In its latest Q3 2009 financial report Overstock.com disclosed a new inquiry by SEC’s Division of Corporation Finance regarding its 2008 Form 10-K/A (amended 10-K report) and its June 30, 2009 Form 10-Q. The company did not disclose the nature of that inquiry.
The SEC Enforcement Division recently re-opened its investigation into financial reporting violations at Overstock.com, fifteen months after it closed a previous probe of the company. After the SEC closed that probe, Overstock.com restated its financial reports for the second time in three years due to GAAP violations. The SEC re-opened its probe of Overstock.com in response to a series of investigative reports by this blog documenting how Overstock.com improperly used a "cookie jar" reserve to materially inflate future earnings or reduce future losses (details here).
Now Overstock.com faces two parallel probes by the SEC. The Enforcement Division is investigating Overstock.com's financial reporting over the last several years and the Division of Corporation Finance is reviewing more recent financial reports.
In Q3 2009, Overstock.com did not restate its previous comparable financial reports to correct its GAAP violations. Instead, CEO Patrick Byrne seems intent on toughing it out with the SEC and forcing it to take enforcement action against the company to comply with GAAP (details here).
I sent Patrick Byrne an email and asked to participate in Overstock.com’s Q3 2009 earnings call, so I could ask questions about Overstock.com's violations of GAAP and other SEC disclosure rules. In response, Patrick Byrne responded with an angry anti-Semitic diatribe, called me a “gonif” (Hebrew/Yiddish word for thief), and posted my email on his Deep Capture blog, despite previous claims that his Deep Capture is unrelated to Overstock.com.
Investigative journalist and best-selling author Gary Weiss summed it up in his blog:
So Byrne immediately went berserk on his Deep Capture smear site, posting Sam's email and a sneering, Jew-baiting response denying the request, saying that Sam could only ask four questions of up to 25 words, sent in advance via email.
This happened shortly before dawn Utah time. That assumes Byrne actually is in Utah, where he makes believe he runs the company, and not in New York, preparing to march in the Halloween Parade, perhaps disguised as a law-abiding corporate executive.
Byrne has every reason to be terrified of Sam, and to go off his nut whenever he hears from him. After all, if it wasn't for Sam, he wouldn't be under a newly reopened SEC investigation.
But evidently Byrne forgot that he has repeatedly argued that Deep Capture has "nothing to do with Overstock," even though he founded it, funds it, it focuses on trashing the company's critics, and it runs on Overstock's Internet servers. Sam's email had nothing to do with Byrne's pet "naked short selling" cause.
In any case, I submitted my questions via email, posted them in my blog, posted them in the comments section of Byrne’s Deep Capture blog, and called into the conference call. Patrick Byrne did not answer any one of my emailed questions and did not allow me to ask questions during the call, despite being alerted by the operator that I was on the line. However, Patrick Byrne did respond to some softball questions from an analyst who participated in the call and even took emailed softball questions from others.
Why is he afraid to address questions about GAAP and other financial reporting violations by his company?
Over the last two years, my blog has documented continuous pattern of deceitful, inconsistent, and contradictory statements made by Patrick Byrne and Overstock.com’s management that more often than not conflicted with other disclosures made by them and Overstock.com. Since its inception, every single financial report issued by Overstock.com has initially violated GAAP or some other SEC disclosure rule. See details here.
Before I continue let’s review some history, below:
A history of violating GAAP and SEC disclosure rules
In February 2006, Overstock.com restated its financial reports from Q1 2002 to Q3 2005 due to inventory accounting errors.
From Q2 2007 to Q2 2008, Overstock.com violated SEC Regulation G governing non-GAAP financial measures such as EBITDA and materially inflated its financial performance. My blog documented how Overstock.com improperly reconciled its reported EBITDA to net income, rather than operating income, and it improperly eliminated stock-based compensation costs from its EBITDA calculation (details here).
In January 2008, the Securities and Exchange Commission Division of Corporation Finance discovered that Overstock.com's revenue accounting failed to comply with GAAP and SEC disclosure rules, from the company's inception (details here). In its correspondence with the SEC, I discovered that the company improperly provided the SEC with a flawed and misleading materiality analysis to convince regulators that its revenue accounting error was not material to avoid restating its financial reports (details here).
Instead of restating prior financial reports to correct its material revenue accounting error, Overstock.com improperly used a one-time cumulative adjustment in its Q4 2007 financial report to hide the material impact of such errors on prior reporting periods. In Q4 2007, Overstock.com’s one-time cumulative adjustment reduced revenues by $13.7 million and increased net losses by $2.1 million resulting from the one-time cumulative adjustment to correct its revenue accounting errors.
On October 24, 2008, Overstock.com disclosed new customer refund and credit errors and the company warned investors that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.” This time, Overstock.com restated all financial reports dating back to 2003.
