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.

Friday, April 25, 2008

Barry Minkow Finds Herbalife President Falsified Credentials

According to a Wall Street Journal article by Keith J. Winstein published today, Gregory Probert, the president and chief operating officer of Herbalife Ltd. (NYSE: HLF) does not have a Masters of Business Administration degree from California State University as claimed in at least nineteen SEC filings by the company. My good friend, former fraudster turned fraud fighter, Barry Minkow, co-founder of the Fraud Discovery Institute hired a private investigator to examine and verify the biographies of Herbalife executives.

According to the Wall Street Journal:

In response, Mr. Probert, 51 years old, said he nearly completed an M.B.A. at Cal State, but "the truth is that my vanity prevailed and I did not take action" to correct Herbalife's biography of him "even though I was aware it was not accurate."

"I suppose that some of us who have been blessed with a certain degree of good fortune are tempted to see the paths we took in romantic versus strictly factual ways," Mr. Probert wrote in an email. "I was wrong for succumbing to my vanity and apologize for doing so."

Barry Minkow has publicly acknowledged that he is shorting Herbalife and has provided law enforcement with online access to his trading account. The Fraud Discovery Insititute has exposed over twenty frauds totaling in excess of a billion dollars.

Herbalife told the Wall Street Journal that the company would correct its disclosures and remove any mention of Mr. Probert's falsely claimed M.B.A.

Gregory Probert's lie about obtaining a Masters of Business Administration degree from California State University violates Herbalife's Corporate Code of Ethics and Business Conduct. See the quote below:

Under various laws, the Company is required to maintain books and records accounting for the Company's transactions. It is mandatory that these books and records be accurate and that they include all pertinent information on a timely and understandable basis. In addition, reports and documents that the Company files with or submits to the Securities and Exchange Commission (SEC), as well as other public communications, must contain full, fair, accurate, timely and understandable disclosure.

Dishonest reporting, or failure to disclose material terms of a transaction on a timely basis, is strictly prohibited. An individual cannot knowingly report information that is inaccurate or organize it in a way intended to mislead or misinform those who receive it.

Employees must not make false or misleading statements in external financial reports, SEC filings or submissions, environmental monitoring reports, other documents submitted to or maintained for government agencies, or other public communications. Dishonest reporting can lead to civil or criminal liability, including significant monetary fines for the Company and possible jail sentences and/or fines for you.

Note: Bold print and italics added by me.

Message to Gregory Probert: You should immediately resign and hire a good securities law attorney. How long did you really think you could continue with your charade knowing that the Fraud Discovery Institute was carefully examining Herbalife's SEC dislosures? If you don't resign, Herbalife Chairman and CEO Michael O. Johnson should fire you. You can read the SEC's Code of Ethics requirements under the Sarbanes-Oxley Act here. There is a saying, "It takes one to know one."

In a previous blog post, I detailed the Fraud Discovery Institute's "Top Ten Red Flags for Fraud at Herbalife."

Disclosure: In the past, I have provided funds to the Fraud Discovery Institute to cover costs of investigations. At the time of this blog post, I am not short or long Herbalife.

Written by:

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

Wednesday, April 23, 2008

Overstock.com SVP Jonathan E. Johnson caught lying in frantic attempt at damage control

As a criminal, I learned the hard way that lies to solve small problems often create even bigger problems. Yesterday, Overstock.com (NASDAQ: OSTK) went on a frantic defensive mode after my Monday blog post detailing how the company illegally manipulated the price of its common shares through a materially and significantly misleading recent earnings release in violation of SEC Rule 10b-5. In the process of attempting to defend Overstock.com's illegal stock market manipulation, Jonathan E. Johnson III (Senior Vice President - Corporate Affairs & Legal) made up new lies and created even more SEC Rule 10b-5 problems for the company. Overstock.com is under investigation by the Securities and Exchange Commission and its CEO Patrick Byrne has admitted to being the target of the SEC probe.

