On Tuesday, February 12, 2008 Overstock.com (NASDAQ: OSTK) issued a press release entitled, "Overstock Applauds Trial Court's Ruling in Gradient Case; Gradient Defendant Loses Dash for Exit as Court Sets September 9 Trial Date," hyping its litigation prospects in its ongoing lawsuit against Gradient Analytics, an independent research firm and Copper River Partners (formerly Rocker Partners), a short seller. However, Overstock.com failed to disclose in its press release the fact that Gradient Analytics recently filed a Motion for Leave to File a Cross-complaint against Overstock.com, Patrick Byrne, and others.
On Wednesday, the day after Overstock.com's press release, above, the company's stock rose to $11.58 per share from the previous closing price of $11.07 per share or a 4.6% increase (before the issuance of the press release).
Did Overstock.com violate Securities and Exchange Commission Rule 10b-5?
Let's review Securities and Exchange Commission Rule 10b-5:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
a. To employ any device, scheme, or artifice to defraud,
b. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
c. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
Note: Bold print and italics added by me.
As any securities attorney will tell you, Rule 10b-5 is the bedrock upon which federal securities law is built. Whether a public company violates GAAP, Regulation G governing non-GAAP financial disclosures, or generally any federal securities law, it is the presentation of untrue information or the omission of any material information that gives rise to fraud (as opposed to a technical violation, without consequence to the public) under the federal securities law.
If a public company issues any statement to the public, whether in a press release or an SEC filing, Rule 10b-5 mandates (DEMANDS) that the company include all material information in connection with the subject matter of the document.
According to the Securities and Exchange Commission:
Section 10(b) of the Exchange Act and Rule 10b-5 proscribe, among other things, misstatements of material fact made in connection with the purchase or sale of securities. Information is material if there is a substantial likelihood that its disclosure would be viewed by a reasonable investor as having significantly altered the total mix of information available.
Note: Bold print and italics added by me.
Information is material under the Rule:
(1) If it is more likely than not that such information if known to the reader would have been included his/her decision in connection with trading the securities of the company, or
(2) The information would alter the "mix of information" before the reader; therefore, if known would cause the reader to come to a different conclusion.
Overstock.com's press release cherry-picks one element of its litigation with the Gradient litigation, by pointing out that:
California Marin Superior Court Judge Lynn O'Malley Taylor ruled against Gradient Defendant Matthew Kliber's bid to exit the case. In addition, Judge O'Malley has set the case for trial on September 9, 2008.
In the press release, Jonathan E. Johnson III, Overstock.com's Senior Vice President of Legal went on to hype the company's litigation prospects:
Once again, defendants' efforts to derail this case fall flat. In every instance the trial and appellate courts have ruled that Overstock has a 'reasonable probability' of prevailing on every claim, just as the California Supreme Court declined Defendants' Petition for Review of those decisions. They are out of running room -- and we now have a trial date set. It's time to bring their conduct into the light of day."
And Patrick Byrne continued his non-stop hyping of the company's litigation prospects:
These broad-tossers have given us a two-and-a half year cook's tour of the California appellate process. They engage in such legal posturing because they know this case will expose a widespread, illegal Wall Street practice that harms American companies and makes money at the expense of American investors. I look forward to the day when the scofflaws are no longer in a backroom seeing their orthodoxies supped by biddable regulators and tractable New York financial journalists, but are instead sitting in a California courtroom trying to rationalize their schemes to twelve citizens."
However, Overstock.com's February 12 press release deliberately omits another new key element in its litigation: the fact that Gradient recently filed a motion for leave to file a cross-complaint. Gradient's cross-complaint, like Copper River's earlier cross-complaint covered in this blog, makes serious detailed allegations of willful misconduct and violations of law by Overstock.com, Patrick Byrne, and others. In addition, consistent with Overstock.com's pattern of failing to disclose material information to the public (like Byrne’s failure to disclose his personal subpoena), the company's website page covering the litigation fails to present a link to defendants’ cross complaints/countersuits, and omits any mention of, or even reference to, the existence of these material filings.
According to the "Proof of Service," Overstock.com and other Cross-Defendants (from the Copper River countersuit) were served on January 30, 2008 with the following documents:
3. Declaration of Brian P. Maschler, Esq. in Support of Defendant Gradient Analytics, Inc.'s Motion for Leave to File Cross Complaint; [Note: Exhibit A to this document includes Gradient's Cross Complaint];
The subject matter of Overstock.com's press release was an update in connection with its ongoing litigation between Overstock and Gradient. Since Overstock.com updated the public about the status of its litigation with Gradient in its press release, under rule 10b and 10b-5, the company cannot cherry pick only so-called favorable information and at the same time exclude new materially negative information.
Overstock cannot present a tenable legal argument to overcome the fact that, more likely than not, some members of the public would have included the omitted information of Gradient's request to file its countersuit in their decisions in connection with trading the securities of the company. The disclosure of Gradient's request to file its countersuit would have clearly altered the mix of information to the readers of its press release.
In short, the standard is not if, more likely then not, all members of the public would have included the omitted information---the standard is whether it is "reasonable to assume" that some members of the public would have included the omitted information in their decisions in connection with the trading of Overstock.com's securities.
Sam E. Antar (former Crazy Eddie CFO and a convicted felon)