Monday, April 28, 2008

Overstock.com: Anatomy of a Stock Market Manipulation Scheme (Part 2)

Pump and dump: $1.0 million of motive and securities law violations, too

If you listened in on Overstock.com’s (NASDAQ: OSTK) first quarter fiscal year 2008 earnings call chances are that you would come away misled into believing that the Securities and Exchange Commission has issued the company a clean bill of health in its investigation of the company's accounting policies and financial disclosures. In the process of claiming that the Securities and Exchange Commission had “sprinkled holy water” and "approved" Overstock.com’s accounting practices and financial disclosures, the company and three of its corporate officers apparently violated both Section 23 of the Securities Act of 1933 and Section 26 of the Securities Exchange Act of 1934 governing unlawful representations. Worst yet, in the two days following Overstock.com’s earnings call, Senior Vice President of Corporate Affairs and Legal, Jonathan E. Johnson III unloaded 55,922 shares of Overstock.com common shares and pocketed gross proceeds totaling about $957,000.

This blog has detailed a continuous pattern of false and misleading disclosures by Overstock.com and outright lies by CEO Patrick Byrne starting as far back as 2000, when Byrne had claimed that Overstock.com was profitable when it was not and used non-GAAP revenue measures interchangeably with GAAP revenue measures without telling anyone to hype Overstock.com’s financial performance. Since then, Overstock.com and its unprincipled management team has engaged in a continuous pattern of false and misleading disclosures in a deliberate effort to hype the company's financial performance and prospects.

You have to wonder, how many lies can Patrick Byrne and his management team make up? Every time I try to find the answer to a simple question, I find even more inconsistencies and newer lies.

Background Chronology

Before, we continue further, let’s review some background relating to recent events at Overstock.com.

On Friday, April 19, 2008, Overstock.com issued a blatantly false and materially misleading surprise first quarter fiscal year 2008 earnings report hyping the company’s performance that was intentionally timed with the expiration of options to manipulate the market (i.e., as a "short squeeze"). In the hours that followed, Overstock.com’s stock price rose from $14 per share to close at $18.47 or a 32% increase in the price of its common shares.

On Monday, April 21, 2008, I posted a blog item detailing how Overstock.com’s earnings release failed to disclose that the company compared Q1 2008 revenues that were reported on a GAAP basis with Q1 2007 revenues that were reported on a non-GAAP basis.

In the Q1 2008 earnings release, Patrick Byrne claimed that:

We returned to above industry-level revenue growth this quarter, capping off our turnaround plan that started with growth in contribution and gross profits over a year ago.

Note: Bold print and italics added by me.

However, in my blog item, referred to above, I detailed several material factors undisclosed in Overstock.com’s earnings release that reduces Byrne’s much hyped return to “industry-level revenue growth” to simple fiction (no surprise). Since Overstock.com did not restate Q1 2007 revenues to conform to GAAP, in violation of Statement of Financial Accounting Standards No. 154, I examined the company’s non-GAAP sales volume disclosures to determine on an “apples to apples” basis if the company had really returned to “industry level growth.”

For example, while Overstock.com compared Q1 2008 GAAP reported revenues to Q1 2007 non-GAAP reported revenues, the company did not disclose that Q1 2007 sales volume had declined about 16.2% in comparison with Q1 2006, creating an inordinately low sales volume base for the company's hyped up resumption of “industry level growth” in revenues. Q1 2008 sales volume when compared to Q1 2006 sales volume grew slightly more than 2% on an annualized basis. In addition, Q1 2008 benefited from the early occurrence of Easter holiday sales and an extra shopping day due to the leap year, a benefit not present in the two previous comparable fiscal year quarters.

So why didn’t the company disclose these factors? One possibility is the desire to cause a short squeeze. Patrick Byrne proudly once proclaimed in a December 2003 interview that, “when opportunities come along where we can knee the shorts in the groin, that's always good for fun and amusement." With Overstock.com’s materially false and misleading Q1 2008 earnings release, issued without a previous announcement, and timed with the expiration of options, the double talking Patrick Byrne appears to have kneed the "shorts in the groin" one more time.