In my previous blog post, one issue of many issues that I detailed was how Overstock.com’s recent Q1 2008 earnings report failed to disclose that the company compared Q1 2008 revenues reported on a GAAP basis to Q1 2007 revenues that were reported on a non-GAAP basis in violation of Statement of Accounting Standards No. 154. However, Jonathan Johnson apparently lied to Betsy Schiffman from Wired.com, by claiming that Overstock.com reported its Q1 2007 revenues in compliance with GAAP (no surprise). According to the Wired.com article:

"In its earnings release, Overstock.com failed to disclose that it compared first-quarter 2008 revenues reported on a GAAP basis to first-quarter 2007 revenues that were reported on a non-GAAP basis," Antar wrote on his White Collar Fraud blog.

For those who don't speak accountantese, "non-GAAP" basically refers to non-standard accounting practices, and the difference between GAAP and non-GAAP numbers is often substantial.

"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.

As detailed above, Jonathan E. Johnson claimed that both Q1 2008 and Q1 2007 revenues in Overstock.com’s Q1 2008 earnings release were reported in accordance with GAAP. However, Jonathan E. Johnson was present during the Q4 2007 earnings call when Patrick Byrne made the surprise announcement that Overstock.com’s revenues and other related items were deliberately not reported in compliance with GAAP and the company's revenue recognition disclosures, which is a violation of SEC Staff Accounting Bulletin No. 99. In addition, Overstock.com’s Q4 2007 8-K report filed with the Securities and Exchange Commission, clearly contradicts Jonathan E. Johnson’s claim to Wired.com regarding Q1 2008 and Q1 2007 revenues that “They’re both GAAP numbers….”

From the company’s inception through the third quarter of 2007, we have recorded revenue based on product ship date. In the fourth quarter of 2007, in response to an accounting comment from the staff of the SEC, we retrospectively changed our policy to recognize revenue based on estimated product delivery date. We have recorded the cumulative effect of this change in the fourth quarter of 2007.

Note: Bold print and italics added by me.

Since Overstock.com failed to restate revenues through Q3 2007, how could Q1 2007 revenues be reported in compliance with GAAP when such revenues were compared to Q1 2008 in the company's earnings release? Jonathan E. Johnson’s false statement, above, creates even more legal problems for Overstock.com with the Securities and Exchange Commission. Rule 10b-5 expressly makes it “unlawful for any person….to make any untrue statement of a material fact.”

Question for Jonathan E. Johnson: If you can't read my blog since you falsely claim that it's rife with "lies" - then who exactly at Overstock.com is reading my blog? My log reports 394 visits and counting to my blog from people working for Overstock.com.

Message to Jonanthan E. Johnson from a convicted felon: The cover up is often worse than the crime.

To be continued....

Written by:

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

Recommended reading:

Tracy Coenen: Latest Overstock.com Lie: 2007 first quarter numbers were GAAP

Gary Weiss: Overstock.com's 'Stock Manipulation Friday'

Gary Weiss: Tracking the lies of Overstock.com and the Fantasies of Patrick Byrne

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

Monday, April 21, 2008

Overstock.com and Patrick Byrne: Anatomy of a Stock Market Manipulation Scheme – First Quarter Earnings Release

On Friday, in a surprise announcement, Overstock.com (NASDAQ: OSTK) released its first quarter fiscal year 2008 earnings report and highlighted in the very first line of Overstock.com’s “Key Q1 2008 Metrics” was Overstock.com’s much hyped increase in first quarter revenues:

Total revenue: $200.7 million vs. $157.9 million (a 27% increase)

In the hours that followed Overstock.com’s surprise earning release, the company’s common stock climbed from an opening price of $14 per share to $18.47 per share, a $4.47 climb in the price of the company’s shares or a whopping 31.93% single day increase.

If this revenue increase were actually sustainable, the market reaction would have been justified. But as I will describe below, the Overstock news release was materially and significantly misleading in violation of SEC Rule 10b-5. Of all the many accounting and disclosure issues I have described in this blog over the past year, Overstock's Friday release was by far the most significant, the most blatant, and most damaging to investors and the integrity of the market.

