The Nasty Lawsuit at Homestore's Door

A shareholder suit, which could have a wide impact, seeks redress from the online real estate outfit for improperly booking revenues

By Chris Palmeri

The allegations read like a legal thriller. In March, 2001, Peter B. Tafeen, vice-president for business development at (HOMS ), allegedly told a colleague, Chief Financial Officer Joseph Shew, behind closed doors that the online real estate listing company would be $15 million short of its revenue target for the quarter, a potentially punishing development on Wall Street.

Tafeen, though, had a plan, according to a 244-page filing made on Nov. 16 in a shareholder class action against Homestore in federal court in California. Working with senior executives at AOL Time Warner (AOL ), Tafeen had allegedly put together a deal wherein Homestore would buy advertising space from a number of smaller Web sites. The complaint alleges that the fees paid for the space were at above-market rates. According to the complaint, the deal's quid pro quo was that those sites would buy space on AOL's House & Home Channel.

Through a revenue-sharing agreement already in place, AOL would send Homestore a portion of the ad purchases, enough to meet Homestore's revenue target. In effect, according to the complaint, Homestore allegedly was paying for its own revenues. The filing even claims that Tafeen said to Shew: It's "scary how perfect it was."


  Homestore has acknowledged that it improperly booked revenues, but it hasn't admitted to breaking any laws. Tafeen's attorney, Robert Friese, says his client did nothing illegal, that all his deals were vetted by Homestore's finance department, and that the accounting treatment of his transactions was not his responsibility. Friese also disputed charges that Tafeen concocted the March, 2001, deal with AOL solely to make a quarterly revenue target. "There was no urgency whatsoever," Friese says. "There were many other revenue sources."

The complaint provides one side's view of the highly charged final days of the dot-com era. According to the lawsuit, in late June of 2001 a new team of AOL executives, including current Vice-Chairman Joseph A. Ripp, who was then serving as chief financial officer, began balking at a space-swapping deal negotiated between Tafeen and AOL's Eric Keller, formerly a senior vice-president, who had gone on leave in April of that year. Keller's attorney declined to comment on the suit.

Ripp allegedly told Homestore's execs, according to the suit, that AOL's accounting department had questions about the credit quality of the third-party Web sites involved in the transaction. The complaint claims that in a tense telephone conference call on June 29, the last day of the quarter, Ripp and Homestore's senior executives allegedly had a showdown. Homestore Chairman and CEO Stuart H. Wolff allegedly threatened to initiate a lawsuit against AOL if Ripp didn't authorize the transaction.

The authorization came late that evening, the lawsuit claims. A source with knowledge of AOL's legal position denies that Ripp tried to subvert any accounting laws. Wolff and Ripp couldn't be reached for comment.


  The supposed motive for the alleged shenanigans is detailed in the complaint, which says Homestore and AOL were in merger talks in the spring of 2001. According to the complaint, Wolff, Tafeen, and other senior Homestore execs stood to make tens of millions of dollars if AOL bought the company, and AOL could write off the transactions as part of the merger costs. The negotiations allegedly fell apart over price, the complaint says. A spokesperson for AOL says the company had no comment. Homestore had no comment and has until Dec. 16 to respond to the class action.

The case follows on the heels of Shew and two other former Homestore executives pleading guilty to securities fraud in October unrelated to the allegations in the shareholder suit. Shew's attorney, Terry W. Bird, says his client is cooperating with pending investigations. And as the Securities & Exchange Commission and the Justice Dept. investigate some former Homestore execs on possible charges of fraud and insider trading, the investigators are said to be very interested in information Shew and other Homestore execs might offer, say sources familiar with the probes.

"This has become a huge spider web of [alleged] fraud," claims Jack Ehnes, chief executive of the California State Teachers' Retirement System (CalSTRS), which is the lead plaintiff in the suit and claims to have lost $9 million on its Homestore stock. Some legal experts say regulators and prosecutors may use the potential findings of this suit to go after bigger fish than Homestore in their efforts to clean up accounting practices that took place at some companies in the 1990s. The SEC is already looking into Homestore's dealings with AOL and Cendant Corp. (CD ).


