June 23, 2000, the date of the Special

Meetings in which the Merger was voted upon and approved .

705. The Joint P roxy Statement Prospectus described herein was a "proxy solicitation"

within the meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgated

thereunder.

706. The Joint Proxy Statement-Prospectus contained untrue statements of material

facts and omitted to state material facts necessary to make the statements made therein not

misleading, as referenced in 1672 .

707. The Defendants named in this Count sought to secure AOL and Time Warner

shareholder approval of the Merger by means of the materially false and misleading Joint Proxy

Statement-Prospectus and solicited proxies from Plaintiff and other members of the Class .

708. The Defendants named in this Count, at the time it issued the Joint Proxy

Statement Prospectus, acted negligently and without due care in distributing or causing to b e

distributed the Joint Proxy Statement-Prospectus containing the false and misleading statement s

and omissions.

709. The Merger required and received the affirma tive vote of the AOL and Tim e



essential link in the accomplishment of the AOL Time Warner merger.

710. In connection with issuing the Joint Proxy Statement-Prospectus, the means and

instrumentalities of interstate commerce and the U.S. mails were used.

711. By reason of the foregoing, AOL, Time Warner, and AOL Time Warner are liable

to Plaintiff and other members of the class who held Time Warner common stock on May 18 ,

48184 276

2000 and June 23, 2000 for violations of Section 14(a) of the Exchange Act and Rule 14a- 9

promulgated thereunder, each of whom has been damaged by reason of such violations .

COUNT SEVEN

(Against Ernst & Young For Violations of § 14(a) of the Exchange Act, and Rule 14a-9Promulgated Thereunder In Connection With the Joint Proxy Statement Prospectus )




against Ernst & Young for violations of Section 14(a) of the Exchange Act, 15 U.S.C. §78n(a),

and Rule 14a-9 promulgated thereunder , 17 C.F.R. § 240 . 14a-9, on behalf of all Class member s

who held Time Warner common stock at the close of business on May 18, 2000, the record date

of eligibility to vote, and on June 23, 2000, the date of the Special Meetings in which the Merge r

was voted upon and approved .

713. The Joint Proxy Statement-Prospectus described herein was a "proxy solicitation"

within the meaning of Section 14(a) of the Exchange Act and Rule 14a-9 promulgate d

thereunder .

714. As set forth in 1657, Ernst & Young permitted the use of its name in the Joint

Proxy Statement-Prospectus to solicit proxies from Plaintiff and other members of the Class .

715. The Joint Proxy Statement-Prospectus contained untrue statements of material

facts by Ernst & Young and omitted to state material facts necessary to make the statement s

made therein by Ernst & Young not false and misleading, as alleged above in ¶ 685.

716. Ernst & Young acted negligently and without due care in making the false and

misleading statements and omissions in the Joint Proxy Statement-Prospectus .

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717. The Merger required and received the affirmative vote of the AOL and Tim e



essential link in the accomplishment of the Merger.

718. In connection with the issuance of the Joint Proxy Statement Prospectus, the

means and instrumentalities of interstate commerce and the U.S. mails were used.

719. By reason of the foregoing, Ernst & Young is liable for violations of Section 14(a)

of the Exchange Act and Rule 14a-9 promulgated thereunder to Plaintiff and the other member s

of the Class, each of whom has been damaged by reason of such violations .

COUNT EIGHT

(Violations Of Section 10(b) Of The Exchange Act And Rule 10b-5 PromulgatedThereunder Against Defendants AOL Time Warner, AOL and Case, Pittman,

Kelly, Colburn, Keller, Ripp, Rindner, Levin and Pace)

720. Except for the Counts not sounding in fraud, Plaintiff repeats and realleges eac h

and every allegation contained above as if fully set forth herein . This Count is asserted against

Defendants Case, Pittman, Kelly, Colburn, Keller, Ripp, Rindner, Levin and Pace for thei r

viola tions of Section 10(b) of the Exchange Act 15 U .S.C. 78j(b) and Rule lOb-5 , 17 C.F.R.

240.10b-5, promulgated thereunder . This Count is also asserted against AOL Time Warner, a s

successor to AOL, and AOL in its own right .

721 . During the Class Period, the Defendants named in this Count carried out a plan ,

scheme and course of conduct which was intended to and, throughout the Class Period, di d

deceive the investing public, including Plaintiff and other Class members, as alleged herein an d

caused Plaintiff and other members of the Class to purchase , exchange or otherwise acquire AOL

and/or AOL Time Warner stock at artificially inflated p rices , and/or to purchase or sell options

48184 278

on AOL and/or AOL Time Warner stock . In'furtherance of this unlawful scheme, plan and

course of conduct, Defendants, and each of them, took the actions set forth herein .