An analysis of their public filings indicates that the actual revenue increase was significantly lower. As will be described below, I believe that this blatantly misleading news release was intentionally timed with expiration of options to manipulate the market (i.e., as a "short squeeze") and to bury and downplay grave news of a criminal investigation in California.

As the criminal CFO of Crazy Eddie Inc., I learned to always accentuate positive news in company press releases and to do my very best to bury any mention of negative news that may cause the stock price to drop. As a good friend Barry Minkow once said, “Financial reports are like icebergs. 90% of its mass is under the surface.” Today, both Barry Minkow and I teach fraud detection seminars to law enforcement, the accounting profession, and Wall Street. One of our most important lessons is to always read financial information from the bottom to the top and to cross check company disclosures.

Working your way up from the bottom

Two questions need to be addressed:

  1. Are these numbers genuine?
  2. Why did Overstock.com, without prior notice, suddenly release what seemed to be on its face very good news for the company, earlier than expected?

Let’s address these questions one by one.

First, are these numbers genuine?

In its earnings release, Overstock.com left out certain key disclosures in an apparent effort to hype its first quarter fiscal year 2008 financial performance.

As detailed above, Overstock.com reported that revenues for Q1 2008 were $200.7 million compared to $157.9 million in Q1 2007 or a 27% increase in revenues. However, in its earnings release, Overstock.com failed to disclose that it compared Q1 2008 revenues reported on a GAAP basis to Q1 2007 revenues that were reported on a non-GAAP basis.

In December 2007, as part of its continuing investigation of Overstock.com, the Securities and Exchange Commission required the company to report its revenues in compliance with GAAP. In previous blog items, (here and here), I detailed how Overstock.com had intentionally departed from GAAP and its own disclosures in reporting revenues dating back at least to fiscal year 2000, in violation of Securities and Exchange Commission Staff Accounting Bulletin No. 99.

At the end of the forth quarter of fiscal year 2007, Overstock.com made a one-time catch up adjustment to revenues and other related items to bring its financial statements in compliance with GAAP. In a previous 8-K report, Overstock.com claimed that $13.7 million of revenue and $2.1 million of net income shifted from Q4 2007 to Q1 2008 as a result of the SEC imposed revenue recognition change to comply with GAAP, and that likewise offsetting amounts would be shifted out of Q1 2008 to Q2 2008. However, by failing to restate its Q1 2007 financial reports, we cannot determine the comparability of Q1 2008 versus Q1 2007. We simply don’t know what Q1 2007 would have looked like if it had been reported in accordance with GAAP.

Not only is this a problem for investors, but it is also another violation of GAAP. Overstock.com’s failure to restate prior year’s financial reports for accounting errors is in violation of paragraph 25 and 26 of Statement of Financial Accounting Standards No. 154. According to Statement 154, Overstock.com’s prior year first quarter revenues and related items must be restated if the company elects to compare it to current period results.

According to an article in the CPA Journal by Robert Bloom and Jayne Fuglister, under SFAS 154:

The nature of an error must be disclosed, as well as the effect on the current and prior periods presented. In addition, if an error affects the current or prior periods presented or is expected to affect subsequent periods, the entity must disclose that comparative information has been restated, the effect of the correction by line-item and per-share amounts for all periods presented, and the amount of the adjustment to opening retained earnings.

Overstock.com makes no such disclosures in its earning release, making comparisons impossible, and violating GAAP in the process. So why didn’t Overstock.com report restated data? We can’t say for sure. But in my experience companies rarely omit disclosures by accident.

Has a turnaround really occurred?

In a letter to investors, contained in Overstock.com’s earnings release, CEO Patrick Byrne claimed:

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. The combination of an expanding top line, gross profits and contribution dollars, along with declining fixed costs, is generating operating leverage in our business.

Note: Bold print and italics added by me.

Did Overstock.com really return to “above industry-level growth” in the company’s first quarter of fiscal year 2008 as touted by Patrick Byrne? The short answer is no. As described in more detail below, Overstock.com’s first quarter revenue growth was helped by several material factors undisclosed in the company’s press release (no surprise) and in the process it violated SEC Rule 10b-5. Before we continue, let's examine 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.

