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Diana Tani, Cal. Bar No. 136656 Attorneys for Plaintiff United States District Court
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Securities and Exchange Commission, Plaintiff, vs. John Giesecke, Jr., Joseph J. Shew and John R. Desimone, Defendants. |
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Case No. Complaint for Violations of the Federal Securities Laws |
Plaintiff Securities and Exchange Commission ("Commission") alleges as follows:
1. The Commission brings this action pursuant to Sections 20(b), 20(d)(1) and 22(a) of the Securities Act ("Securities Act"), 15 U.S.C. § 77t(b), 77t(d)(1) and 77v(a), and Sections 21(d)(3)(A), 21(e) and 27 of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. §§ 78u(d)(3)(A), 78u(e) and 78aa.
2. The Defendants made use of the means and instrumentalities of interstate commerce, of the mails, or of the facilities of a national securities exchange, in connection with the transactions, acts, practices, and courses of business alleged herein.
3. This district is an appropriate venue for this action under Section 22(a) of the Securities Act, 15 U.S.C. § 77v(a), and Section 27 of the Exchange Act, 15 U.S.C. § 78aa, because, among other reasons, most of the transactions, acts, practices and courses of business constituting the violations alleged herein occurred within the Central District of California.
4. This action concerns a massive financial fraud perpetrated on the investing public by senior finance executives of a public company. Defendants John Giesecke, Jr., Joseph J. Shew, and John R. DeSimone are three former senior or mid-level executives of Homestore, Inc., a Delaware corporation ("Homestore" or the "Company") located in Westlake Village, California. At the time of the alleged violations, Homestore was one of the top Internet portals for real estate and related services.
5. From at least March 2001 through November 2001, the Defendants engaged in a fraudulent scheme to misstate Homestore's results of operations by overstating advertising revenues. In the face of the demise of many dot-com companies and a market demanding steady growth in revenues, Defendants fraudulently inflated the Company's revenues to beat Wall Street expectations. The scheme involved a complex structure of "round-trip" transactions using various third party companies for the sole purpose of generating advertising revenues for Homestore. The essence of these transactions was a circular flow of money by which Homestore recognized its own cash as revenue. Specifically, Homestore paid inflated sums to various vendors for services or products, and, in turn, the vendors used these funds to buy advertising from two media companies. The media companies then bought advertising from Homestore in the course of these related transactions either on their own behalf or as agents for otheradvertisers. Homestore recorded the money received from the sale of such advertising as revenue in its financial statements in violation of applicable accounting principles.
6. The Defendants knew that the round-trip transactions had no economic substance and that recognizing revenue from these transactions violated applicable accounting principles. Specifically, they knew that Homestore paid large sums of cash to numerous third parties for the primary purpose of selling advertising and recognizing revenue from these or related transactions. Nevertheless, the Defendants facilitated this arrangement and recorded, or caused to be recorded, revenues on these deals. All of the Defendants lied to the Company's independent auditors, PricewaterhouseCoopers, LLP ("PwC"), about the round-trip transactions and withheld business records from PwC during the auditor's 2001 quarterly reviews of the financial statements. Defendants Shew, Homestore's former Chief Financial Officer, and Giesecke, Homestore's former Chief Operating Officer, also made misrepresentations to and/or concealed material facts from securities analysts covering Homestore.
7. As a result of the Defendants' fraudulent conduct, the Company filed with the Commission reports on Forms 10-Q containing financial statements with materially inflated revenue for the quarters ended March 31, 2001, June 30, 2001, and September 30, 2001. Defendant Shew signed Homestore's Forms 10-Q for the first three quarters of 2001 despite knowing that the financial statements contained in these filings materially overstated the Company's revenues for those periods. Defendant Giesecke reviewed portions of each of these Forms 10-Q and caused the Forms 10-Q to be filed despite the misstatements contained therein.
8. After the scheme was uncovered, the Company issued corrected financial statements for these quarters that sharply reduced the previously reported revenues. The Company admitted that it had overstated total revenues in its first three quarterly financial statements for 2001 by $119 million (51%).
