The retrial of Stuart Wolff, former Homestore.com founder, chairman and chief executive officer, has been postponed until next year as prosecutors investigate allegations by his defense team that evidence in the case was modified or destroyed by Homestore’s accounting firm.

Wolff’s lawyers say the government’s case against him turns on allegations that "Wolff and others

The retrial of Stuart Wolff, former Homestore.com founder, chairman and chief executive officer, has been postponed until next year as prosecutors investigate allegations by his defense team that evidence in the case was modified or destroyed by Homestore’s accounting firm.

Wolff’s lawyers say the government’s case against him turns on allegations that "Wolff and others engaged in a conspiracy to actively conceal financial records and information" from accounting firm PricewaterhouseCoopers.

But in an Oct. 23 motion, Wolff’s defense team claims a review of recently produced documents and electronic records in the case reveals "irrefutable proof" that internal work papers documenting auditing work PricewaterhouseCoopers performed for Homestore (now Move Inc.) were altered after the fact.

Other evidence in the case documenting communications between or within the two companies is missing or has been destroyed, Wolff’s attorneys said.

A PricewaterhouseCoopers spokesman who was provided with a copy of the motion said the company "believes that we complied with professional standards in connection with our services to Homestore."

In recent weeks, court documents show, the FBI has interviewed three current or former PricewaterhouseCoopers employees about the allegations, after the U.S. Department of Justice agreed to push back the start of the trial from Oct. 13, 2009, to Jan. 26, 2010, in order to investigate the allegations.

At Wolff’s original criminal trial, government prosecutors relied on the work papers to corroborate testimony by witnesses that Wolff and other Homestore executives concealed from the auditor the nature of circular "round-trip" advertising deals that later forced the company to restate millions in earnings.

Homestore — the Realtor.com operator that rebranded as Move Inc. — was accused of overpaying vendors for products and services. The vendors allegedly took surplus profits and purchased something from a third-party intermediary like America Online, which would buy advertising on Homestore’s Web sites.

Prosecutors said that Homestore was essentially buying its own revenue, and Wolff was accused of concealing the circular nature of the transactions from auditors and Homestore investors.

Wolff’s 2006 fraud conviction and 15-year prison sentence for his alleged involvement in the scheme was vacated last year, when an appeals court ruled that the judge presiding over the case should have disqualified himself because he owned stock in America Online (see story).

Wolff remains free on bail, having posted a $2 million bond secured by his home in Thousand Oaks, Calif. Under a June 2008 court order, he is no longer subject to electronic monitoring but is barred from traveling outside of the U.S., and must obtain prior court approval for most trips outside the state.

A total of 13 former Homestore employees have been convicted of violating securities law or settled charges with the U.S. Securities and Exchange Commission (SEC). Homestore and other defendants in civil suits have paid out $120 million to settle claims that they violated securities law by misleading investors about how the company generated revenue (see story).

When Homestore announced that it would miss its third-quarter revenue projections in the first week of October 2001, the company’s stock closed at $6.20 — down from peak of $122.25 at the height of the dot-com boom in January 2000. 

Homestore paid $13 million in cash and turned over 20 million shares of company stock to settle with investors, who claimed $853 million in losses.

PricewaterhouseCoopers paid $17.5 million to settle allegations by Homestore investors that it coached the company in some of the techniques it allegedly used to inflate revenue. …CONTINUED

Continuing saga

If Wolff does go to trial as currently scheduled in January, nearly five years will have passed since his April 2005 indictment.

After Wolff’s conviction was overturned in January 2008, the case was reassigned to Judge Valerie Baker Fairbank. But Fairbank quickly recused herself because her husband had represented a former Homestore executive who pled guilty and testified against Wolff at his original trial.

A February 2009 trial date was pushed back at the request of both Wolff and prosecutors. Plans to try the case in October have been pushed back as the Department of Justice investigates charges by Wolff’s defense team that PricewaterhouseCoopers altered work papers that document details of the work it performed in auditing Homestore’s quarterly and annual reports to the SEC.