By omitting material and significant information, described in more detail below, Overstock.com's earning release violates SEC Rule 10b-5 by misleading investors in a deliberate effort to drive up the market value of the company's stock and squeeze short sellers.

Overstock.com violates Rule 10b-5 by omitting material facts from its earnings release

During Q1 2008, Overstock.com disproportionately benefited from the arrival of an early Easter season and an extra shopping day due to the leap year not present its recent two fiscal year first quarters. Overstock.com’s previous two fiscal year first quarters did not include high volume Easter holiday sales. The leap year benefit was also absent in prior years. In addition, the arrival of Easter at the tail end of Q1 2008 (March 23), provided a disproportionate bump to cash flows.

In addition, most of Overstock.com’s touted growth in revenues for Q1 2008 compared to Q1 2007 resulted from the fact that Q1 2007 revenues had declined substantially in comparison to Q1 2006, creating an inordinately low revenue base to “improve” upon.

Since Overstock.com did not restate prior year’s revenues as required by SFAS 154, we need to examine other financial disclosures by Overstock.com to determine if the company has really returned to “industry level growth.” I’ll examine Overstock.com’s non-GAAP sales volume disclosures. Consider the next table below:

Other Data

Q1 2006

Q1 2007

Q1 2008

2008 v 2007

2008 v 2006

Shopping bookings (in 000s)

$200,900

$170,362

$216,322

27.00%

7.68%

Auction gross merchandise volume (in 000s)

$8,079

$4,695

$2,610

-44.41%

-67.69%

Total volume (in 000s) - computed by me

$208,979

$175,057

$218,932

25.06%

4.76%

Average customer acquisition cost (shopping customers only)

$19.40

$24.58

$25.21

2.56%

29.99%

Two things stand out in the above table. While total sales volume increased 25.06% in Q1 2008 compared to Q1 2007, unlike Q1 2007, Q1 2008 benefited from high volume Easter holiday sales and an extra shopping day due to a leap year. In addition, Overstock.com’s Q1 2007 sales volume had dropped 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.

Since the drop in Q1 2007 sales volume compared Q1 2006 created a low base of comparison with Q1 2008, we should instead compare Overstock.com’s Q1 2008 sales with Q1 2006. By this comparison, Overstock.com’s Q1 2008 sales only grew 4.76% compared to Q1 2006, hardly the return to “above industry-level growth” as hyped by Byrne. On an annualized basis, this is barely above 2% growth.

Now consider the fact that this 2% annualized growth rate was made possible only because of high volume Easter sales. Q1 2006 did not receive this benefit, nor did it receive the benefit of an extra shopping day due to a leap year.

By failing to disclose the material information above, Overstock.com's earnings release violates Rule 10b-5 by omitting "a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading."

Auction volume falls substantially

On January 10, 2008, Patrick Byrne congratulated Overstock.com’s Auction Community posting a letter on the company’s discussion board:

Dear Auction Community,

You made it. This experiment, this alternative to eBay, has pulled through. That only happened because of a lot of faith and trust from you, the community, as well as a lot of hard work from people inside the company whom most of you will never meet. As hard as you worked, and as much patience as you exhibited, you should know that a group here really coughed up lungs to make this work on your behalf. And now, it has. In 2007 it paid for itself, and even left a few sheckles over. And things look better and better from here.

Note: Bold print and italics added by me.

Contrary to Byrne’s statement, Q1 2008 results paint a very different picture. Auction gross merchandise volume declined steeply from $8.1 million in Q1 2006, to $4.7 million in Q1 2007, and only $2.6 million in Q1 2008. With this kind of dismal performance, it’s hard to see what the double talking CEO of Overstock.com was talking about when he claimed that “In 2007 it paid for itself, and even left a few sheckles over. And things look better and better from here.”

