Risk Management

Homestore Founder Wolff Gets 15 Years

The former CEO is one of 11 Homestore employees convicted in a case that raised questions about the liability of companies whose financial transact...
Stephen Taub and Rob GarverOctober 13, 2006

Stuart Wolff, the founder and former chief executive of Homestore Inc., was sentenced Thursday to 15 years in prison and ordered to pay $8.64 million in restitution and a $5 million fine for his role in a scheme to defraud investors.

As CFO.com reported this summer, Homestore’s fraud became the subject of Simpson v. AOL Time Warner, one of the most significant legal cases to come out of the many financial scandals that marked the start of the decade.

At issue in the case was whether shareholders of a company that commits financial fraud can sue other companies if their financial transactions aided and abetted the fraud. In the Simpson case, the plaintiffs were shareholders in the company that in 1996 launched Homestore.com, a real-estate Website now called Move.com.

Homestore took part in a number of “triangular” transactions that created phony revenue, purchasing products it didn’t need from other firms with the understanding that those firms would use the proceeds from the sale to buy advertising space on Homestore’s Website through America Online. That allowed Homestore to report higher earnings than most Web-based businesses and made it, however briefly, a favorite of Internet investors. When news broke in 2001 that the company was under investigation for fraud and its stock price cratered, shareholders lost more than $100 million in market value.

Homestore itself settled with one of the primary plaintiffs in the case, the California State Teachers Retirement System, for $71 million. But the victims of the fraud continued their attempts to recover damages from AOL, Cendant Corp., and L90, all three of which engaged in the transactions in question. Earlier this summer, the 9th Circuit Appeals Court ruled that these so-called secondary actors cannot be held liable. Drawing on a test proposed by the Securities and Exchange Commission, the court held that “to be liable as a primary violator of 10(b) for participation in a ‘scheme to defraud,’ the defendant must have engaged in conduct that had the principal purpose and effect of creating a false appearance of fact in furtherance of a scheme.”

Wolff — the 11th former Homestore employee convicted on federal charges stemming from the scheme — was convicted in June of conspiracy, five counts of insider trading, three counts of filing false reports with the SEC, five counts of falsifying corporate records, and four counts of lying to company auditors. (Homestore, by contrast, is one of only a handful of companies whose cooperation with the SEC allowed it to escape without punishment from the securities regulator, as CFO magazine reported last year.)

The evidence presented during the trial showed that Wolff knew the transactions fraudulently generated a circular flow of money in which Homestore recognized its own cash as revenue and that he participated in concealing the scheme from the company’s auditors, the Department of Justice pointed out. “Wolff misled investors and analysts about Homestore’s true financial condition and used the September 11, 2001, terrorist attacks as a pretense for Homestore’s financial decline,” it added.

“The lengthy sentence handed out to Mr. Wolff should serve as a warning to other business leaders who may be tempted to cook their books in order to please market analysts,” U.S. Attorney Debra Wong Yang reportedly said in a statement.