Monday, July 11, 2011

Overstock admits to deceptive advertising

O.co, also known as Overstock.com, (NASDAQ: OSTK) has admitted to a key allegation leveled against it in a lawsuit brought by several California District Attorneys alleging consumer fraud, according to court documents. In those court filings, the California District Attorneys say that Overstock.com has admitted that it "knowingly" used false comparison prices on its website, a practice that deceives customers into thinking they are getting better prices than they actually did. Further, those documents reveal that the company is continuing to stonewall compliance with a court order compelling it to turnover contact information of former employees with potential knowledge of alleged wrongdoing.

Background

On November 17, 2010, District Attorneys from seven California counties sued Overstock.com alleging that it engaged in fraudulent advertising practices after a two year investigation. The District Attorneys are seeking at least $15 million of restitution, fines, penalties, and cost reimbursements from Overstock.com. The lawsuit alleged that:

9. ...Overstock routinely and systematically made untrue and misleading comparative advertising claims about the prices of its products…. 11. …Overstock used various misleading measures to inflate the comparative prices, and thus artificially increase the discounts it claimed to be offering consumers…. 22. Often Overstock has not been determining or verifying the price other merchants charge for those identical products. Rather, Overstock has been using various misleading methods to make up its own “straw-man” prices which it claims other merchants are charging for those products, and then claiming that its own prices are significantly lower. 23. Overstock has advertised comparative prices which do not exist (i.e., simply making up the prices charged by other merchants).

A day after the lawsuit was filed, Chris Morran from the Consumerist blog remarked:

Apparently, the "O" in Overstock.com stands for "Overstating discounts and misleading customers," at least according to the district attorneys in seven California counties.

Best-selling author and financial columnist Gary Weiss noted in his personal blog that Overstock.com was still making up its competitor's prices:

Just for the heck of it I checked out Overstock's price for the paperback edition of Andrew Sorkin's Too Big to Fail. The price at Overstock is $11.06 and the search page for the book fraudulently says "compare at $20.55" and "you save 46%."
Baloney. The biggest online retailer, Amazon, lists the book at $9.90 and gives the list price as $18.00, not "$20.55." Barnes and Noble also prices the book at $9.90, and gives the correct list price.

Overstock.com President Jonathan Johnson argued that it was being "singled-out" by the California District Attorneys.

California District Attorneys say company admits to key allegation

On June 24, 2011, the People of the State of California and Overstock.com filed a “Joint Case Management Statement” which states:

Even at this early stage of the litigation, Overstock has admitted that in many cases it knowingly advertised comparison prices that were often significantly higher than “street prices” at which other merchants sold the identical products. Compare Overstock’s Verified Second Amended Answer to the Complaint ¶ 46, with People’s Complaint, ¶¶ 45-46.

In court papers, the company claims that “….virtually every retailer does it.” That's like someone who is stopped by a State Trooper for speeding arguing with the cop that they shouldn’t get a ticket because everyone else speeds from time to time.

Further, Overstock.com's excuse appears to conflict with its Code of Business Conduct and Ethics which clearly states that:

Obeying the law, both in letter and spirit, is the foundation on which the Company's ethical standards are built. All employees must respect and obey the laws of the cities, states, and counties in which we operate.

If the company's senior officers condoned illegal advertising practices, it is required to disclose a waiver from its Code of Ethics under Section 406 of the Sarbanes-Oxley Act.

Stonewalling compliance with court order

On April 1, 2011, the District Attorney of Alameda County filed a motion to compel Overstock.com to turn over the present or last known contact information for certain former employees with knowledge of alleged fraudulent advertising practices:

Specifically, the People will and do hereby move for an order compelling Overstock.com to further respond to Special Interrogatories 8 and 14 by providing current contact information for the former employees whose names Overstock disclosed in response to these Interrogatories.
The People met and conferred via email in good faith in an attempt to informally resolve this dispute and have offered to enter into a protective order as a means of satisfying Overstock.com’s asserted privacy objections. Nevertheless, Overstock.com has refused to provide the People with the information sought. [Emphasis added.]

Afterwards, Overstock.com CEO Patrick Byrne accused the California District Attorneys of not acting in good faith:

It is not our job to host DA’s on a no-limits fishing trip, especially when they have not acted in good faith in the past.

Patrick Byrne
On May 17, 2011, Judge Robert B. Freeman rejected Overstock.com's arguments and Byrne’s accusations. The Judge issued a court order granting the California District Attorney’s motion to compel the company to turn over the contact information of certain former employees:

IT IS HEREBY ORDERED THAT:
The Motion of Plaintiff The People of the State of California (“Plaintiff”) to Compel Further Responses to First Set of Interrogatories is ruled on as follows:
At issue are the responses of defendant Overstock.com, Inc. (“Defendant”) to Plaintiff’s Special Interrogatories (“SI”) 8 and 14 which seek identifying information regarding Defendant’s former employees who set “SET COMPARISON PRICES” and those who “worked as an OVERSTOCK BUYER” during the relevant time period. Defendant supplied Plaintiff with names, but refused to provide current contact information, asserting the privacy rights of these former employees.
The Motion is GRANTED. On balance, the importance to Plaintiff of obtaining contact information of Defendant’s former employees, all of whom may be fairly characterized as potential witnesses in this case, outweighs the privacy interests that these persons have in this information. [Emphasis added.]