Customer acquisition costs keep going up

Another key financial measure that Patrick Byrne would like to ignore is Overstock.com’s continual growth in customer acquisition costs, which hampers its ability to make profits. The average customer acquisition cost for shopping customers continues to rise, growing at 2.56% in Q1 2008 vs. Q1 2007 and 29.99% in Q1 2008 vs. Q1 2006.

Now put it all together

Now let’s put it all together. Compare the 29.99% rise in shopping customer acquisition costs from Q1 2008 to Q1 2006 with the tepid rise in customer sales volume of 7.68% during the same period. Then factor in the inclusion of Easter and an extra shopping day due to a leap year on Q1 2008 and the absence of such factors in Q1 2006. Last, consider the fact that the company still lost money, despite all of the one-time benefits enjoyed during the quarter. Now ask yourself, have things really improved? Or is Overstock still losing ground?

The next question is, why not be forthright with shareholders? Was it just another effort by Patrick Byrne to “knee the shorts in the groin” with his pattern of lies, deceit, and false and misleading statements and disclosures.

Why did Overstock.com, without prior notice, suddenly release what seemed to be on its face very good news for the company, earlier than expected?

On Friday April 19, all put and call options were due to expire at the close of the market. Patrick Byrne’s disdain for short sellers, and just about any person or entity that has a skeptical position or opinion of his company is well known. For example, when asked about a short squeeze in December 2003 Patrick Byrne replied, “when opportunities come along where we can knee the shorts in the groin, that's always good for fun and amusement."

Was Friday’s press release by Overstock.com a deliberate attempt to “knee the shorts in the groin” and manipulate the price of Overstock.com common stock? To determine this, let’s examine Overstock.com’s first quarter earnings release from the bottom up.

Buried at the very bottom of Overstock.com’s press release was the following new disclosure:

On April 15, 2008, we received a letter from the Office of the District Attorney of Marin County, California, stating that the District Attorneys of Marin and four other counties in California have begun an investigation into the way we advertise products for sale, together with an administrative subpoena seeking related information and documents. We follow industry advertising practices and we intend to respond fully to the subpoena and cooperate with the investigation.

By placing news of a multi-county California District Attorney investigation of Overstock.com’s advertising practices at the bottom of the press release while heralding a supposed 27% increase in revenues, apparently Patrick Byrne wanted to bury news of such investigation while accentuating Overstock.com’s supposedly good financial performance. Apparently, Overstock.com wanted to bury the news of a criminal investigation of the company’s advertising practices by the early issuance of an earnings release that overstated its financial performance. In the process, the stock would rise and cause losses to short sellers as their put options expired.

Sell high, buy low, and afterwards drive the stock price higher again

To make matters worse, on December 15, 2006, Overstock.com sold about 2.7 million common shares to a group of institutional investors at $14.63 per share several weeks before releasing unexpectedly horrendous results for the final quarter of that fiscal year. Several months later, in April 2007, Patrick Byrne revealed a previously undisclosed "game plan" and admitted that "We knew things were going to get really ugly and that the company was going to have take medicine.... in the form of dumping a bunch of inventory....We knew it was going to get ugly."

During Q1 2008, the company repurchased 1.1 million shares at an average price of $10.90 or $3.73 per share lower than it sold shares to institutional investors in December 2006. After Overstock.com’s materially and significantly misleading Q1 2008 earnings release, as described above, the company’s shares climbed from $14.00 per share to close at $18.47 per share.

Apparently, Patrick Byrne's "game plan" for Overstock.com is to hype the company's financial performance and screw investors by selling shares to investors at higher prices to finance his perennially money losing company before releasing unexpected horrendous news. Afterwards, Overstock.com buys back such shares at lower prices before releasing a materially misleading earnings release, again hyping the company's financial performance. Overstock.com uses that same materially misleading earnings release to drive the stock price back up and "knee the shorts in the groin."

Conclusion

The Overstock.com news release was intentionally misleading in violation of Rule 10b-5, and was timed to manipulate the market. In the process, the company walked away with some nice trading profits, too.

To be continued….

