Friday, October 09, 2009

Overstock.com CEO Patrick Byrne Is In a Very Sour Pickle

Overstock.com CEO Patrick Byrne is in a pickle or let’s just say that he is in a sour pickle. He has to make key decisions within the next weeks, before issuing his Q3 2009 financial reports, on how to handle certain financial reporting violations uncovered by this blog and now being investigated the Securities and Exchange Commission. As a result of my forensic accounting analysis, the SEC took the highly unusual step of bravely restarting its investigation of Overstock.com’s financial reporting violations, after dropping a previous investigation in June 2008 (details here).

My forensic accounting report to the Securities and Exchange Commission

In my open letter to the SEC, I detailed how Overstock.com failed to comply with Generally Accepted Accounting Principles (GAAP) in correcting its customer refund and credit errors and improperly created a "cookie jar reserve" to materially inflate reported earnings or reduce losses in future reporting periods (details here).

In October 2008, Overstock.com disclosed new customer credit and refund accounting errors and restated all financial reports from Q1 2003 to Q2 2008 to reflect an additional $8.2 million of claimed accumulated losses in prior reporting periods. It was the second time in two years that Overstock.com restated its financial reports due a violation of GAAP.

Those customer refund and credit errors also caused Overstock.com to underbill earned income due from its fulfillment partners for offsetting costs and reimbursements. Overstock.com restated its prior financial reports to correct its customer refund and credit errors. However, the company failed to make offsetting corrections and accrue underbilled income earned from its fulfillment partners in those same affected prior reporting periods, as required by GAAP. Instead, Overstock.com improperly recognized income from its underbilled fulfillment partners using a non-GAAP cash basis as amounts were collected future accounting periods (Q4 2008 $1.8 million, Q1 2009 estimated at $1.4 million, and Q2 2009 $87k).

In effect, Overstock.com improperly created a "cookie jar reserve" to inflate earnings in future reporting periods. For example, the company should have reported a Q4 2008 loss, but instead reported a profit for that quarter by violating GAAP. That improperly reported net profit enabled Overstock.com to report its first quarterly profit after a string of 15 consecutive quarterly losses and beat mean analysts’ consensus expectations for earnings per share.

Patrick Byrne’s choices

When Overstock.com issues its next financial report (due in a few weeks), the company can either restate its affected prior financial reports to properly reflect income from underbilling its fulfillment partners as it was earned in those periods or the company can tough it out and wait for the SEC or Grant Thornton (new auditors) to force a restatement of its financial reports.

If Patrick Byrne chooses to restate financial reports

If Overstock.com restates its financial reports it will be the third time in three years that the company had to correct financial reports due to violations of GAAP: (1) inventory accounting error - Q1 2002 to Q3 2005, (2) customer refund and credit error – Q1 2003 to Q2 2008, and (3) underbilled income from fulfillment partners – Q1 2003 to Q2 2009. Patrick Byrne will have the unique distinction being the CEO of a company that restated financial reports from overlapping prior accounting periods three times: Q1 2003 to Q3 2005.

I have no doubt that Patrick Byrne will continue to falsely claim it’s all an honest mistake (See Gary Weiss Blog, here). However, Overstock.com was notified by me of its GAAP violations starting in January 2009 and the company deliberately failed to act on it. Instead, I was viciously smeared by Patrick Byrne during earnings calls (Q4 2008, Q1 2009, and Q2 2009).

Patrick Byrne sent his paid internet stalker Judd Bagley to threaten me into settling my divorce case with my ex-spouse and smear me on the internet as retaliation for my exposure of Overstock.com's GAAP violations.

Another paid henchman used by Patrick Byrne to smear his critics is Mark Mitchell, a former Columbia Journalism Review (CJR) reporter who left his job under a cloud, when serious questions were raised about his journalistic integrity and ethics. In Byrne's Deep Capture blog, Mitchell claimed:

Antar writes with almost daily regularity that Deep Capture reporter Patrick Byrne is running a fraudulent company (Overstock.com), though he has produced nothing to support his claims, and every reputable person who has examined his arguments has concluded that they are absurd.

Yes, I do believe that Patrick Byrne has committed securities fraud. However, contrary to Mitchell's claim that I have "produced nothing" to support my claims, my blog has thoroughly documented false and misleading financial reporting by Overstock.com and lies to investors by Patrick Byrne dating back some ten years (some details, here).

In fact, every single financial report issued by Overstock.com, since its inception, has initially violated GAAP or other SEC disclosure rules. Only certain disreputable members of the management team running Overstock.com have disputed my findings. The SEC apparently agrees with me and not Byrne or Mitchell and it has restarted its investigation of Overstock.com.

If the SEC did not re-start its investigation of Overstock.com, I doubt that the company on its own would ever restate its improper financial reports to properly comply with GAAP as I have called for in my blog. For example, it took me a year of blogging and letter writing to Overstock.com and the SEC to push the company into properly complying with SEC Regulation G governing non-GAAP financial measures such as "Earnings before interest, taxes, depreciation, and amortization" or EBITDA (details here and here). During that time, Patrick Byrne, current company President Jonathan E. Johnson, and former CFO (now demoted) David Chidester falsely claimed that Overstock.com's improper EBITDA measure complied with Regulation G. However, Overstock.com finally changed its improper disclosures to comply with Regulation G and I was proven right.