At issue is whether PricewaterhouseCoopers auditors were aware of the circular nature of advertising deals that were allegedly used to inflate Homestore’s revenue. The government’s indictment alleges that approximately two dozen transactions entered into by Homestore during 2001 were accounted for incorrectly.

Wolff’s attorneys charge that internal work papers maintained by PricewaterhouseCoopers to document the company’s work were "altered after the fact to make it look as though Homestore executives provided false information and directly lied to (PricewaterhouseCoopers) during the course of its quarterly reviews of 2001."

Some of the alterations allegedly took place after Nov. 14, 2001, when Homestore’s audit committee launched an internal investigation into potential accounting improprieties, Wolff’s attorneys said.

In December 2001, Homestore issued a formal announcement that it would restate seven quarters of earnings. According to court filings in a civil suit filed the same month by Homestore investors, the company ultimately erased $192.6 million in revenues allegedly generated by the circular deals from its books.

PricewaterhouseCoopers was soon added as a defendant in the civil suit. In a Jan. 16, 2002, e-mail, one of the auditor’s own lawyers, Hilary Krane, advised managers to instruct employees not to alter any documents that might be connected to the case.

"Now that we have been named in a lawsuit, I wanted to emphasize that all documents (related to audits, reviews, investigations and other work for Homestore) must be preserved in their current form and not modified," Krane’s e-mail said.

The order covered "all versions of all documents in any form, hard copy or electronic, including work papers, e-mails and desk files. I wanted to make sure to put everyone on notice to use special care to preserve the documents as they exist now."

PricewaterhouseCoopers, Wolff’s attorneys say, was required by law to maintain a set of work papers "that specifically documented what they knew and what work they did when they reviewed and signed off on the revenue numbers at the heart of this case."

According to Wolff’s defense team, the firm’s employees "have long denied making any substantive changes to its work papers … particularly after the commencement of an internal investigation that commenced on November 14, 2001."

At Wolff’s original trial, Wolff’s attorneys said, PricewaterhouseCoopers lead audit partner Richard Withey denied that work papers were materially modified after the launch of Homestore’s internal audit.

New evidence

But Wolff’s defense team now claims that its review of millions of pages of newly obtained documents and electronic records reveals "a pattern of work paper modifications" by the auditor’s employees that "go to the heart of the case: what (PricewaterhouseCoopers) knew about costs being associated with revenue in various transactions and when it knew." …CONTINUED

Subpoenas of PricewaterhouseCoopers and Homestore issued after Wolff’s first trial have turned up the equivalent of 50 million pages of documents, his defense team said, including e-mail back-up server tapes from Homestore (now Move Inc.) and the computer hard drives of key witnesses thought to have been lost.

The new evidence also included five CDs of electronically stored work papers from PricewaterhouseCoopers, plus paper databases and three CDs with different versions of the auditor’s work papers that had been turned over to the SEC but never seen by Wolff’s defense team.

Not only did Wolff go into his first trial without a number of key records, his lawyers alleged, but a review of the newly obtained documents in the case shows some of the evidence used against him was altered by PricewaterhouseCoopers.

Work papers documenting PricewaterhouseCoopers’ work in reviewing Homestore’s financial statements for the second and third quarters of 2001, for example, were allegedly altered in a "totally self-serving manner" after the accounting firm became involved in Homestore’s internal investigation, Wolff’s lawyers charge.

Wolff’s lawyers allege that PricewaterhouseCoopers employees altered original versions of work papers to include details about revenue associated with six transactions between Homestore and outside vendors.

The lawyers allege that the phrase "management represented that the price paid" for each product "was fair market value and that the agreement was limited to a cash outlay for asset (i.e., no revenue associated with this agreement)" was added — the original language did not state that there was no revenue associated with those agreements.