Written by:

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

Disclosure: Not short or long Overstock.com

Thursday, April 17, 2008

Patrick Byrne has a new pet journalist with a captured mind

It looks like Patrick Byrne has a new pet journalist with a captured mind. I just received the following email from Mark Mitchell about a story he wants to publish on Patrick Byrne's blog, hosted by Overstock.com (NASDAQ: OSTK). See Gary Weiss's blog for background on Mark Mitchell.
From: Mark Mitchell [mailto:mitch0033@gmail.com]
Sent: Thursday, April 17, 2008 1:38 PM
To: Sam E. Antar
Subject: Interview possible?
Dear Sam,

I am writing a story about short-selllers (sic) and their relationships with independent researchers and the media. I would like to give you the opportunity to respond to various allegations regarding your work.

Is there a time when I can interview you? If so, please provide me with a phone number and a time when it would be convenient for me to call.

My story is for a Web site called DeepCapture.com.

Best regards,

Mark Mitchell
847-XXX-XXXX
I guess that the temperature is rising in Overstock.com's corporate suite as the Securities and Exchange Commission zeros in on the company and Patrick Byrne, the admitted target of their probe. New information has come to light that strongly suggests that Overstock.com bribed Utah Attorney General Mark Shurtleff to defame me. For background information on Utah Attorney General Mark Shurtleff read here and here. I will release other taped conversations with persons at the Utah Attorney General's office, soon.
Update:
Read Gary Weiss's updated blog item "The 'Mark Mitchell Mystery' Solved" and the comments section for an exchange between Gary Weiss and Mark Mitchell. Apparently, Mark Mitchell is being paid Patrick Byrne to do hatchet jobs on other Byrne critics, too.
In adddtion, please read "Shop at Overstock, support Cyberstalking," by Zac Bissonnette.
Written by,
Sam E. Antar (former Crazy Eddie CFO and a convicted felon)

Friday, April 11, 2008

Fraud Discovery Institute Lists "Top Ten Red Flags for Fraud at Herbalife"

In a devastating new press release together with a video on You Tube, convicted felon turned fraud fighter, Barry Minkow, co-founder of the Fraud Discovery Institute takes aim at Herbalife LTD (NYSE: HLF), a multi-level marketing company, listing "ten red flags for fraud" and scolding Wall Street analysts for their failure to carefully examine such red flags stating:

One day in the very near future Wall Street and all of its analysts will marvel that a company possessing so many red flags of fraud could be embraced so widely with the overwhelming credulity that it has.

Minkow goes on to say that:

These red flags, especially those citing saturation, are an apparent motive for the unparalleled insider dumping of the past two quarters by Herbalife (NYSE: HLF) insiders.

The Fraud Discovery Institute's latest press release citing "10 red flags" is based on an updated report by noted multilevel marketing expert, Robert L. Fitzpatrick (a full copy of Fitzpatrick's report is on the Fraud Discovery Institute web site) that is "being submitted to law enforcement, the media, and the general public in hopes of shining light on what appears to be and financial crime in progress."

In the YouTube video, Minkow takes aim at Herbalife's business model:

Some twenty years ago I was the darling of Wall Street with my Z Best carpet cleaning company. Analysts heralded how great of a stock Z Best was but much to my shame I was a liar and a thief and went to prison, deservingly so. The irony is, some twenty years later, there is another darling of Wall Street that is nothing more in our view than a financial crime in progress devastating thousands of victims each week, and each month and each year. And that company is Herbalife, a multi-level marketing company that uses the imputation credibility of being a New York Stock Exchange Company to silence any critics of their business model. A business model that’s doomed by design.

The only way to stop this company is to provide full disclosure to those supervisors and distributors before they sign on the very restrictive dotted line and try to earn money from a company that spends 82% of its compensation on less than 1% of its distributors.