If Patrick Byrne chooses to tough it out

If Overstock.com is willing to take the risk of an SEC enforcement action to compel the company to correct its financial reports, the company will face almost certain sanctions from the SEC for delaying its restatements. According to a paper issued by major securities law firm Paul Weiss:

Waiting for the SEC to force disclosure of accounting irregularities and making misleading statements to the press during an investigation in respect to the underlying focus of the investigation...all have the potential to result, and have in fact resulted, in significant penalties.

Paul Weiss specifically cited the SEC investigation of Dynegy (See page 3 and 4).

Patrick Byrne’s denials of wrongdoing and at the same time vilifying me in various earnings calls (Q4 2008, Q1 2009, and Q2 2009) and false and misleading statements to the press such as to Crain’s New York Business (subscription required), Deseret News, and the Salt Lake Tribune make him subject to stiff SEC sanctions. For example, Patrick Byrne told the Deseret News:

Byrne doesn't think Antar should get his hopes up as the restatements involve a trio of bookkeeping mistakes that when added and subtracted together decrease the company's bottom line by a mere $2 million against a total of $5 billion that was originally reported.

As Gary Weiss reported in his blog:

Byrne is obscuring the issue. All accounting errors cancel out over time (any forensic accountant can tell you about the double down effect-–you have to commit twice the fraud to maintain the fraud). It’s the timing of the accounting errors and their impact of quarterly results that counts – the "cookie jar reserve" that Sam has described in his blog. That's what has impacted the bottom line in several quarters.

For example, Overstock used smoke and mirrors to turn a fourth quarter 2008 loss into its "first quarterly profit in sixteen quarters." Didn't happen. Byrne's trying to portray this deliberate chicanery as "carelessness." Except that it was totally deliberate. Byrne has been on notice about these GAAP violations all along.

If anything, Patrick Byrne's actions reflect his deliberate intent to avoid following GAAP and SEC disclosure rules.

Issues with new auditors

Overstock.com’s new auditors, Grant Thornton, faces a thorny issue, too. The former auditors, PricewaterhouseCoopers signed off on Overstock.com’s 2008 financial reports, but failed to require Overstock.com to restate prior financial reports to properly reflect when underbilled income was actually earned from its fulfillment partners. Overstock.com’s GAAP violations in 2008 caused material errors in 2009 financial reports that Grant Thornton must audit. I doubt that Grant Thornton will go out on a limb and risk issuing a clean audit opinion without Overstock.com restating financial reports to correct its GAAP violations.

A CEO and company that apparently is unwilling to abide by the rules

Patrick Byrne once said:

Well, first of all, I’m all about GAAP. I have been so critical of the companies that do–I don’t believe in one-time charges; I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook.

To this day, Overstock.com and its CEO Patrick Byrne were never about GAAP or following SEC disclosure rules such as Regulation G governing non-GAAP accounting measures such as EBITDA. So far, the company has restated its financial reports two times due to GAAP violations and an SEC Division of Corporation Finance review found that all financial reports from the company's inception to Q2 2008 failed to follow GAAP in reporting revenues. Financial reports from Q1 2003 to Q2 2009 must be restated to properly reflect when income was earned from underbilled fulfillment partners.

From Q2 2007 to Q2 2008, Overstock.com materially overstated its financial performance by using a non-compliant EBITDA in violation of SEC Regulation G. Patrick Byrne had said above that, "I don't believe in EBITDA. If somebody talks EBITDA, put your hand in your wallet: they're a crook." Overstock.com not only used EBITDA in its financial reports, it also misused EBITDA by excluding certain items from the calculation in violation of SEC Regulation G. Therefore, Patrick Byrne is a self-defined "crook" and a violator of securities disclosure rules.

In every single period of its existence, Overstock.com has issued financial reports that at least initially violated GAAP and other SEC disclosure rules. Meanwhile, Overstock.com has lost money in every single year of its existence while taking advantage of gullible investors by raising capital and issuing phony financial reports. In recent quarters, Overstock.com made $5.7 by buying back debt at a discount (less than face value) from unfortunate investors who relied on financial reports that failed to follow GAAP and SEC disclosure rules. Just about the only thing that Patrick Byrne is "about" is issuing phony financial reports, while taking money from his investors to finance a company that has never made money in any year.

Written by:

Sam E. Antar

Disclosure:

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. The Paul, Weiss law firm was Crazy Eddie's outside corporate counsel. I scammed them, too.

I do not own Overstock.com securities short or long. My research on Overstock.com and in particular its lying CEO Patrick Byrne is a freebie for securities regulators and the public in order to help me get into heaven, though I doubt that I will ever get there anyway. I will probably end up joining corporate miscreants such as Patrick Byrne in hell.

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