9. While the fraud was ongoing, Defendants exercised stock options, reaping substantial profits ranging from about $169,000 to approximately $3.2 million. The stock price during these trades ranged between approximately $21 and $32 per share.
10. John Giesecke, Jr., age 42, is a resident of Malibu, California. Giesecke joined Homestore in June 1998 as the Vice President of Finance. Within six months, he was promoted to Chief Financial Officer (CFO). He became the Chief Operating Officer (COO) in or about January 2001, reporting to the Chief Executive Officer (CEO), and served in that capacity until December 2001. In 2001, Giesecke reviewed portions of Homestore's Forms 10-Q, signed false management representation letters to PwC for the quarterly reviews, approved false press releases, and made false statements to securities analysts. Giesecke is a CPA licensed in California.
11. Joseph Shew, age 37, is a resident of West Chester, Pennsylvania. Shew was Homestore's CFO from about February 2001 through December 2001, reporting to the CEO. Before his promotion to CFO, Shew was Homestore's Vice President of Finance. In 2001, Shew signed the quarterly Forms 10-Q as well as false management representation letters to PwC, and made false statements to securities analysts. Shew is a CPA licensed in Pennsylvania.
12. John DeSimone, age 33, is a resident of Hermosa Beach, California. DeSimone was Homestore's Director of Planning and Transactions from June 1999 until his promotion to Vice President of Transactions within the Finance Department in or about January 2001. DeSimone served in that position until December 2001. During his tenure as Vice President of Transactions, DeSimone reported to Shew and assisted him in carrying out the fraudulent scheme, including lying to PwC.
13. Homestore, Inc., previously known as Homestore.com, Inc., is a Delaware corporation headquartered in Westlake Village, California. Homestore was one of the top portals for on-line real estate and related services in 2001. Homestore provides Internet real estate listings to consumers on Realtor.com and also markets services and products to real estate brokers. The Company's stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act and trades on the Nasdaq National Market System.
14. Throughout 2000 and 2001, Homestore had two primary sources of revenue. The Company generated approximately 60% of its revenue from the sale of subscriptions, products, and services to real estate agents. The remaining 40% was derived from the sale of on-line advertisements that appeared on the Company's website. Because advertising revenue was one of the key components of Homestore's overall financial results, the Company separately disclosed it in its financial statements.
15. Homestore entered into several unconventional barter transactions in 2000 and early 2001. Through these deals, Homestore bought on-line advertising or some service or right (such the ability to operate a co-branded website) from a vendor. On the same day, or immediately thereafter, that vendor bought on-line advertising from Homestore in roughly the same amount as Homestore's purchase from the vendor. Homestore recorded this as advertising revenue.
16. During the first quarter of 2001, Homestore decided to develop a fraudulent scheme involving round-trip transactions to circumvent the accounting rules for barter transactions. The essence of the fraud was to inject a third party(in some cases several third parties) into the previous two-way barter deals. Specifically, Homestore devised three legs in the round-trip transaction to (a) effect a circular flow of money; and (b) create an illusion that each leg of the transaction was independent of the other(s). The following diagram illustrates the structure of these transactions:
17. Generally accepted accounting principles ("GAAP") do not permit companies to recognize revenue on transactions without any economic substance, such as the round-trip transactions. Further, GAAP requires that barter revenue be recorded based on the fair value of the assets or services involved. For barters involving an exchange of advertising, the fair value is determined based on similar cash transactions of the company within the prior six-month period. Additionally, under GAAP, barter transactions must be disclosed, as such, in the financial statements.
18. To sell its common stock and other securities to members of thepublic and maintain public trading of its securities, Homestore was required to comply with statutes, rules and regulations designed to ensure that the Company's financial information was accurately recorded and disclosed to the investing public. Under these statutes, rules and regulations, Homestore had a duty to, among other things: (a) make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflected its transactions and dispositions of assets; (b) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP or any other criteria applicable to such statements and to maintain accountability for assets; and (c) file with the Commission quarterly reports on Form 10-Q for each of the first three quarters of each fiscal year including financial statements that disclose its financial condition and results of business operations for each three-month period.