We’re going to profile people in interviews on YouTube where they share their experiences of attending functions, buying books and tapes and products and trying whole heartedly to succeed as both a supervisor and or a distributor of Herbalife, but they failed. And you’re going to hear their stories on YouTube for the world to see because when you type in Herbalife to Google these videos will start coming up, so people will have a shot before they loose their money, to hear the other side of the story because the company is not going to tell you that. Sadly, the analysts don’t either on Wall Street. Almost every red flag for fraud exists in one place – Herbalife. Insiders dumping at alarming rates, while simultaneously repurchasing stock on the open market and going into debt to do so.

At the end of the You Tube video, Barry Minkow warns Herbalife:

And should this company try to sue us, it's been tried and tossed.

Watch to the entire YouTube video by Barry Minkow below:



The press release issued by Fraud Discovery is below:

Herbalife (NYSE: HLF) Red Flags for Fraud Issued

Sub title: Top 10 Red Flags for Fraud at Herbalife LTD (NYSE: HLF), from Fraud Discovery Institute

For Immediate Release

SAN DIEGO/EWORLDWIRE/Apr 11, 2008 --- The Fraud Discovery Institute has just released a list of the Top Ten Red Flags of Fraud at Herbalife, LTD (http://www.frauddiscovery.net/)based upon experts' analysis of the company. According to Barry Minkow, "One day in the very near future Wall Street and all of its analysts will marvel that a company possessing so many red flags of fraud could be embraced so widely with the overwhelming credulity that it has."

Mr. Minkow is referring to the following Top 10 red flags that are a part of a larger report being submitted to law enforcement, the media and the general public in hopes of shining light on what appears to be a financial crime in progress. "These red flags, especially those citing saturation, are an apparent motive for the unparalleled insider dumping of the past two quarters by Herbalife (NYSE: HLF) insiders," Minkow says. "Moreover, FDI will begin utilizing its ever-growing YouTube subscriber base to profile Herbalife victims through multiple interviews of failed supervisors and distributors."

The Top 10 Red Flags are:

1. Nearly 70% of Stock Holdings Dumped:
Approximately seventy percent of senior managements stock holdings were dumped in 2008. While this promotional senior management team touted record earnings, sales and growth potential, it simultaneously dumped approximately 70 percent of their entire holdings. In 2008 alone, senior management dumped and subsequently received over $40 million and in 2007 over $130 million, for a stunning $170 million total. This is one of the most aggressive insider dumpings in recent history, when one simply compares the shares-sold to the percentage of total ownership. To solve the "no more to dump" problem, CEO Michael Johnson received additional stock options this week.

2. Devastating 90% Miss on New Supervisor Growth:
Although not evident until one digs below the surface, when one removes China's new supervisors from the equation - based on the fact that it is an entirely different business model, the company had a devastating 90 percent miss on the growth rate for new supervisors in 2007. To compare, new supervisors were up 20.1 percent in 2005 and 22.6 percent in 2006. A 21 percent increase in new supervisors during 2007 would have given the company over 40,000 new supervisors. Instead, the company only added just over 4,000 new supervisors, or only 10 percent of the growth expected based upon the average rate for the last two years. This is a dramatic drop in new supervisors and is further evidence of saturation. This is especially significant when one considers that Herbalife is ten times the apparent fraud that Usana is in that they recruit at least one million new distributors a year just to draw even. Thus, missing this supervisor growth rate for a company totally contingent upon a million new people a year is serious.

3. 80% Saturation:
Approximately 80 percent of the world is already saturated by Herbalife despite the claim of unlimited growth potential. The company is dependent upon continuous expansion into new territory not just for growth but survival. Yet, already, Herbalife's expansion has reached more than 80 percent of the world's population as the entire continent of Africa, for the most part, is not in the market for weight loss products.

4. 60% Supervisor Turnover:
Approximately 60 percent of Herbalife "supervisors" turn over each year, which accounts for more than half of the company's total revenue. The company admits in its most recent 10-K that growth is only achieved through recruitment of new distributors, which is done by this pool of supervisors. There is no growth to be had in sales of products to existing distributors. The company is therefore dependent on an endless chain of recruiting in this already saturated market. There is no truth to the assertion that the company has unlimited growth potential, as markets are quickly exhausted due to the 80 percent figure cited above.