In addition, Overstock.com reversed its one-time cumulative adjustment in Q4 2007 that it previously used to improperly correct its revenue accounting errors. This time Overstock.com properly restated all previous financial statements to correct those errors revenue accounting errors, as I previously recommended.
In amended financial reports filed with the SEC in connection with its restatement, Overstock.com quietly revised its improper EBITDA measure and replaced it with “Adjusted EBITDA” without any explanation.
The company reported that the combined amount of revenue accounting errors (previously uncovered by the SEC) and newly disclosed customer refund and credit accounting errors resulted in a cumulative reduction in previously reported revenues of $12.9 million and an increase in previously reported accumulated losses of $10.3 million.
However, Overstock.com continued to violate GAAP in later accounting periods because did not include in its restatement a correction for offsetting costs and reimbursements earned from its fulfillment partners that resulted from the customer refund and credit errors reported in October 2008. Instead, Overstock.com falsely claimed that a “gain contingency” existed and improperly reported such income on a non-GAAP cash basis in future accounting periods In effect, Overstock.com improperly created a "cookie jar reserve" to inflate earnings in future reporting periods (details here).
Note: I recommend reading forensic accountant and author Tracy Coenen's blog on how cookie jar reserves work.
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 (See: SEC Staff Accounting Bulletin No. 99 about Materiality).
Therefore, single financial report issued by the company at least initially violated GAAP and SEC disclosure rules. Currently, the SEC is investigating whether Overstock.com should restate its financial reports for the third time in three years as a result of new GAAP violations exposed in my blog.
Why I asked my questions
Generally Accepted Accounting Principles are based on the principle of the comparability or being able to compare financial reports of a current reporting period against the same reporting period in a previous year. To properly achieve comparability, there must be a consistent application of accounting principles.
However, Overstock.com’s financial reporting is simply not comparable due to GAAP violations (described above) and other accounting tricks. Therefore, it is impossible to accurately compare Overstock.com’s financial reporting in any period to a previous comparable period. That’s why accounting errors are corrected by restating financial reports. According to the SEC, “GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error.” (Source: Cease and Desist order issued “In the matter of Carl M. Apel”).
As I described above, in Q3 2008 Overstock.com reported that it underbilled its fulfillment partners offsetting costs and reimbursements arising from its customer refund and credit errors. It should have corrected all previously issued financial reports to include income already earned, but underbilled or still owed by its fulfillment partners, less a reasonable allowance for uncollectable amounts. For additional details see SFAS No. 154 and SFAS No. 5 paragraph 1, 2, 8, 22, and 23.
Instead, Overstock.com made up a phony “gain contingency” so it could improperly recognize such income as it was collected in future accounting periods and not when it was actually earned in prior accounting periods. Therefore, you have a distortion in Overstock.com’s financial reporting that makes it impossible to accurately compare financial reports in any period to a previous comparable period.
For example, Overstock.com claimed a net loss of $2.497 million for the nine months ended September 30, 2009. However, the company disclosed that it reduced its reported net losses by $1.7 million “due to recoveries from partners who were underbilled in 2008 for certain fees and charges, and for a refund of overbillings by a freight carrier for charges from the fourth quarter of 2008.” Therefore, if Overstock.com properly recognized such income when it was actually earned in prior reporting periods, its net loss would have been $4.197 million, instead of $2.497 million or nearly double the amount reported.
For the nine months ended September 30, 2008, Overstock.com claimed a net loss of $13.672 million. However, its net loss for that period improperly excluded an undetermined correction for income earned from offsetting costs and reimbursements that were not billed to its fulfillment partners.
Therefore, Overstock.com's net loss for the nine months ended September 30, 2008 was lower than reported by some indeterminable amount, while Overstock.com’s net loss for the following year period was higher by $1.7 million. We simply cannot accurately compare the current year's nine month reporting period to the previous year's nine month reporting period. Any claimed improvement by Overstock.com in its financial performance for the current nine month reporting period has to be much lower.
In Q3 2009, Overstock.com claimed reported a net loss of $0.787 million compared to a net loss of $1.589 million during Q3 2008 or an $800,000 reduction in net losses. However, $700,000 of the $800,000 disappears because Overstock.com received $700,000 “from an insurer in the settlement of a dispute regarding insurance coverage of a legal matter.”
In Q3 2008, we do not know how much income Overstock.com would have reported if the company properly made corrections for income earned from offsetting costs and reimbursements that were not billed to its fulfillment partners. Therefore Q3 2008's reported net loss of $1.589 million may have been lower than previously reported. If Overstock.com's Q3 2008 net loss was just $100,000 lower, its claimed improvement in reducing losses in the following year would have disappeared.
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.
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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