Jonathan Johnson lies to Wired.com

A day later, on Tuesday April 22, 2008, Senior Vice President Corporate Affairs & Legal Jonathan E. Johnson III lied to Betsy Schiffman from Wired.com in a frantic attempt at damage control. Specifically, Mr. Johnson falsely claimed that both Q1 2008 and Q1 2007 revenues were reported on a GAAP basis:

"Sam is just wrong," says Jonathan Johnson, senior vice president of legal at Overstock. "They're both GAAP numbers . . . I can't read his blog because it's so full of lies."

Note: Bold print and italics added by me.

In a new follow up blog post, responding to Jonathan Johnson’s outright lie, I provided details from Overstock.com’s financial disclosures to the Securities and Exchange Commission that flat out contradicted Johnson’s claim that Q1 2007 revenues were reported in accordance with GAAP. Jonathan Johnson was caught red handed, lying. That same day, Overstock.com held an earnings conference call and the lies continued.

Q1 2008 earnings call: a three man orgy of lies

During the Q1 2008 earnings call, Patrick Byrne falsely claimed that the Securities and Exchange Commission has “sprinkled holy water” on Overstock.com’s accounting practices and financial disclosures. To make matters worse, CFO David Chidester and Mr. Johnson joined in to make it a three man orgy of lies.

Here are some quotes:

Patrick Byrne:

So they [the Securities and Exchange Commission] reviewed the whole bunch of things. For example, they reviewed our treatment of the way we handle partner revenue recognizing as gross versus net and unsurprisingly they agreed with it.…. They reviewed a number of issues and signed off on a number of issues.

David Chidester responds:

...you basically summed it up correctly, and all the issues that they had have been resolved, and I think we are fine and we'll move forward from here.

Patrick Byrne responds to David Chidester:

So it is fair to say that all these other issues that the knuckleheads keep on raising as issues, the SEC examiners, looked at and sprinkled holy water on?

Again, David Chidester chimes in:

Yeah, I mean they took a deep dive they do that every three years or so. And again they are very good to work with. It is not adversarial at all and we’ve got all the issues resolved and it’s nice to know that we could move forward.

Later, Jonathan E. Johnson III joins in:

I just think it’s important, particularly given our litigation. But the SEC has now approved our accounting of how we treat partner revenues. That was an important piece for us.

Note: Bold print and italics added by me. Bracketed information added by me for clarity.

After listening to double-talk above from the earnings call, chances are that you would have probably been misled into believing that all of Overstock.com’s accounting and disclosure issues have been resolved with the Securities and Exchange Commission. It’s simply not true. First off, the SEC investigation of Overstock.com continues and Patrick Byrne is the admitted target of their probe.

SEC Enforcement Division Still Investigating Overstock.com

Patrick Byrne, David Chidester, and Jonathan Johnson—really outdid themselves this time. The truth of the matter is that Overstock was under scrutiny by two separate divisions of the SEC. The first division, the Division of Corporate Finance, conducts periodic, routine examinations of a company’s disclosures. It was the Division of Corporate Finance that actually concluded a standard review of Overstock’s disclosures. But its review does not conclude whether or not the company has further violated any accounting rules or securities laws. The second division, the Enforcement Division, is investigating Overstock.com’s questionable accounting practices and financial disclosures for violations of securities laws.

Worse yet, the SEC Division of Corporate Finance requires all filers reviewed by them to sign what is known as a “Tandy” letter.” According to the SEC, the Tandy letter “requires companies to represent in writing that they will not use the SEC's comment process as a defense in any securities related litigation against them.” See below:

The staff may ask companies to represent in writing that they will not use the SEC's comment process as a defense in any securities related litigation against them. This request is known as a "Tandy" letter. Since we will be making all comment letters and responses publicly available, either in response to a FOIA request or pursuant to this announcement, we will ask all companies whose filings are reviewed for such representation. This request and representation should not be construed as confirming that there is or is not, in fact, an inquiry or investigation or other matter involving the filer.

Note: Bold print and italics added by me.