722. Defendants : (a) employed devices, schemes , and arti fices to defraud; (b) made

untrue statements of material fact and/or omitted to state material facts necessary to make the

statements not misleading ; and (c) engaged in acts, practices, and a course of business which

operated as a fraud and deceit upon the purchasers of AOL' s or the Company's stock in an effort

to maintain artificially high market prices for these securi ties in violation of Section 10(b) of the

Exchange Act and Rule 1 Ob-5 . All Defendants named in this Count are sued as primary

participants in the wrongful and illegal conduct charged herein .

723. Defendants, individually and in concert, directly and indirectly, by the use, mean s

or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a

continuous course of conduct to conceal adverse material informa tion about the business ,

operations and future prospects of AOL and AOL Time Warner as specified herein .

724. Defendants employed devices, schemes and artifices to defraud , while in

possession of material adverse non-public information and engaged in acts, practices, and a

course ofconduct as alleged herein in an effort to assure investors of AOL's and AOL Tim e

Warner's value and performance and continued substantial growth, which included the making

of, or the participation in the making of, untrue statements of material facts and omitting to stat e

material facts necessa ry in order to make the statements made about AOL and AOL Time

Warner and their operating condition, advertising revenue, goodwill and future prospects in the

light of the circumstances under which they were made, not misleading, as set forth more

particularly herein, and engaged in transactions, practices and a course of business which

operated as a fraud and deceit upon those who purchased, exchanged or otherwise acquired AO L

48184 279

or AOL Time Warner stock and/or those who bought or sold op tions on AOL and/or AOL Time

Warner stock during the Class Period .

725. As more fully described in the paragraphs relating to fraud (¶ 98-239,240-394

and 395-432), the viola tions of GAAP (J 90-97 and 98 -234) and the scienter of the Defendants

named herein (J 451-593), each of the Defendants' primary liability arises from the followin g

facts: (i) the Individual Defendants were high-level executives and/or directors at AOL and AOL

Time Warner during the Class Period and members of the Company's management team or had

control thereof; (ii) each of these Defendants, by virtue of his responsibil ities and ac tivities as a

senior officer and/or director of AOL and AOL Time Warner was privy to and pa rticipated in the

creation, development and reporting of AOL' s and the Company's internal budgets, plans,

projections and/or reports ; (iii) each of these Defendants enjoyed significant personal contact and

familiarity with the other defendants and was advised ofand had access to other members of

AOL's and the Company's management team, internal reports and other data and informatio n

about AOL's and the Company's advertising revenue, finances, opera tions, and sales at all

relevant times ; and (iv) each of these Defendants was aware of, participated in or caused the

dissemination of information to the investing public of AOL and AOL Time Warner filings with

the SEC, press releases and regis tration statements . These statements and documents were

materially false and misleading in that, among other things, they misrepresented, and failed t o

disclose, AOL's and AOL Time Warner' s sham transac tions , improper recognition of adver tising

revenue and improper accounting for goodwill, during the Class Period .

726. The Defendants had actual knowledge of the misrepresentations and omissions o f

material facts set forth herein, or acted with reckless disregard for the truth, in that they failed t o

ascertain and disclose such facts, even though such facts were available to them. Such

48184 280

Defendants' material misrepresentations and/or omissions were made knowingly or recklessly

and for the purpose and effect of. (1) concealing AOL's and AOL Time Warner's operatin g

condition, advertising revenue, goodwill and future business prospects from the investing public;

(2) consummating the Merger; and (3) supporting the artificially inflated prices of its stock. As

demonstrated by Defendants' overstatements and misstatements of AOL 's and the Company's

business, operations, advertising revenue, goodwill, earnings and future business prospectus

throughout the Class Period, Defendants, if they did not have actual knowledge of the

misrepresentations and omissions alleged, were reckless in failing to obtain such knowledge by

deliberately refraining from taking those steps necessary to discover whether those statement s

were false or misleading.

727. As a result of the dissemination of the materially false and misleading information

and failure to disclose material facts, as set forth above, the market price of AOL and AOL Time

Warner stock was artificially inflated during the Class Period . In ignorance of the fact that

market prices of such publicly-traded stock was artificially inflated, and relying directly o r

indirectly on the false and misleading statements made by Defendants, or upon the integrity o f

the market in which the securities trade, and/or on the absence of material adverse informatio n

that was known to or recklessly disregarded by Defendants, but not disclosed in public

statements by Defendants during the Class Period, Plaintiff and other class members acquired

such stock and/or bought or sold options on such stock during the Class Period at artificially high

prices and were damaged thereby.