19. As a result of Homestore's significant revenue shortfall in the first quarter of 2001, Homestore devised a plan to use a major media company (the "Media Company") to act as an intermediary in the overall round-trip deal. To carry out the scheme, vendors that Homestore referred to the Media Company were required to purchase on-line advertisements from the Media Company. The Media Company then purchased on-line advertising from Homestore on behalf of entities for which the Media Company acted as a media buyer. Homestore recognized revenue on this amount of on-line advertising purchased by the Media Company. In effect, Homestore recycled its own money to generate revenue.
20. As a result of a shortfall in Homestore's estimated revenues in the second quarter of 2001, Homestore conducted a similar round-trip transaction with the Media Company in the second quarter.
21. Under this structure, Homestore paid a total of $49.8 million tovarious vendors in the first two quarters of 2001. These vendors then collectively paid $45.1 million to the Media Company to purchase on-line advertisements. Homestore, in turn, recorded $36.7 million in revenue received from the Media Company for the purchase of Homestore on-line advertisements. Through this structure, Homestore was able to surpass the revenue estimates of securities analysts covering Homestore in the first two quarters of 2001.
22. Defendants understood and intended at the outset that if Homestore referred an agreed amount of advertising to the Media Company through various vendors, then the Media Company would spend that money on advertising with Homestore.
23. As part of the first leg of the transactions, Homestore purchased services (such as software licenses or marketing rights) and products from various vendors. In the first two quarters of 2001, Homestore paid $16.3 million and $33.4 million, respectively, to a total of sixteen different vendors.
24. Homestore generally had no business need to enter into these deals. Homestore paid the maximum amount possible that could be defended as the "fair market value" for the products and services. In all instances, Homestore paid the vendors the entire purchase price up-front while agreeing to receive the goods or services over a period of two to five years. As a condition of these transactions, Homestore required the vendors to buy on-line advertisements at the Media Company with most or all of the money received from Homestore.
25. In its financial statements, Homestore capitalized the payments to the vendors as prepaid assets and amortized them over the terms of each agreement. This effectively reduced current expenses on Homestore's income statement, thereby increasing net earnings. Thus, Homestore successfully deferred recognizing the expenses of the purchases despite the immediate cash outlay.
26. Most of the funds transmitted to the vendors were used to purchase advertising from the Media Company. In the first and second quarters of 2001, the sixteen vendors cumulatively bought advertising from the Media Company in the amounts of $15.8 million and $29.2 million, respectively. Beginning in the second quarter of 2001, the Media Company agreed to pay Homestore a 5% fee for referring the vendors to the Media Company.
27. Homestore, and particularly each of the Defendants, intentionally concealed this leg of the round-trip transaction from PwC. In addition, Homestore did not record revenues on approximately $1.4 million that the Media Company paid in referral fees in the second quarter of 2001, to further hide the true nature of the transaction.
28. After obtaining the funds from the vendors, the Media Company purchased a significant amount of Homestore advertising in 2001 as a media buyer for other non-vendor companies. This amounted to approximately $40 million during the first three quarters of 2001.
29. Homestore recorded about $36 million in advertising revenues during the first three quarters of 2001 ($15 million, $18 million and $3 million in the first, second and third quarters, respectively) from these round-trip transactions even though Defendants knew that these transactions were bogus and had no economic substance. Moreover, by recording these amounts as revenue in its financial statements included in the Forms 10-Q in 2001, Homestore violated GAAP.
30. In the second and third quarters of 2001, Homestore engaged in round-trip transactions using a second media company (the "Second MediaCompany"). These transactions similarly had no economic substance and were done solely to inflate revenues.
31. In the second quarter of 2001, Homestore paid $4.55 million to a vendor to acquire on-line marketing data. The vendor then transferred most of this money to the Second Media Company in exchange for advertising. Simultaneously, the Second Media Company, either for itself or its subsidiary, purchased $4 million of on-line advertising from Homestore. Homestore recorded this amount as revenue and reported it in its financial statements, in violation of GAAP.
