HE good news for Amazon.com is that the Securities and Exchange Commission did not charge it with faking its own books in connection with its Amazon Commerce Network, an alliance of other Internet sites in which Amazon both invested and received advertising revenue. The bad news is that the S.E.C. concluded that Amazon did help one of those companies falsify its books.
The result yesterday was that Amazon.com accepted a cease-and-desist order from the S.E.C., ordering it not to help anyone else violate securities laws. As penalties go for violating securities laws, it was one of the lesser ones, but it was a violation nonetheless.
Two former top officers of the other company, Ashford.com, an Internet jewelry retailer, did not get off so easy. They settled S.E.C. fraud accusations in Federal District Court in Washington. Kenneth E. Kurtzman, Ashford's former chief executive, agreed to pay a penalty of $60,000, and Brian E. Bergeron, the former chief financial officer, agreed to pay $25,000.
The problem was not the basic nature of the arrangements by the two companies, which produced a lot of reported income for Amazon even though cash was going out Amazon's door, never to return. The problem was that after a promotional campaign was botched in early 2000, the two sides reached a settlement that called for Amazon to pay $600,000 to Ashford. Amazon received some noncash credits related to a promotional deal by the two companies.
After that settlement was reached, the S.E.C. said, Ashford realized that it would not produce the needed boost for its fiscal year that was about to end on March 31, 2000. So it persuaded Amazon to split the deal into two letters, one that made it look as if Ashford had given up little to obtain the cash, and the other showing the rest of the deal. Ashford then showed just the first letter to its auditors. The result was that Ashford was able to boast that it had exceeded the pro forma guidance it had given to analysts. In those days, pro forma numbers were all the rage. By keeping the costs in the second letter out of its financial reports, Ashford was able to report that it had beaten the Street forecasts by a penny a share, instead of coming in a penny worse.
Why did Amazon agree to prepare two letters documenting different parts of the deal? There is no obvious explanation other than to help Ashford look better than it should have looked when it released its financial results. Patty Smith, an Amazon spokeswoman, declined to answer the question. All she would say was: "We neither confirm nor deny any wrongdoing. We prepared the letters at the request of Ashford."
Under a deal with Ashford, Amazon had agreed to provide customer referrals. For Valentine's Day, it sent out coupons to Amazon customers, but they were not numbered and someone posted the details in an Internet chat room, enabling many non-Amazon customers to use the discounts. Ashford was upset, and the settlement was negotiated.
The S.E.C. says that Ashford went on to commit more violations in later quarters, though those were done without any help from Amazon. By late 2000, it was reclassifying marketing expenses into the depreciation and amortization category and then boasting about how low its costs were to attract customers. That made its pro forma numbers look much better than they were because they excluded depreciation and amortization charges.
None of this helped Ashford in the end. Its shares had climbed as high as $35 in late 1999, just before Amazon invested. Amazon was able to drive a much better deal, receiving a price of about $14.13 a share and paying for much of that stock, not in cash but in advertising allowances and an agreement in which it would not compete in certain areas with Ashford.
Amazon did put up $10 million in cash for the 7.4 million shares it received, but it also got $6 million of that back from Ashford, with Ashford paying for customer referrals that it hoped to obtain from Amazon. Amazon was able to recognize revenue from the advertising and the customer referrals and the noncompete clause, which helped its financial statements look better than they would have without the deal.
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And how did Amazon do in the end? On a cash basis, it was out just $4.6 million, the extra $600,000 coming from the settlement it negotiated in 2000, the one that ended up producing the S.E.C. charges. Looked at that way, Amazon paid just 62 cents a share in cash for its Ashford stake.
That sounds like a bargain, but it wasn't. Earlier this year, Ashford was merged into Global Sports, which was later renamed GSI Commerce. Ashford shareholders received 26 cents a share in cash and GSI stock. Amazon says it has since sold the GSI stock.
Speaking of pro forma earnings, all that noncash revenue from Ashford was included in Amazon's pro forma earnings. But when it wrote off a total of $233 million in bad investments in 2000 and 2001 — an undisclosed amount of that related to Ashford — those losses were not in the pro forma figure, though they were part of net losses the company reported.