728. At the time of said misrepresentations and omissions, Plaintiff and other members

of the Class were ignorant of their falsity, and believed them to be true. Had Plaintiff and the

other members of the Class and the marketplace known the truth regarding the problems tha t

48194 281

AOL and AOL Time Warner were experiencing, which were not disclosed by Defendants,

Plaintiff and other members of the Class would not have purchased or otherwise acquired such

stock or bought or sold op tions on such stock, or, if they had acquired-such stock or bought or

sold op tions on such stock during the Class Period, they would not have done so at the ar tificially

inflated prices which they paid .

729. By virtue of the foregoing, Defendants named in this Count have violated Section

10(b) of the Exchange Act, and Rule lOb-5 promulgated thereunder. Asa direct and proximate

result of Defendants' wrongful conduct, Plaintiff and the other members of the Class suffered

damages in connection with their respec tive purchases or acquisitions of AOL and AOL Time

Wame?s stock and/or purchases or sales of options on such stock during the Class Period .

COUNT NINE

(Against Ernst & Young for Violations of § 10(b) of the Exchange Act and Rule lOb-5)

730. Except for the Counts not sounding in fraud , Plaintiff repeats and rea lleges each

and every allegation contained above as if fully set forth herein . This Count is asserted agains t

Ernst & Young for violations of Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule

lOb-5, 17 C.F.R. 244.IOb-5 .

731 . Ernst & Young, individually and in concert with others, directly and indirectly, by

the use of means or instrumentali ties of interstate commerce and/or of the mails, engaged and

participated in a continuous course of conduct that operated as a fraud and deceit upon Plaintiff

and the other members of the Class ; made various untrue and/or misleading statements of

material facts and omitted to state material facts necessary in order to make the statements made,

in light of the circumstances under which they were made, not misleading made the above

statements with a severely reckless disregard for the truth; and employed devices, and artifices t o

48184 282

defraud in connection with the purchase and sale of AOL and/or AOL Time Warner stock,

and/or the purchase or sale of options on such stock, which were intended to, and did : (i) deceive

the investing public, including Plaintiff, regarding, among other things, AOL and AOL Time

Warner's sham transactions, improper recognition of advertising revenue and improper

accounting for goodwil l ; (ii) artificially inflate and maintain the market price of AOL and AOL

Time Warner stock ; and (iii) cause Plaintiff and class members to purchase AOL and AOL Time

Warner stock at artificially inflated prices and/or purchase or se ll op tions on such stock.

732. As more fully described in the paragraphs relating to the fraud , (% 98-239, 240-

394 and 395432), the violations of GAAP (J 90-97 and 98-234) and Ernst & Young 's scienter

(J 594-644), pursuant to the aforesaid plan and course of conduct, Ernst & Young participated ,

directly and indirectly, in the preparation and/or issuance of the statements and document s

referred to above, including in AOL and AOL Time Warner filings with the SEC, press releases ,

and registration statements . These statements and documents were materially false and

misleading in that, among other things, they misrepresented , and failed to disclose, AOL's and

AOL Time Warner's sham transactions , improper recognition of advertising revenue and

improper accounting for goodwill, during the Class Period .

733. Ernst & Young, among others, engaged in such a device, scheme or artifice to

misrepresent the financial condition and results of AOL and AOL Time Warner and to

consummate the Merger, and maintain and/or inflate the prices of AOL and AOL Time Warner's

stock to, among other things, gain lucrative auditing and other consulting services from AOL and

AOL Time Warner. Specifically, Ernst & Young knew or recklessly disregarded that AOL's

reported annual financial results for fiscal years 1999, 2000 and the transition period for the year

ended December 31, 2000 (including December 31, 1999) and AOL Time Warner's reported

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annual financial results for 2001 as filed with the SEC in AOL and AOL Time Warner's Forms

IO-K, in the Merger Registration Statement and other SEC filings, and disseminated to th e

investing public, were materially overstated and were not presented in accordance with GAAP,

that Ernst & Young's audits were not performed in accordance with GARS , and, therefore, that

Ernst & Young's unqualified audit reports, as included or incorporated by reference in those

annual reports on Forms 1 O-K and other SEC filings, were materially false and misleading .