However, court documents reveal that Overstock.com is continuing to stonewall compliance with the Judge’s order. The company wants the California District Attorneys to agree to “immediately destroy or return materials following final disposition of this case.” The California District Attorneys have complained to the Judge that:

The District Attorneys, acting on behalf of the People, are law enforcement agencies having a duty to maintain evidence relating to law enforcement actions for purposes, among others, of enforcing any injunctions that may be entered. Agreeing to destroy or return evidence at the conclusion of the case would make it more difficult to enforce such an injunction months, or even years, later, and thereby amount to an abdication of that law enforcement duty. [Emphasis added.]

Financial disclosures reveal “probable” recognition of liability arising from California litigation claims

On June 11, 2010, the SEC Division of Corporation Finance reviewed Overstock.com's 2009 10-K report and Q1 2010 10-Q report and found that its disclosures did not fully comply with applicable disclosure rules concerning its litigation risks (See question 30).

At that time, Overstock.com had disclosed that it was under investigation by District Attorneys from seven California counties for alleged consumer fraud. The SEC required Overstock.com to add a disclosure that it had accrued $1.2 million in loss contingencies to cover its potential litigation risks.

Overstock.com revealed to the SEC Division of Corporation Finance reviewers that its loss contingency accruals only covered two matters:

There are two matters for which we have established accrued liabilities, namely, the California district attorneys’ investigation and the administrative proceeding before the Ohio Tax Commissioner.

In the Ohio tax proceeding, Overstock.com disclosed that it faces potential claims of $612,784 in taxes, interest, and penalties. Therefore, at the very minimum, Overstock.com had accrued $587,216 in loss contingencies for claims arising from the California District Attorneys' investigation, before the lawsuit was filed. Note: Loss contingency of $1.2 million minus $612,784 potential claims in Ohio tax proceeding equals $587,216.

According to the company’s 10-Q report for the quarter ended March 31, 2011:

In the normal course of business, we are involved in legal proceedings and other potential loss contingencies. We accrue a liability for such matters when it is probable that a loss has been incurred and the amount can be reasonably estimated. When only a range of possible loss can be estimated, the most probable amount in the range is accrued. If no amount within this range is a better estimate than any other amount within the range, the minimum amount in the range is accrued. We expense legal fees as incurred. [Emphasis added.]

Therefore, Overstock.com's disclosures acknowledge “it is probable that a loss has been incurred” in connection with consumer fraud claims made by the California District Attorneys. The company accrued only the “minimum amount” of loss contingency allowed under accounting rules.

The amount of money that Overstock.com has so far set aside to resolve claims by the California District Attorneys may be too low. Back in June 2010, the company’s correspondence with the SEC Division of Corporation Finance reviewers emphasized (in underlined and italicized type font) that:

It is reasonably possible that the potential loss may exceed our accrued liability. 

Afterwards, the company rejected a $7.5 million dollar offer by the California District Attorneys to settle the investigation, before the lawsuit was filed.

The lawsuit seeks over $15 million of restitution, fines, penalties, and cost reimbursements from the company. Since the lawsuit started, the company has increased its total loss contingency reserves (which include the Ohio tax matter) by a mere $100,000 to $1.3 million, according to its latest 10-Q report.

Ongoing SEC investigation

Overstock.com also has to contend with an ongoing investigation by the SEC Enforcement Division into securities law violations by the company. In 2009, this blog identified certain violations of Generally Accepted Accounting Principles (GAAP) by Overstock.com that allowed it to fabricate a Q4 2008 profit rather than a properly reported loss. I sent emails to Overstock.com and the SEC alerting them about the company’s illegal accounting practices. I urged the company to restate its financial reports to correct its improper accounting practices. Instead of properly complying with GAAP, Overstock.com continued to materially overstate its income in Q1, Q2, and Q3 2009.

In September 2009, the SEC started investigating Overstock.com. In October 2009, the company fired Grant Thornton as its auditor after it finally agreed with my recommendation to restate its financial reports. In March 2010, Overstock.com finally admitted that it violated GAAP and restated its financial reports to correct its violations, as I recommended a year earlier.

Conclusion

In June 2011, Overstock.com changed its name to O.co in an effort to improve its tarnished image.  However, there is an old saying, “You can’t put lipstick on a pig.” The company may have changed its name, but the same people are still running the show.

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach white-collar crime classes for various government entities, professional organizations, businesses, and colleges and universities.

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time. My past sins are unforgivable.

I do not own any Overstock.com securities long or short.

1 comment:

john lichtenstein said...

They should have paid the 7.5M and buried this before the rebranding.

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