32. Similarly, in the third quarter of 2001, Homestore entered into another round-trip deal with the Second Media Company. In September 2001, Homestore paid approximately $5.7 million to a different vendor. After circulating the funds to various conduit entities of the vendor, they were subsequently transferred to the Second Media Company. Thereafter, the Second Media Company and/or its subsidiary bought $5.65 million in advertising from Homestore. Again, Homestore recorded this transaction as advertising revenue and reported it in its financial statements, in violation of GAAP.
33. As with the transactions with the Media Company, the Defendants did not tell PwC of the relationship between Homestore's payment to these vendors and the revenue generated from the sale of advertising to the Second Media Company. Defendants, by their actions, recorded, or caused to be recorded, inflated revenues in the second and third quarters of 2001 of up to $9.6 million pertaining to the round-trip transactions with the Second Media Company.
34. Homestore, through Defendants' conduct, misrepresented its revenues in Commission filings, analysts' conference calls, and press releases.
35. Homestore included financial statements in its quarterly reports filed on Forms 10-Q with the Commission for the first three quarters of 2001. Thesefinancial statements included the revenue derived from the round-trip transactions. Homestore overstated its advertising revenue from the transactions with the Media Company and the Second Media Company by 64% and its total revenue by 15% for the first three quarters. The following chart shows the significance of the advertising revenue as part of Homestore's financial statements:
| The Media Company Revenue | The Second Media Company Revenue | Reported Advertising Revenue | % Bogus | % Over-stated | Reported Total Revenue | % Bogus | % Over-stated | |
|---|---|---|---|---|---|---|---|---|
| Q1 2001 10-Q | $15,000,000 | 0 | $40,119,000 | 37% | 60% | $105,491,000 | 14% | 16% |
| Q2 2001 10-Q | $18,445,000 | $4,000,000 | $50,615,000 | 44% | 80% | $129,283,000 | 17% | 21% |
| Q3 2001 10-Q | $3,315,000 | $5,650,000 | $28,574,000 | 31% | 46% | $116,135,000 | 8% | 8% |
| Total | $36,760,000 | $9,650,000 | $119,308,000 | 39% | 64% | $350,909,000 | 13% | 15% |
36. In quarterly conference calls with analysts, Defendants Giesecke and Shew informed the securities analysts about the financial condition of the Company and specifically gave them information regarding its advertising revenues. In these calls, Defendants Giesecke and Shew intentionally did not disclose the entire circular nature of the round-trip transactions.
37. During 2001, the Company issued press releases pertaining to the Company's current earnings and/or guidance with respect to future earnings on April 25th, July 25th, October 3rd and November 1st that contained inflated revenue amounts from the round-trip transactions. At that time, the Defendants knew, or were reckless in not knowing, that these press releases were false.
38. The Defendants were fully aware of the entire fraudulent scheme. They knew that the purpose of the round-trip transactions was to inflate Homestore's revenues, and they purposefully withheld this information fromHomestore's auditors. They also caused false filings to be made to the Commission and false press releases to be issued to the investing public.
39. Giesecke became aware of the fraudulent scheme in or about March 2001. He authorized the wire transfers for inflated and improper payments to the vendors in the round-trip transactions. As the COO, he reviewed the Company's press releases and portions of the Forms 10-Q filed with the Commission, and thereby permitted the dissemination of false and misleading financial statements to the public. Similarly, Giesecke provided only general information about the Media Company transactions to the securities analysts in the quarterly conference calls, even though he knew that the circular nature of these transactions was material information. He signed and provided to PwC management representation letters during 2001, falsely representing that the Company's financial statements were fairly presented in accordance with GAAP and had included all necessary disclosures. He also approved of the concealment of material information from PwC to facilitate and implement the fraudulent scheme. During the time of the misconduct, Giesecke exercised Homestore stock options at a profit of $3,284,075.
