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The Honolulu Advertiser

Posted on: Thursday, July 31, 2003

SEC probes AOL tally of subscribers

By David A. Vise
Washington Post

AOL Time Warner, whose New York headquarters is seen here, is the focus of several investigations, the latest of which involves allegations that the company inflated its subscriber count through questionable practices.

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WASHINGTON — The Securities and Exchange Commission is investigating whether America Online Inc. improperly inflated its subscriber count through questionable practices ranging from the inclusion of hundreds of thousands of nonpaying customers on its membership rolls to the use of deeply discounted "bulk sales," sources familiar with the probe said yesterday.

Inside America Online's Northern Virginia headquarters, employees were warned this week that the SEC wants them to retain, and not destroy, "hard copy and electronic documents, e-mail, and computer contents pertaining to bulk subscription arrangements, as well as any documents and other materials relating to the company's practices, policies and procedures for counting subscribers," according to an e-mail from AOL's legal department.

AOL Time Warner officials declined comment yesterday.

The expansion of the SEC probe comes as federal investigators continue to examine America Online's aggressive methods for reporting revenue, profit and advertising, before and after its merger with Time Warner Inc. in January 2001.

The SEC's increased scrutiny follows two recent events: AOL Time Warner's disclosure last week that America Online recently had purged more than 400,000 customers from its ranks who had been included in its subscriber numbers even though they were nonpaying, and a published report that the firm had used bulk sales to ramp up its subscriber count, sources said.

The nonpaying customers were counted even though they had been suspended for service violations such as spam or foul language, or because they failed to complete the process of signing up for AOL, sources said. They were not being billed for service.

Yesterday, Merrill Lynch analyst Jessica Reif Cohen said that shortcomings in America Online's subscriber figures were being addressed as AOL Time Warner officials applied more rigorous internal standards.

"As part of the broad restructuring of the AOL business segment ... the company has provided increasingly detailed disclosure, including its subscriber count," Cohen wrote to investors.

The fresh SEC request for information from AOL also stems from a story in the Wall Street Journal last week disclosing the Internet firm's use of bulk sales to jack up its subscriber count in 2000-2001.

During that period, AOL increased its subscriber rolls by selling hundreds of thousands of cut-rate subscriptions to Sears, Roebuck and Co., Target Corp. and J.C. Penney Co., which in turn sold them to their own employees, sources said.

AOL added about 800,000 subscribers to its rolls during that period through the aggressive bulk sales, which it made reference to in its annual SEC disclosure in 2001. The initiative was born out of the company's difficulty maintaining its base of about 25 million subscribers due to massive turnover each year.

The company's churn of more than 40 percent of subscribers annually means that AOL must replace more than 10 million of its 25 million customers just to stay even, Wall Street sources said.

The turnover is due in part to millions of people grabbing AOL disks, signing up for free service for 45 days, but failing to become paying customers.

At any given time, AOL counts millions of trial users as subscribers, even though they have not begun to pay. Yesterday, Merrill Lynch estimated that AOL has about 4 million trial subscribers included in its current membership count.