Therefore, contrary to the claims of Byrne, Chidester, and Johnson above, the examination by the Division of Corporate Finance does not have any bearing on whether there is an inquiry or investigation by the commission’s Enforcement Division. Moreover, the results of the Division of Corporate Finance’s examination cannot be used as a defense in any future litigation that may arise from the SEC Enforcement Division’s continuing investigation of Overstock.com nor in its litigation with Gradient Analytics and Copper River Partners (formerly Rocker Partners).

The false and misleading comments by Byrne, Chidester, and Johnson during the Q1 2008 earnings call about the Securities and Exchange Commission's claimed "approval" of Overstock.com's accounting practices and financial disclosures clearly violate both Section 23 of the Securities Act of 1933 and Section 26 of the Securities Exchange Act of 1934 governing unlawful representations. Section 23 clearly states:

Unlawful Representations

Neither the fact that the registration statement for a security has been filed or is in effect nor the fact that a stop order is not in effect with respect thereto shall be deemed a finding by the Commission that the registration statement is true and accurate on its face or that it does not contain an untrue statement of fact or omit to state a material fact, or be held to mean that the Commission has in any way passed upon the merits of, or given approval to, such security. It shall be unlawful to make, or cause to be made to any prospective purchaser any representation contrary to the foregoing provisions of this section.

Note: Bold print and italics added by me.

In addition, Section 26 clearly states:

Unlawful Representations

No action or failure to act by the Commission or the Board of Governors of the Federal Reserve System, in the administration of this title shall be construed to mean that the particular authority has in any way passed upon the merits of, or given approval to, any security or any transaction or transactions therein, nor shall such action or failure to act with regard to any statement or report filed with or examined by such authority pursuant to this title or rules and regulations thereunder, be deemed a finding by such authority that such statement or report is true and accurate on its face or that it is not false or misleading. It shall be unlawful to make, or cause to be made, to any prospective purchaser or seller of a security any representation that any such action or failure to act by any such authority is to be so construed or has such effect.

Note: Bold print and italics added me.

Therefore, Section 23 of the Securities Act of 1933 and Section 26 of the Securities Exchange Act of 1934 clearly prohibit any person from making certain representations concerning the effect of the SEC registration and review process. A company or its management cannot claim that, as a result of the comment process, the Commission is deemed to have:

  1. found that any registration statement or financial report is true and accurate on its face;
  2. found that any registration statement or financial report is not false and misleading;
  3. found that any registration statement of financial report does not contain an untrue statement of fact or material omission; or
  4. passed on the merits of, or given approval to, the security or the transaction

After lying about the nature of the SEC actions, Jonathan Johnson unloads nearly $1.0 million in Overstock shares

On April 23 and 24, 2008, in the two days following the latest lies by Overstock.com’s management team, Jonathan Johnson unloaded 55,922 Overstock.com common shares and pocketed gross proceeds totaling about $957,000 (Source: SEC Form 4 – here and here). In the months prior to Jonathan Johnson’s stock sales, Overstock.com repurchased 1.1 million shares at an average price of $10.90. Afterwards, Jonathan Johnson sold his shares at an average price of $17.13 per share or $6.23 higher than Overstock.com’s cost of buying back shares. The company still intends to spend another $8 million to buyback shares. Therefore, you have a lethal combination of false and misleading disclosures combined with the company simultaneously buying back shares to boost the market price of its common stock, while a key insider is selling.

On Friday April 25, Overstock.com's stock price climbed to $19.87 per share or an increase of 41.9% after the company released its materially misleading Q1 2008 earnings report on the previous Friday. Will the company buy back even more shares at almost twice the cost of previous purchases to further bolster the market price of its shares?

The desire to sell shares at a profit could provide one heck of a motive to lie about Overstock’s first quarter performance and the status of the ongoing formal inquiry being conducted by the SEC’s Enforcement Division. But if the stock price subsequently falls, Mr. Johnson too could find himself the target of an investigation by the Enforcement Division. And, no, Mr. Johnson, it won’t be the Division of Corporate Finance that investigates your trades.

Written by:

Sam E. Antar (former Crazy Eddie CFO and a convicted felon)

Note: Please read Gary Weiss and Tracy Coenen's blogs for up to date coverage of Overstock.com.

Disclosure: At the time of this blog post, I am not long or short Overstock.com.

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