40. Shew was also aware of the round-trip transactions with the Media Company beginning in March 2001. To facilitate the scheme, Shew circumvented Homestore's internal controls by instructing Homestore employees to use as vendors only those entities that were privately held, thereby hoping to attract less scrutiny. Further, at Shew's direction, Homestore employees requested the vendors to use a separate entity, as a conduit, to purchase the advertising from the Media Company. Additionally, Shew prepared and signed the 2001 Forms 10-Q. At that time, he knew, or was reckless in not knowing, that the financial statements contained in the 2001 Forms 10-Q were materially misstated and that the revenues were inflated. He also signed and provided to PwC management representation letters during 2001, falsely representing that the Company's financial statements were fairly presented in accordance with GAAP and hadincluded all necessary disclosures. At that time, Shew knew, or was reckless in not knowing, that these representations were false. Shew affirmatively represented to PwC that there were no side agreements or revenue arrangements associated with the vendor transactions and withheld documents from PwC in an effort to continue perpetrating the fraud. During the time of the misconduct, Shew made profits of $1,004,825 from the exercise of Homestore stock options.
41. As the Company's Vice President of Transactions, DeSimone played a substantial role in overstating the Company's revenues in the first three quarters of 2001. Similar to Shew and Giesecke, DeSimone knew the entire structure of the round-trip transactions. He worked at the direction of Shew and assisted in implementing the scheme. Specifically, he worked closely with Homestore employees in structuring the deals so that Homestore could record the round-trip revenue while successfully hiding the circular nature of the overall transaction. At Shew's direction, he instructed Homestore employees to seek out vendors who could use a conduit to purchase advertising from the Media Company. He instructed a subordinate to "scrub" certain websites so as to conceal the relationship between the vendor and the conduit entity. DeSimone facilitated the backdating of certain documents in order to recognize revenue on certain barter transactions. Finally, DeSimone falsely represented to PwC that there were no revenue or side agreements related to the vendor purchases in the round-trip transactions. During the time of the misconduct, DeSimone's profits from the exercise of Homestore stock options amounted to $169,782.
42. The Commission realleges and incorporates by reference Paragraphs 1 through 41 above.
43. The Defendants, and each of them, by engaging in the conduct described above, directly or indirectly, in the offer or sale of securities, by the use of means or instruments of transportation or communication in interstate commerce or by use of the mails:
a. with scienter, employed devices, schemes or artifices to defraud;
b. obtained money or property by means of untrue statements of material fact or by omitting to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
c. engaged in transactions, practices or courses of business which operated or would operate as a fraud or deceit upon the purchaser.
44. By reason of the foregoing, the Defendants have violated, and unless restrained and enjoined will continue to violate, Section 17(a) of the Securities Act, 15 U.S.C. § 77q(a).
45. The Commission realleges and incorporates by reference Paragraphs 1 through 41 above.
46. The Defendants, and each of them, with scienter, by engaging in the conduct described above, directly or indirectly, in connection with the purchase or sale of securities, by the use of means or instrumentalities of interstate commerce, or of the mails:
a. employed devices, schemes or artifices to defraud;
b. made untrue statements of material fact or omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or
c. engaged in acts, practices or courses of business which operated or would operate as a fraud or deceit upon other persons.
47. By reason of the foregoing, the Defendants have violated, and unless restrained and enjoined will continue to violate, Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5.
48. The Commission realleges and incorporates by reference Paragraphs 1 through 41 above.
49. Homestore violated Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 by filing materially false and misleading quarterly reports on Forms 10-Q with the Commission during the first three quarters of 2001.
50. Defendants Giesecke, Shew and DeSimone knowingly provided substantial assistance to Homestore's violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
51. By engaging in the conduct described above and pursuant to Section 20(e) of the Exchange Act, Defendants Giesecke, Shew and DeSimone aided and abetted, and unless restrained and enjoined will continue to aid and abet,Homestore's violations of Section 13(a) of the Exchange Act, 15 U.S.C. § 78m(a), and Rules 12b-20 and 13a-13, 17 C.F.R. §§ 240.12b-20 and 240.13a-13.