Wolff’s lawyers say another work paper showed PricewaterhouseCoopers had received a management representation letter from Homestore for its third-quarter 2001 financial statement. But the reason the government dropped one count from its original indictment against Wolff was that it realized the accounting firm did not have a representation letter signed by Wolff for that statement, his defense team claims.

(A management representation letter is typically drafted by an auditor and given to a client’s senior management to sign, confirming that they have provided the auditor with all relevant information and that all necessary transactions are reflected in a financial statement).

In another alleged instance of PricewaterhouseCoopers’ willingness to "revise, modify and even falsify" its historical records, Wolff’s attorneys cite a May 2001 e-mail exchange in which the accounting firm allegedly attempted to obtain a management representation letter from Homestore associated with another financial report that had been filed more than a year previously.

Because Homestore had relocated its corporate headquarters in the meantime, PricewaterhouseCoopers requested that Homestore provide it with a backdated letter signed by Wolff with the company’s old address.

"I’m sure I’m pushing my luck on this one, but if you have letterhead with the Thousand Oaks address, it would be great if you could print it on that letterhead instead of the new building’s address," a Pricewaterhouse Coopers employee said in an e-mail to Jason Boling, Homestore’s manager of U.S. Securities and Exchange Commission reporting.

Boling replied that he had discussed the request with Homestore’s controller, Evelyn Yalung, "and she feels this looks really bad to be giving a letter to Stuart that is over one year old for his signature. Call me when you get this."

The exchange is one of a number of Homestore-related e-mails that Wolff’s defense team complain PricewaterhouseCoopers did not turn over to them. Wolff’s lawyers said they were only able to obtain them from other parties to those communications.

It may be impossible to discover the extent of the accounting firm’s revisions to work papers documenting its work for Homestore because many records are missing or have been destroyed, Wolff’s attorneys said.

Wolff’s defense team says it’s been unable to obtain a complete set of PricewaterhouseCoopers e-mails from 2000 and 2001, or facsimile correspondence between the firm and Homestore regarding the quarterly review and audit work for years 2000 and 2001. …CONTINUED

A database created by a PricewaterhouseCoopers employee to track information the firm requested and received from Homestore in 2001 is also allegedly missing.

On July 22, Wolff’s defense team sent a 35-page memorandum to the government outlining its allegations that PricewaterhouseCoopers employees had modified or destroyed evidence in the case.

On Sept. 2, U.S. District Judge Gary Feess signed an order continuing Wolff’s trial date to Jan. 26. The order — drafted by Wolff’s defense team — said a continuance was needed "to allow the government to meaningfully investigate the newly discovered evidence put forward by the defense," and for the defense to complete its review of the "voluminous" additional documents obtained.

The order also leaves open the possibility that Wolff will attempt to negotiate a plea agreement with prosecutors.

A continuance, the order said, would "permit the parties to prepare appropriate pre-trial motions predicated on the new evidence, if resolution of the issue and/or case is not otherwise achieved."

FBI interviews

Neither the lead attorney for Wolff’s defense team or the U.S. Attorney’s Office for the Central District of California, which is prosecuting the government’s case, would comment on the latest developments in the case.

But court documents show the FBI has interviewed Withey and two other PricewaterhouseCoopers employees in recent weeks. Reports of those interviews and an e-mail by a prosecutor in the case suggest the government does not see the latest twist in the case as an obstacle to prosecuting Wolff.

Robert Page, a PricewaterhouseCoopers employee who allegedly modified documents and managed e-mails that the accounting firm directed its employees to save, was interviewed by FBI Special Agent Marie H. Kondzielski on Sept. 17.

According to Kondzielski’s report, Page said "it was normal for the audit team to add information to the quarterly work papers after the quarterly report was filed."

About 80 percent of the documentation was compiled by the audit team during the quarter, Page told Kondzielski, and more complex information continued to be documented for a year-end audit.

"This was the procedure in 2001 with regard not only to work done on Homestore, but for other (PricewaterhouseCoopers) clients," Page told Kondzielski.

