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|  | JUNE 17, 2004
Goldman's 1% Solution for AOL In 2000, it cut a questionable deal that smoothed the AOL-Time Warner merger. Will the SEC take action? In more ways than one, the news from the European Union was bad. It was October, 2000, and the EU's executive arm, the European Commission, had just jolted America Online with a ruling that its pending acquisition of Time Warner (TWX ) could harm competition in Europe's media markets, especially the emerging online music business. The EC was concerned that AOL was a 50-50 partner with German media giant Bertelsmann in one of Europe's biggest Internet service providers, AOL Europe. Now the EC was ordering Bertelsmann to give up control over AOL Europe. With the AOL-Time Warner deal due to close in just three months, Bertelsmann needed to reduce its AOL Europe holding -- pronto. But the obvious buyer, AOL, didn't want to own more than 50% of the venture, either. Going above half might trigger a U.S. accounting rule that would force AOL to consolidate all the struggling unit's losses on its books when AOL was already grappling with deteriorating ad revenues and a declining stock price. Enter Goldman Sachs Group (GS ). BusinessWeek has learned that the premier Wall Street bank agreed to buy 1% of AOL Europe -- half a percent from each parent -- for $215 million. AOL Europe, in return, agreed to a "put" contract promising Goldman that it could sell back the 1% by a specific date and at a set price. That simple transaction solved Bertelsmann's EU problem without trapping AOL in an accounting conundrum -- a perfect solution. MORE LEGAL HEADACHES? Or so it seemed at the time. But the deal also may have violated U.S. securities laws. The Securities & Exchange Commission and the Justice Dept. have construed some deals involving promises to buy back assets at a specific time and price as share-parking arrangements designed to mislead investors. The former chief executive of AOL Europe says the Goldman deal may have kept up to $200 million in 2000 losses off of the combined AOL-Time Warner financials -- enough, he says, that Time Warner might have tried to change the terms of the $120 billion merger, since AOL wouldn't have looked as healthy. But as the deal moved toward consummation, the Goldman arrangement was never disclosed in public documents to AOL or Time Warner shareholders. The AOL Europe transaction threatens to create problems for Goldman Sachs. But it could also prolong the legal headaches of Time Warner, as the AOL-Time Warner combine is now called. For the past two years, Time Warner has been in heated negotiations with the SEC over AOL's accounting for advertising revenues. Just as the SEC is wrapping up that case -- it could warn Time Warner as early as this summer that it intends to bring civil fraud charges -- the Goldman transaction raises troubling new questions about AOL's financial dealings prior to the merger. The SEC has not brought charges over the 1% solution, and an SEC spokesman would not comment on whether the agency is probing the deal. Time Warner spokeswoman Tricia Primrose Wallace says the company will not comment on any part of the Goldman arrangement. A lawyer for Stephen M. Case, AOL's chairman and CEO at the time of the deal, referred questions to Time Warner. Thomas Middelhoff, who was Bertelsmann's chairman at the time of the deal and negotiated the AOL Europe joint venture with Case in 1995, says through a spokesman that the sale of a 0.5% stake was "purely a financial technique" handled by others. And Lucas van Praag, a Goldman Sachs spokesman, says: "We handled this entirely appropriately. We don't believe there is anything untoward here." "A BRIDGE LOAN." A lawsuit that the SEC brought in March, 2003, against Merrill Lynch & Co. raises a troublesome precedent for Time Warner and Goldman. That case grew out of Merrill Lynch's acquisition from Enron of an interest in generators mounted on barges floating off the coast of Nigeria late in 1999. Merrill paid $7 million into a special-purpose entity that let Enron book income on the deal and get the barges off its balance sheet. But in a side deal, Enron promised to buy the barges back from Merrill in six months -- at a 22.5% return -- according to SEC documents. The SEC called this a case of asset-parking designed to help Enron meet analysts' earnings expectations. "This was, at best, a bridge loan because the risks and rewards of ownership...did not pass to Merrill Lynch," the agency said. Without admitting or denying guilt, Merrill last September paid $80 million to settle charges that it aided and abetted Enron's financial-statement fraud. The penalties may not stop at fines. Four former Merrill officials, including the former head of investment banking, and two ex-Enron employees face the prospect of jail time if found guilty of criminal charges alleging that they arranged the barge transaction knowing that it violated securities laws. The six have pleaded not guilty. Could AOL and Goldman face similar civil and criminal charges? If the 1% of AOL Europe that Goldman acquired didn't really change hands, then the SEC could conclude that AOL, and later Time Warner, had clear control and should have consolidated the European unit on its financial statements in 2001. Time Warner did not merge AOL Europe's figures until 2002, when it bought Bertelsmann's remaining 49.5%.
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