A lawyer for the U.S. Securities and Exchange Commission, in a rare move, has filed a legal brief charging that a district court mishandled a shareholder case involving Homestore and several business partners, including Cendant Corp., AOL Time Warner and L90.

Giovanni P. Prezioso, general counsel for the SEC, stated in a court brief filed Thursday that “the district court made several legal errors in its resolution of the claims against the business partner defendants” in the Homestore case, and that the court’s decision “would undermine the purpose of the antifraud provisions” of the law.

Homestore is affiliated with the National Association of Realtors and operates several real estate related sites including Realtor.com, a popular home-search Web site. The brief was filed last week in the U.S. Court of Appeals for the Ninth Circuit in California.

The California State Teachers’ Retirement System, which lost $9 million when Homestore’s stock price dropped, filed a civil lawsuit in 2002 that named several companies that conducted business with Homestore, claiming that the companies engaged in bogus transactions with Homestore that inflated Homestore’s stock price and led to faulty financial numbers. Richard Smith, chairman and CEO of Cendant’s Real Estate Franchise and Operations Division, was named individually in the shareholder lawsuit, along with two AOL executives.

The federal court in 2003 dismissed the claims against business partners Cendant, AOL and L90.

Homestore was forced to restate its revenues for 2000 and 2001 by about $190 million, the court brief states. “The restatement was necessary because Homestore had inflated its revenues through a series of transactions whose purpose and effect was to create the false appearance of legitimate revenues, thus enabling Homestore to meet or exceed targets set by Wall Street analysts and maintain the high price of the company’s stock,” according to the SEC statement to the court.

Homestore in 2003 agreed to pay approximately $64 million in cash and stock to settle the lawsuit headed by CalSTRS. The class-action settlement covered only Homestore and certain officers and directors.

While the SEC was not involved with the lawsuit, Prezioso argued in the brief that the court’s resolution of the case “could have a bearing on the commission’s authority to proceed against violators of the antifraud provisions of the Securities Act.” The action by the SEC is reportedly not unprecedented, though it is rare.

There have been several recent court cases that have raised similar questions as to whether business partners’ alleged fraudulent conduct could make them primary violators of securities law, according to the brief. “This situation has arisen in several recent cases involving schemes to inflate the revenues of internet companies, as well as other types of schemes to misrepresent the financial condition of publicly traded companies,” the brief states.

The court determined that Homestore officers were the “primary architects of the scheme,” and others “who actively participated in the scheme, did not ’employ’ the scheme to defraud investors, and are therefore secondary violators,” according to the brief, though SEC lawyers argue that there should be liability against any person who engages in a deceptive act to defraud another, “regardless of who designed the scheme.” And under the district court’s earlier rule, “all of the other schemers could be insulated from liability as a matter of law.”

Last month, three former Homestore executives pleaded guilty and settled charges that they engaged in a fraudulent scheme to inflate the company’s advertising revenue.

Clayton Chang, 39, former vice president of Homestore’s strategic alliances group, and Geoffrey Infeld, 36, a former salesperson with Homestore, agreed to plead guilty to criminal charges and settle with the SEC. Infeld also owned or controlled several private Internet companies that he used to assist Homestore in the fraud.

Gregory Antoniono, 42, who was the contracts manager at Homestore during 2001 and later served as Homestore’s director of contracts, also agreed to settle the SEC charges though he was not criminally charged.

The SEC has sued a total of 14 individuals for their roles in the fraudulent transaction scheme in 2001, and nine of those individuals have been criminally charged by the U.S. Attorney in Los Angeles.

Homestore’s former COO John Giesecke, former CFO Joseph Shew, former VP of Transactions John DeSimone and former finance department manager Jeffrey Kalina have also pleaded guilty to criminal charges brought by the Department of Justice and settled SEC actions.

And in September 2003, the SEC filed a civil complaint that charged Thomas Vo, 29, of Westwood, Calif., who was a manager in Homestore’s strategic alliances group from January 2001 until January 2002, Sailesh Patel, 36, of Los Angeles, Calif., who was director of business development at Homestore from August 2000 until October 2001, and Jessica McLellan, 29, of San Francisco, who was a manager in Homestore’s strategic alliances group from January 2001 through April 2002.

Vo, Patel and McLellan had agreed to settle the SEC’s lawsuit, to plead guilty to the criminal charges and to cooperate with the government in its ongoing investigations.

***

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