  Ten individual defendants are named in the class action, including Tafeen, Wolff, Cendant real estate division chief Richard A. Smith, and two former AOL executives, Keller and David Colburn. And 16 corporate partners, including AOL and Cendant, are named as allegedly participating in the supposed revenue manipulation schemes. Meanwhile, other Homestore corporate partners, including General Motors Acceptance Corp., Bank of America (BAC ), and Wells Fargo (WFC ), are accused of participating in the alleged schemes although they are not named as defendants in the suit.

Among the accusations made in the complaint: GMAC, the lending division of auto giant General Motors (GM ), agreed to buy $20 million worth of Web services from Homestore in exchange for 100,000 warrants to purchase Homestore stock. The complaint says that under accounting rules, Homestore should have netted the revenues generated from deals like that against the cost of issuing the warrants, but it didn't. That would have made Homestore's revenues seem smaller and its expenses higher. A spokesperson for GMAC declined to comment.

Bank of America had no comment. Says Wells Fargo's spokesperson Lynn Greenwood: "We are not aware of any wrongdoing on the part of Wells...we have not been contacted by any law enforcement authority."


  The complaint alleges other instances of "buying revenue" involving rental car giant, Budget Group, now a part of Cendant, which provided BusinessWeek Online with this statement: "Following an initial review of the complaint, we believe the claims are without merit and reckless. We will aggressively defend ourselves against this spurious and egregious suit."

And where were the auditors? The complaint alleges that there was a great deal of debate between some Homestore executives and PricewaterhouseCoopers, the company's auditor then and now, about how to account for many of Homestore's transactions. The complaint claims that Homestore executives went to great lengths to hide the true nature of many deals from its auditors, including creating "fair market value" analysis that corroborated the high prices Homestore was paying for space on other sites.

According to the complaint, some Homestore execs also allegedly chose third parties to use as conduits for the money because PricewaterhouseCoopers did not audit them, and thus the transactions would be less likely to be discovered. Says a spokesperson for the accounting firm: "The lawsuit is without merit. The complaint clearly established that PwC was clearly not a party to the [alleged] conspiracy but rather a victim of it." Homestore declines comment.


  One of the defendants in the class action suggested that Homestore shareholders and their attorneys added more companies to the suit because they are looking for additional parties from which to recover money. Plaintiffs dismiss that charge. "The addition of these companies to the complaint does not have to do with what can be recovered, but with their participation in the overall [alleged] fraud," says Bruce Simon, an attorney for the plaintiffs.

As one measure of how seriously the allegations are being taken, Federal Insurance Co. and three other companies that provide "directors and officers" insurance to Homestore have already sued to rescind coverage for potential claims, arguing that their policies were entered into fraudulently, according to Michael F. Perlis, an attorney for Federal. Homestore declines comment on this suit. A hearing is set for Jan. 6 on Homestore's motion for a stay delaying any further action in this suit until after the class action is resolved.

Homestore, a formerly high-flying provider of online real estate listings and related services, is already on shaky ground. Its stock trades for $1.30 a share, down from an all-time high of $122 in January, 2000. In March and April, it announced that $160 million worth of revenues, nearly a third of its reported results for 2000 and 2001, were improperly booked. The SEC said in September that thanks to the cooperation of Homestore's new management, the commission would not bring charges against the company.

But Homestore may not be able to rid itself as easily of this shareholder suit. Some investors fear that it could be forced to settle and dip into its $87 million cash on hand to pay shareholders, which could further hurt Homestore's financial situation. Clearly, this thriller is far from over.

Palmeri is a correspondent in BusinessWeek's Los Angeles bureau

Edited by Beth Belton

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