Class Action suit filed against America Online, Inc. and its officers, directors and accountants alleging misrepresentations, false financial statements and insider trading

Business Wire, Feb 24, 1997

NEW YORK--(BUSINESS WIRE)--Feb. 24, 1997--A class action has been commenced in the United States District Court for the Eastern District of Virginia, Alexandria Division, on behalf of purchasers of America Online, Inc.("AOL") common stock during the period August 10, 1995 to October 29, 1996.

The complaint, as detailed below, alleges that AOL and certain of its officers, directors and AOL's outside public accountants violated the federal securities laws. AOL provides on-line services to personal computer users, in competition with other on-line service providers and with direct Internet access and service providers. During AOL's 1996 fiscal year ("F96"), ended June 30, 1996, AOL reported strong growth in net income and earnings per share ("EPS") totaling $29.8 million or $.28 per share with shareholders' equity increasing to $512 million, based on AOL's largest single asset -- "Deferred Subscriber Acquisition Costs" -- of $314 million, resulting from AOL's vastly increasing marketing expenditures to try to attract subscribers to its system. AOL's interim F96 financial results were reviewed by Ernst & Young ("E&Y") and represented by AOL as fairly presenting its financial condition and results of operations in conformity with Generally Accepted Accounting Principles ("GAAP"), as were its F96 results which were certified by E&Y as being fairly presented in conformity with GAAP, after an audit by E&Y in accordance with Generally Accepted Auditing Standards ("GAAS"). AOL and E&Y justified AOL's deferral of hundreds of millions of subscriber acquisition costs (basically direct response advertising and marketing expenditures) and their amortization over a 24-month period on the ground that the average AOL subscriber stayed with AOL for over 40 months and had a lifetime subscription value of over $700. In addition, AOL represented that its new direct Internet access service -- Global Network Navigator ("GNN") -- and its Booklink WebBrowser was very successful and attracting large numbers of subscribers -- thus enabling AOL to effectively compete in the Internet access market. As a result of its success, positive momentum and subscriber growth resulting from its increasing marketing expenditures, AOL forecast increased F97 EPS of $1.00 and that AOL would reach 10 million subscribers by June 1997, and AOL's stock soared to an all-time high of $71 per share in May 1996.

However, during June-Oct. 1996, AOL's stock declined sharply, as AOL revealed that despite its greatly increased marketing expenditures it was suffering from slowing subscriber growth and increased subscriber cancellations, such that it could not forecast future subscriber retention rates, i.e., subscriber life. Thus, AOL had to reduce its marketing expenditures and concentrate on trying to increase subscriber retention. Then, on Oct. 29, 1996, just a few weeks after AOL had issued its F96 financial statements and E&Y had certified its assets, earnings and shareholders' equity, as well as the appropriateness of AOL's accounting practices, AOL revealed that it was taking huge write-offs of $460 million, including: (i) a $385 million write-off of all previously deferred or (capitalized) subscriber acquisition costs, and would end its practice of not expensing such costs; and (ii) a $75 million "restructuring" write- off which, inter alia, would completely eliminate AOL's investment in GNN and its WebBrowser, which had failed as an Internet access product, resulting in the firing of over 300 employees. Thus, AOL instantly eliminated in its entirety the largest single asset on its balance sheet, reduced its shareholders' equity by 80% and wiped out by five times over the total pre-tax net income it had ever reported. It is now clear that AOL had never earned any profits and, in fact, had been incurring huge operating losses in prior years rather than the profits it had claimed, AOL will not reach 10 million subscribers by June 1997 and instead of the profitable growth forecast by and for it in F97, AOL will suffer huge losses. During mid-Oct. 1996, AOL stock collapsed to as low as $22-3/8 per share -- 70% below its Class Period and all-time high of $71.

However, before the truth about AOL's huge losses, improper accounting practices, failed Internet access product and inability to reach the 10 million subscriber mark by June 1997 were revealed, AOL and the 18 insiders named as defendants took advantage of the artificial inflation in AOL's stock their false and misleading statements had caused to sell off 4.9 million and 2.1 million shares of AOL stock, respectively, at prices as high as $55-3/8 per share. This enabled AOL to obtain $139 million in badly needed new capital and the 18 insiders to pocket over $95 million in insider trading profits. AOL's co-founder and Chairman Emeritus James V. Kimsey sold 82% of his AOL stock -- 651,000 shares at as high as $55-3/8 per share pocketing $24.5 million. AOL's co-founder, Chairman and CEO Stephen Case sold 76% of his AOL stock -- 575,000 shares at as high as $55 per share pocketing $29.1 million. AOL's Chief Financial Officer, Lennert Leader, sold 66% of his AOL stock -- 210,800 shares at as high as $54 per share, pocketing $10 million. Collectively, the 18 AOL insiders named as defendants unloaded 72% of their AOL holdings during the Class Period.