The world's largest media firm, AOL Time Warner, has admitted the US financial watchdog is investigating its accounting practices.

News of the investigation overshadowed the fact that the firm has reported its first profit since completing its mega-merger.

Despite the strong results, fears over the inquiry sent AOL shares 7% lower in after-hours trade, despite the broad gains in the rest of the markets.

The investigation by the Securities and Exchange Commission (SEC)is in response to allegations in the Washington Post that the firm boosted online advertisement revenue through a series of "unconventional" deals between 2000 and 2002.

The SEC is cracking down on corporate fraud, and also on Wednesday announced an investigation into 12 investment banks over the conduct of their securities analysts.

No proof

The AOL investigation is still at the preliminary "fact-finding" stage.

That means there is no proof that AOL has been involved in the same sort of accounting deceptions that brought down Enron and WorldCom.

But such a fact-finding investigation was the first step that unravelled those firms.

AOL Time Warner has said in a statement that all its transaction have been in accordance with generally accepted accounting principles.

AOL user growth

The news of the inquiry came in a conference call regarding AOL Time Warner's financial results for April, May and June.

The firm reported profits of $394m, compared to a net loss of $734m the previous year.

Despite the improvements, sales growth at the AOL internet unit was much slower than had been expected.

The company has been struggling with a slowdown in advertising spending and subscriber growth.

Its share price has been hammered 65% so far this year, as investors have begun to doubt that its merger would pay-off.

During the first three months of the year, the firm was forced to make a record write-down of $54bn, effectively admitting that it had over-valued the assets it had bought.