734. The SEC Form 1 d-Ks, the Merger Registration Statement and other SEC filings

were materially false and misleading; contained untrue statements of material facts ; omitted to

state material facts necessary to make the statements made in those filings, under the

circumstances in which they were made, not misleading; and failed to adequately disclose

material facts. As detailed herein, the misrepresentations contained in, or the material facts

omitted from, those SEC filings included, but were not limited to, the overstatement o f

advertising revenue through sham transactions and improper recognition of revenue and backlo g

and percentage increases in the amounts and the overstatement of the value of goodwill create d

in the Merger, as well as the representations in Ernst & Young's unqualified audit reports issued

in connection with Ernst & Young's audits of AOL and AOL Time Warner 's financial

statements and AOL Time Warner 's balance sheet for those years, in which Ernst & Young

certified that: (i) it had audited AOL and AOL Time Warner' s financial statements in accordance

with GAAS; (ii) it had planned and performed those audits "to obtain reasonable assurance abou t

whether the financial statements are free of material misstatements"; (ii i) in its opinion, AOL and

AOL Time Warner' s financial statements "present fairly , in all material respects, the

consolidated financial position" of AOL and AOL Time Warner " in conformity with generally

accepted accounting principles" or "accounting principles generally accepted in the United

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States;" and (iv) Ernst & Young's audits provided a "reasonable basis" for its opinions . As

detailed herein, Ernst & Young's audit reports were materially false and misleading . Ernst &

Young knew or recklessly disregarded, that the statements described above, which were

contained in the SEC Form 10-Ks, registration statements and incorporated by reference in other

SEC filings, were untrue, were made with omissions of material facts, and were misleading.

735. Ernst & Young, with knowledge or reckless disregard of the falsity and

misleading nature of the statements contained in its unqualified reports, and in reckless disregard

of the true nature of its audits, caused the complained of public statements to contain

misstatements and omissions of material facts as alleged herein . As described herein, Ernst &

Young's audit of AOL and AOL Time Warner's financial statements for 1999, 2000, the 2000

AOL transition period ended December 31, 2000 (including December 31, 1999) and the year

December 31, 2001 were not performed in accordance with GAAS, and, in fact, Ernst & Young

had no basis for its unqualified opinions rendered in connection therewith . Ernst & Young's

unqualified reports dated July 21, 1999, July 20, 2000, January 31, 2001 and January 28, 2002,

issued in connection with those audits, as included in the SEC Form 10-Ks, registration

statements and other SEC fillings, in which Ernst & Young opined, among other things, that its

audits were performed in accordance with GAAS, were materially false and misleading .

736. As described in detail above, Ernst & Young acted with scienter throughout th e

Class Period , in that it either had actual knowledge of the misrepresenta tions and omissions of

material facts set forth herein , or acted with reckless disregard for the truth , in that they failed to

ascertain and to disclose the true facts, even though such facts were available to them . Ernst &

Young was AOL's and AOL Time Warner's auditor, and, therefore, was directly responsible for

the false and misleading statements and omissions disseminated to the public th rough its

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unqualified audit reports .

737. As a result of the dissemination of the materially false and misleading informa tion

and failure to disclose material facts , as set forth above, AOL and AOL Time Warner stock wa s

sold in the public market, and the market prices of such stock was artificially inflated during the -

Class Period. In ignorance of the materially false and misleading nature of the reports and

statements described above, Plaintiff and class members relied to their detriment on th e

statements described above and/or on the integrity of the market prices as reflecting th e

completeness and accuracy of the informa tion disseminated in connection with their purchases o f

the stock and/or options .

738. At the time of said misrepresentations and omissions, Plaintiff and the class were

ignorant of their falsity, and believed them to be true . Plaintiff and the class members could not,

in the exercise of reasonable diligence, have known the actual facts . Had Plaintiff and the class

members known the truth, they would not have taken such ac tion.

739. By virtue of the foregoing, Ernst & Young has violated Section 10(b) of th e

Exchange Act and Rule lOb-5 promulgated thereunder . As a direct and proximate result of Erns t

& Young's wrongful conduct, Plaintiff and the other members of the Class suffered damages i n

connection with their respective purchases or acquisi tions of AOL and AOL Time Warner' s

stock and/or purchase or sale of options on such stock during the Class Period .

COUNT TEN

(Against Defendants Case, Kelly, Pittman, Colburn, Ripp, Levin and Pace for LiabilityUnder § 20(a) Of The Exchange Act For Violations Of § 10(h) Of The Exchange Act And

Rule 10b-5 Promulgated Thereunder)

740. Plaintiffrepeats and realleges each and every a llega tion contained above as if


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incorporate herein any a llegations of fraud in connection with this Count. This Count is asserted

against Defendants Case, Kelly, Pittman, Colburn, Ripp, Levin and Pace for their violations o f

Section 20 of the Exchange Act, 15 U .S .C. §78t(a), on behalf of all Class members who

purchased, exchanged or acquired AOL and/or AOL Time Warner stock and/or bought or sold

options on such stock during the Class Period and were damaged thereby .