5. $365 Million Debt:
Herbalife had $365 million in debt - with over $200 million of that on a $250 million line of credit - on the balance sheet at the end of 2007. Were the proceeds of the line of credit used for research and development to improve products? How about for refunds to failed associates and supervisors? The money was used to repurchase almost $366 million of outstanding shares of Herbalife shares in 2007, with $145 million drawn on the line of credit for this purpose in the fourth quarter of 2007. At the same time, insiders dumped at a record pace.

6. Declines in Major Markets:
After more than 20 years in the United States, Herbalife has more sales in Mexico than in its native and headquartered nation - and now the Mexican market is waning. Germany, the largest country in Europe, is dropping steeply. Brazil, the largest market in South America, is in decline.

7. China isn't Viable Long-term:
Herbalife admits in its most recent 10-K: "In August 2005, China published regulations governing direct selling (effective December 1, 2005) and prohibiting pyramid promotional schemes (effective November 1, 2005). These regulations require us to use a business model different from that which we offer in other markets." The word, "China," is repeated more than 100 times in the 2007 Herbalife 10-K and yet by the company's own admission, it cannot conduct multi-level marketing in that country. "Expanding in China represents a significant growth opportunity for us as we believe that China could become one of the largest direct-selling markets in the world over the next several years." The company says that sales in Hong Kong and Taiwan were down as distributors focused more on China. "But the unanswerable question is, 'Why?' Since Taiwan and Hong Kong allow multi-level marketing and China prohibits it, why would distributors focus on the restricted country?" According to Minkow, "It is the hope of cheating in China."

8. Cannibalization of Markets:
The multi-level marketing business model has essentially no repeat customers. Over 80 percent of Herbalife's distributors quit within one year, never to return. With this devastating statistic, the company is forced to find hew territories if it is to replace those distributors and continue to increase the total number of distributors.

9. Unrest in China:
Troubles in China for another multi-level marketing company, Nu Skin Enterprises, are indicators of trouble ahead for Herbalife and similar multi-level marketing companies. Nu Skin was the target of several investigations "... that have resulted in several cases in fines being paid by us, which in the aggregate have been less than 1 percent of our revenue in China." While the figure of less than 1 percent of the China revenue - which was $205 million in 2007 - appears immaterial, it is troubling because it is an indicator of difficulties that other multi-level marketing companies will face while doing business in China.

10. Like Usana, not like Usana:
It appears that Herbalife and the analysts covering multi-level marketing companies make comparisons to competitor Usana Health Sciences in the most convenient of ways. When the SEC's informal investigation into Usana was closed, one analyst remarked that this boded well for Herbalife with its own SEC inquiry ("The companies are alike."). Yet on March 28 when Usana released negative news about lower earnings due to lower recruitment numbers, another analyst reported that Usana's problems were "company specific" ("Usana and Herbalife are not alike."). Only in the world of multi-level marketing can two opposing positions exist simultaneously.

The Fraud Discovery Institute will profile Herbalife victims on YouTube to provide a level playing field for new recruits. Educating the public about the doomed-by-design, multi-level marketing model was effective in the case of Usana. FDI will launch a series of new profiles that will help consumers searching for, "Herbalife," on the Internet. They will now hear the other side of the nightmare that is the Herbalife business opportunity for all but the top 1 percent of distributors.

I will provide my own analysis of Herbalife soon. To be continued.

Disclosure: Not long or short Herbalife or Usana at the time of this writing. I have provided funds in the past to the Fraud Discovery Institute to cover costs of its investigations.

Fraud Discovery Institute has publicly disclosed on its web site that:

In April of 2008, Mr. Minkow once again had an in-person meeting at the Los Angeles office of the Securities and Exchange Commission and informed the commission that he was now shorting Herbalife stock to finance the continued investigation of Herbalife in China and to produce You Tube videos of Herbalife victims. Mr. Minkow also provided direct, online access to the specific trading account where the transaction took place both to the FBI and the SEC including user name and password for the purposes of full disclosure.

Written by,

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