Time Warner’s agreement to pay $3 billion to settle investor claims comes as a surprise, not because of the fact of the deal, but due to its size and its timing.

The settlement is among the top five securities fraud class-action settlements ever and is the second-largest in history paid by an issuer of securities and its auditor, according to Samuel Heins of Heins Mills & Olson, the Minneapolis law firm representing the plaintiffs. The largest settlement of a shareholder suit by an issuer (as distinct from banks working for issuers) was Cendant Corporation’s $2.8 billion payout in 1999.

In addition to the $2.4 billion to settle the class-action suit, Time Warner said it would reserve another $600 million for still pending shareholder lawsuits. It has already agreed to just more than $500 million worth of settlements with the Justice Department and the Securities and Exchange Commission.

Time Warner agreed yesterday to pay the enormous sum despite the fact that it had a pending motion for summary judgment and investors’ lawyers had yet to conduct even a single deposition, said sources who are close to the lawyers and asked to remain anonymous as the settlement must still be approved by the court.

The lawsuit has been widely reported as stemming from the famously failed merger between the publishing and broadcast giant and the Internet firm, a relative upstart, which was announced in January 2000 at the very height of the Internet bubble. But the connection with the merger was tangential.

The investors’ main charge, as laid out in court filings, was that America Online, starting prior to the merger, inflated Internet advertising revenue through sham transactions, mostly where various firms traded ad space on Web sites, allowing each to book revenues as if cash had actually been exchanged.

Time Warner acknowledged in securities filings that up to $477 million in revenues over a two-year period might have to be restated. The plaintiffs said the number could be put at $1.7 billion, but this much larger figure was yet to be proved or conceded.

The plaintiff investors argued that inflating the ad revenues also juiced the AOL share price, which made it more valuable as a currency to buy Time Warner. But no one suggested that Internet advertising revenues, especially not four or five years ago,were anything but a small fraction of AOL’s revenue stream, the vast bulk of which was from subscriptions (as is still the case).

Compared to the overall revenues of the merged company ($42 billion in 2004), Internet advertising remains a pittance. For the second quarter, Time Warner’s revenues were $10.7 billion, down 1% from a year ago in part due to substantial subscriber defections at the America Online division.

Time Warner, which had been called AOL Time Warner for the first two-and-a-half years after the merger, announced the settlement on the same day as it announced second quarter earnings and a $5 billion share buyback. The company seems to have successfully obscured the importance of the settlement within the investment community.

In a conference call with analysts, the chairman and chief executive, Richard Parsons, was barely asked about the $2.4 billion payout. He did allow that the settlement marked “substantial progress in closing this chapter,” adding, “It’s an important step for our company.”

Consistent with dropping the AOL name, Time Warner, which owns an extensive stable of magazines, HBO, cable systems and channels, and movie studios, has been trying to move past the deal with AOL, which is one of the few divisions losing revenue. AOL’s subscriber base fell to 20.8 million, down from 23.4 million just two years ago, even as the average subscriber is paying less and more are signing on to discount plans, the company reported.

Its subscription revenue is down 9% compared to last year. Internet advertising, however, has finally hit its stride. Revenue from ads on AOL is up 45% since last year, though it still provides just 15% of AOL’s total sales.

Many of the executives who were involved in the questionable advertising deals from 1999 to 2001 have no doubt left the company, as did an AOL cofounder, Steve Case, who quit as board chairman in January 2003. Rather than have them return to their old stomping grounds, this time as witnesses in the lawsuit, Time Warner bought its peace.