U.S. Securities and Exchange Commission
Litigation Release No. 17745 / September 25, 2002
Accounting and Auditing Enforcement Release No. 1636
SEC v. John Giesecke, Jr., Joseph J. Shew and John Desimone (U.S. District Court for the Central District of California, Civil Action No.CV 02-7471S VW (RZX)
SEC Files Financial Fraud Case Charging Three Former Homestore Executives; Defendants Agree to Repay $4.6 Million in Illegal Trading Profits
Defendants to Plead Guilty in Related Criminal Actions Brought by U.S. Attorney's Office for the Central District of California
The Securities and Exchange Commission today filed charges against three former senior executives of Homestore Inc. (formerly Homestore.com Inc.), based in Westlake Village, Calif., for perpetrating an extensive scheme to fraudulently inflate Homestore's on-line advertising revenues in 2001. The complaint, filed today in U.S. District Court in Los Angeles, charges that John Giesecke Jr., Homestore's former chief operating officer; Joseph J. Shew, its former chief financial officer; and John DeSimone, its former vice president of transactions, caused Homestore to overstate its advertising revenues by $46 million (64%) for the first three quarters of 2001. This action was brought in coordination with the U.S. Attorney's Office for the Central District of California, which simultaneously announced related criminal charges against the three defendants. Giesecke, Shew, and DeSimone have each agreed to settle the Commission's lawsuit, to plead guilty to the criminal charges, and to cooperate with the government in its continuing investigation. At the time of the violations, Homestore was one of the top Internet portals for real estate and related services.
The Commission's complaint charges Giesecke, Shew, and DeSimone with arranging fraudulent "round-trip" transactions for the sole purpose of artificially inflating Homestore's revenues in order to exceed Wall Street analysts' expectations. The defendants circumvented applicable accounting principles and lied to Homestore's independent auditors about these transactions. While the fraud was ongoing, the defendants exercised stock options at prices ranging between approximately $21 and $32 per share, reaping profits ranging from approximately $169,000 to approximately $3.2 million.
The Commission's complaint alleges as follows:
Bogus Barter Transactions. Throughout 2000 and 2001, Homestore's sale of on-line advertisements was one of its primary revenue sources. Homestore engaged in a series of complex round-trip barter transactions to inflate revenues and meet Wall Street estimates. 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; in turn, the vendors used these funds to buy advertising from two media companies. The media companies then bought advertising from Homestore either on their own behalf or as agents for other advertisers. Homestore recorded the funds it received from the media companies as revenue in its financial statements, in violation of applicable accounting principles.
As a result of a significant revenue shortfall in the first quarter of 2001, the company devised a plan to use a major media company as an intermediary in some round-trip transactions. The overall scheme required Homestore to "refer" vendors to the media company, and the vendors to purchase on-line advertisements from that company. In return, the major media company purchased on-line advertising from Homestore for which the media company acted as a media buyer.
Using this structure, Homestore paid a total of $49.8 million to various vendors in the first two quarters of 2001. These vendors then paid $45.1 million to a major media company to purchase on-line advertisements. Homestore, in turn, recorded $36.7 million in revenue from the major media company's related purchase of Homestore on-line advertisements. In short, Homestore recycled its own money to generate revenues. Homestore used this same general plan with another media company in the second and third quarters of 2001 to fraudulently recognize an additional $9.7 million in revenue.
Charges Against the Defendants. In connection with these round-trip transactions, the Commission's complaint charges Giesecke, Shew, and DeSimone with securities fraud, lying to the auditors, falsifying Homestore's books and records, and aiding and abetting Homestore's reporting and record-keeping violations. The complaint alleges that Giesecke, Shew and DeSimone knew that the round-trip transactions had no economic substance and that Homestore paid cash to numerous intermediaries for the primary purpose of selling advertising and recognizing revenue from these or related transactions. Nevertheless, Giesecke, Shew and DeSimone carried out the fraudulent plan and recorded, or caused the company to record, revenue on these bogus deals. All three defendants lied to the company's independent auditors about the round-trip transactions and withheld business records from the auditors during their 2001 quarterly reviews. Shew and Giesecke also misrepresented Homestore's revenues to securities analysts covering the company, while Giesecke approved press releases containing inflated revenue numbers.
The individuals charged and the terms of their settlements are:
The returned ill-gotten gains of approximately $4.6 million will be paid to the benefit of Homestore shareholders. In addition, the Commission is seeking the permission of the court to have Giesecke's civil monetary penalty of $360,000 paid to the benefit of shareholders under the Fair Funds provision of the recently enacted Sarbanes-Oxley Act of 2002.
In related proceedings filed today by the U.S. Attorney's Office in Los Angeles, Giesecke has agreed to plead guilty to one count of conspiracy and one count of wire fraud, Shew has agreed to plead guilty to one count of conspiracy, and DeSimone has agreed to plead guilty to one count of securities fraud. Giesecke and DeSimone each face a maximum possible penalty of 10 years in prison, while Shew faces up to 5 years in prison. Their pleas are based on fraudulent conduct similar to that described in the Commission's complaint. As part of their plea agreements, all three defendants have agreed to cooperate with the Commission and the criminal authorities.
The Commission also announced today that it would not bring any enforcement action against Homestore because of its swift, extensive and extraordinary cooperation in the Commission's investigation. This cooperation included reporting its discovery of possible misconduct to the Commission immediately upon the audit committee's learning of it, conducting a thorough and independent internal investigation, sharing the results of that investigation with the government (including not asserting any applicable privileges and protections with respect to written materials furnished to the Commission staff), terminating responsible wrongdoers, and implementing remedial actions designed to prevent the recurrence of fraudulent conduct. These actions, among others, significantly facilitated the Commission's expeditious investigation of this matter.
This case is the product of an investigation by the Commission, the Federal Bureau of Investigation, and the U.S. Attorney's Office for the Central District of California.