741 . As alleged above in Count Eight, AOL Time Warner, AOL and the Individua l

Defendants violated Section IOb-5 of the Exchange Act and Rule IOb-5 promulgated hereunder .

742. The Defendants named in this Count acted as controll ing persons of AOL and

AOL Time Warner within the meaning of Section 20 of the Exchange Act as alleged herein .

These Defendants had the power and authority to cause AOL and the Company to violat e

Section I0(b) of the Exchange Act and Rule I Ob-5 promulgated thereunder .

743 . By virtue of their high-level posi tions as executives and/or directors at AOL and

AOL Time Warner during the Class Period and members of AOL and the Company' s

management teams, and their ownership and contractual rights, participation in and/or awarenes s

of AOL's and the AOL Time Warner's operations , the Defendants named in this Count had th e

power to influence and control and did influence and control, directly or indirectly, the decision-

making of AOL and AOL Time Warner, including the content and dissemination of the various

statements which Plaintiff contends are materially false and misleading . Each Defendant named

in this Count, because of his responsibilities and activities as a senior officer and/or director of

AOL and/or AOL Time Warner, was privy to and participated in the creation, development and

reporting of AOL's and the AOL Time Warner' s internal budgets, plans, projec tions and/or

repo rts . The Individual Defendants were provided with or had unlimited access to copies of the

reports, press releases, public filings and other statements alleged by Plaintiff to be misleadin g

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prior to and/or shortly after these statements were issued and had the ability to prevent the

issuance of the statements or cause the statements to be corrected .

744. In particular, each of these Individual Defendants had direct and supervisory

involvement in the day-to-day operations of AOL and AOL Time Warner and, therefore, i s

presumed to have had the power to control or influence the particular transactions giving rise to

the securities violations as alleged herein, and exercised the same .

745. The Individual Defendants were culpable participants because they were aware of

the dissemination of information to the investing public which they knew or recklessly

disregarded was materially false and misleading. As a result, the Individual Defendants knew or

recklessly disregarded that AOL and AOL Time Warner were engaging in fraudulent conduct in

violation Section I0 (b) of the Exchange Act and Rule 1Ob-5 promulgated thereunder.

746. By reason of the foregoing, the Individual Defendants are jointly and severally

liable as contro lling persons pursuant to Section 20 of the Exchange Act for AOL's and AOL

Time Warner's violation of Section I0(b) of the Exchange Act and Rule 1Ob-5 promulgated

thereunder. As a direct and proximate result of the Individual Defendants' wrongful conduct ,

Plaintiff and other members of the Class suffered damages in connection with their purchases ,

exchange or acquisitions of AOL and/or AOL Time Warner stock and/or purchase or sale of

options on such stock during the Class Period .

X. PRAYER FOR RELIEF

WREREFORE, Plaintiff prays for relief and judgment, as follows :

(a) Determining that this action is a proper class action, and appointing

Plaintiff as representative of the class under Rule 23 of the Federal Rules of Civil Procedure ;

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(b) Awarding compensatory damages in favor of Plaintiff and the other Clas s

members against all Defendants, jointly and severally, for all damages sustained as a result o f

Defendants' wrongdoing, in an amount to be proven at trial, including interest thereon ;

(c) Awarding Plaintiff and the Class their reasonable costs and expense s

incurred in this action, including fees for Plaintiff's counsel and experts ;

(d) Awarding extraordinary, equitable andlor injunctive relief as permitted b y

law, equity and the federal statutory provisions sued hereunder, pursuant to Rules 64, 65, an d

any other appropriate state law remedies ; an d

(e) Such other and further relief as the Court may deem just and proper.

XT. JURY TRIAL DEMANDED

Plaintiff hereby demands a trial by jury .

3Datedl.A ~

obert A . Skirnick RS (2636)(2636)MEREDITH CGH EN GREENFOGEL& SKERNICK, F.C.One Liberty Plaza, 3511' FloorNew York, NY 10006(212) 240-0020(212) 240-0021 Fax

Attorneys for Lead Plaintiff MinnesotaState Board of Investment and LocalCounsel for the Class

Samuel f) . He'vnsStacey L. MillsBryan L. CrawfordAlan 1 . GilbertDaniel C. HedlundLori A. JohnsonHEINS MILLS & OLSON, P .L.C.3550 IDS Center80 South Eighth StreetMinneapolis, MN 55402(612) 338 -4605(612) 338-4692 Fax

Attorneys for Lead Plaintiff MinnesotaState Board of Investment and LeadCounsel for the Clas s

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Documents

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