As for the missing e-mails, Page said that PricewaterhouseCoopers did not keep all e-mails it generated or received in 2001.

"Page asked Homestore audit team members to retrieve their e-mails in connection with the Homestore investigation, but it was not the practice (at the firm) to retain all e-mails," Kondzielski reported.

In an interview with Kondzielski the same day, PricewaterhouseCoopers lead audit partner Withey said that in testifying at Wolff’s first trial, he "got confused about the time line" when he said no work papers had been modified after Homestore’s audit committee launched its internal investigation.

"Withey’s recollection about freezing work papers pertained to instructions he received from (PricewaterhouseCoopers) attorneys in January 2002," Kondzielski said in another report documenting her interview of Withey. …CONTINUED

Withey also said it was not unusual for PricewaterhouseCoopers to get a management representation letter after the majority of the work was done on a quarterly review.

"If a company executive was traveling, sometimes the executive gave (PricewaterhouseCoopers) a verbal acknowledgement that the representative letter would be signed upon the executive’s return," Kondzielski reported. "Sometimes PWC received a management representation letter via fax. Withey does not recall … having trouble getting a representation letter from Homestore until the third quarter of 2001."

In an Oct. 20 interview with the FBI, Mary Shelton Rose — one of PricewaterhouseCooper’s lead auditors on the Homestore account — allegedly called modifications made to work papers in November and December 2001 "typical practice in connection with the then-upcoming annual audit."

According to a summary of the interview provided to Wolff’s lead defense attorney by Assistant U.S. Attorney Michael Wilner, Rose told Kondzielski that "she did not become aware of the round-trip nature of the improper Homestore deals until after New Year’s 2002. She was not involved in the company’s investigation into misconduct at Homestore during November/December 2001."

Page had told Kondzielski that he recalled being at the Homestore offices "late one night while the second-quarter 2001 review was under way. He recalled (Rose) obtaining explanations about why Homestore bought certain items during that period."

Evidentiary hearing

Having already obtained a continuation in September of his trial date to Jan. 26, Wolff’s defense team now says the FBI’s interviews of PricewaterhouseCoopers employees demonstrates the need for an evidentiary hearing in the case to permit the defense "to challenge the government’s and PricewaterhouseCooper’s denials of wrongdoing and determine the entire extent to which the evidentiary record in this case has been affected."

In its Oct. 23 motion for an evidentiary hearing, Wolff’s defense team said the new interviews demonstrate that the government and PricewaterhouseCoopers have abruptly changed course.

Instead of denying that evidence was modified, they "now take the position that (the) modifications were not improper because they occurred at a time when PricewaterhouseCoopers had virtually no knowledge of the facts and allegations being explored in the internal investigation and was being frozen out of that investigation by Homestore’s outside attorneys," Wolff’s lawyers allege.

"In a nutshell, PricewaterhouseCoopers and the Government contend that even if the defense is correct and (PricewaterhouseCoopers) had wanted to modify its work papers to protect itself and point the finger elsewhere, it would not have known what to change."

Wolff’s lawyers state that an evidentiary hearing would allow them — with the court’s assistance — to "compel an explanation" of what the work papers originally documented, and why support materials and documentation related to the work papers allegedly "mysteriously" vanished, when litigation "has been continuously under way since January 2002 and (PricewaterhouseCoopers’) document retention guidelines demanded" that they be preserved.

"In short, the evidentiary record has been heavily tampered with and the current playing field is so uneven it is unplayable," Wolff’s lawyers charge in their motion. "Without an evidentiary hearing narrowly tailored to provide answers to these questions, the defense cannot properly analyze either the need for or the propriety of additional pre-trial motions, nor can it adequately prepare for trial."

A spokesman for the U.S. Attorney’s Office for the Central District of California, Thom Mrozek, said the government is reviewing the motion and that a written response will be filed in court in about two weeks.

"At this moment, while we’re still considering the legal issues, I’m not prepared to provide any comment," Mrozek said in an e-mail.

***

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