52. The Commission realleges and incorporates by reference Paragraphs 1 through 41 above.
53. Homestore violated Section 13(b)(2)(A) of the Exchange Act by failing to make or keep books, records and accounts that in reasonable detail accurately and fairly reflected the transactions and disposition of the assets of the issuer.
54. Defendants Giesecke, Shew and DeSimone knowingly provided substantial assistance to Homestore's violation of Section 13(b)(2)(A).
55. By engaging in the conduct described above and pursuant to Section 20(e) of the Exchange Act, each of the Defendants aided and abetted, and unless restrained and enjoined will continue to aid and abet, Homestore's violations of Section 13(b)(2)(A) of the Exchange Act, 15 U.S.C. § 78m(b)(2)(A).
56. By engaging in the conduct described above, each of the Defendants, directly or indirectly, violated Exchange Act Rule 13b2-1 by falsifying and causing to be falsified Homestore's books, records, and accounts subject to Section 13(b)(2)(A) of the Exchange Act. Unless restrained and enjoined, Defendants Giesecke, Shew and DeSimone will continue to violate Rule 13b2-1, 17 C.F.R. § 240.13b2-1.
57. The Commission realleges and incorporates by reference Paragraphs 1 through 41 above.
58. By engaging in the conduct described above, Defendants Giesecke, Shew and DeSimone violated Section 13(b)(5) of the Exchange Act which prohibits any person from circumventing or failing to implement a system of internal accounting controls, or from knowingly falsifying any book, record or account described in Section 13(b)(2) of the Exchange Act.
59. By reason of the foregoing, the Defendants have violated, and unless restrained and enjoined will continue to violate, Section 13(b)(5) of the Exchange Act, 15 U.S.C. § 78m(b)(5).
60. The Commission realleges and incorporates by reference Paragraphs 1 through 41 above.
61. By engaging in the conduct described above, and in connection with an examination of the financial statements of Homestore and the preparation and filing of statements and reports with the Commission, Defendants Giesecke, Shew and DeSimone, directly or indirectly, made or caused to be made materially false or misleading statements to accountants and omitted to state, or caused another person to omit to state to accountants, material facts necessary in order to make statements made to the accountants, in light of the circumstances under which such statements were made, not misleading.
62. By reason of the foregoing, the Defendants have violated, and unless restrained and enjoined will continue to violate, Exchange Act Rule 13b2-2, 17 C.F.R. § 240.13b2-2.
WHEREFORE, the Commission respectfully requests that the Court:
Issue findings of fact and conclusions of law that Defendants Giesecke, Shew and DeSimone committed the violations alleged and charged herein.
Issue final judgments of permanent injunctions in a form consistent with Fed. R. Civ. P. 65(d), enjoining Defendants Giesecke, Shew and DeSimone from violating Section 17(a) of the Securities Act, and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-13, 13b2-1 and 13b2-2 thereunder.
Order Defendants Giesecke, Shew and DeSimone to disgorge any ill-gotten gains, including prejudgment interest.
Order Defendants Giesecke, Shew and DeSimone to pay civil penalties pursuant to Section 20(d) of the Securities Act, 15 U.S.C § 77t(d), and Section 21(d)(3) of the Exchange Act, 15 U.S.C. § 78u(d)(3).
Enter an order, pursuant to Section 21(d)(2) of the Exchange Act, 15 U.S.C. § 78u(d)(2), prohibiting Defendants Giesecke, Shew and DeSimone from acting as officers or directors of any issuer that has a class of securities registered pursuant to Section 12 of the Exchange Act, 15 U.S.C. § 781, or that is required to file reports pursuant to Section 15(d) of the Exchange Act, 15 U.S.C. § 78o(d).
Retain jurisdiction of this action in accordance with the principles of equity and the Federal Rules of Civil Procedure in order to implement and carry out the terms of all orders and decrees that may be entered, or to entertain any suitable application or motion for additional relief within the jurisdiction of this Court.
Grant such other and further relief as this Court may determine to be just and necessary.
DATED: September 24, 2002
Respectfully Submitted,
_____________________
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