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Patrick Byrne To Tough It Out With SEC Over GAAP Violations

Apparently, (NASDAQ: OSTK) is going to stubbornly tough it out and force the Securities and Exchange Commission to take enforcement action to make its financial reports comply with Generally Accepted Accounting Principles (GAAP). The SEC re-opened its investigation of in response to a series of investigative reports by this blog documenting continuing GAAP violations by the company and other false and misleading representations to investors by its management team, led by CEO Patrick M. Byrne.

Flawed financial reports incorporated in new registration statement

Earlier today, filed a registration statement in connection with its 2005 Equity Incentive Plan. CEO Patrick M. Byrne, CFO Steven J. Chesnut, audit committee members Allison H. Abraham, Clay Corbus, and Joseph J. Tabacco Jr. all signed off on's SEC filing. In addition, PricewaterhouseCoopers (PWC),'s former auditors, consented to the company using flawed financial reports in its SEC filing. See below:


We hereby consent to the incorporation by reference in this Registration Statement on Form S-8 of our report dated February 23, 2009 relating to the financial statements, financial statement schedule and the effectiveness of internal control over financial reporting, which appears in, Inc.’s Annual Report on Form 10-K/A for the year ended December 31, 2008.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP

Salt Lake City, UT

October 26, 2009

As I will detail below,'s 2008 Annual Report on Form 10K/A contained material accounting errors and GAAP violations that were overlooked by PWC during the course of its audit. Therefore, internal controls of financial reporting was ineffective. Worst yet, PWC has given similar consents to in the past, only to have such financial reports later restated due to GAAP violations.

Summary of latest GAAP violations exposed in this blog

In October 2008, 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 restated its financial reports due a violation of GAAP. PWC had erroneously given clean audit opinions on the company's financial reports before each restatement correcting GAAP violations for such reports.

Those customer refund and credit errors also caused to underbill earned income due from its fulfillment partners for offsetting costs and reimbursements. restated its prior financial reports to correct its customer refund and credit errors. However, the company failed to make offsetting corrections and properly accrue underbilled income earned from its fulfillment partners in those same affected prior reporting periods, as required by GAAP.

Instead, 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. For additional details see SFAS No. 154 and SFAS No. 5 paragraph 1, 2, 8, 22, and 23.

In effect, 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 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).'s phony "gain contingency" excuse

After my early blog posts (here and here) detailing's above GAAP violation, the company later claimed that when it initially discovered the accounting error, it immediately determined that a “gain contingency” existed on underbilled amounts due from fulfillment partners because "recovery of such amounts was not assured." See below:

When the underbilling was originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency. Accordingly, we determined that the appropriate accounting treatment for the potential recoveries was to record their benefit only when such amounts became realizable (i.e., an agreement had been reached with the partner and the partner had the wherewithal to pay).

Note: Bold print and italics added by me.

However, in my report to the SEC, I showed that no gain contingency existed because:

(1) The company already earned amounts due from underbilling its fulfillment partners in prior reporting periods,

(2) Its fulfillment partners were already contractually liable to pay all underbilled amounts from prior reporting periods, and

(3) The collection of large sums of such underbilled amounts due from its fulfillment partners was reasonably assured.

Both and PWC had to know that the collection of significant amounts due from underbilling of its fulfillment partners was assured, contrary to its disclosure that "the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency." floats the cash that it receives from customers and is later required to pay fulfillment partners in up to 30 days. The company has the right to offset various errors against future remittances to its fulfillment partners. The company can withhold a larger portion of the monthly remittances from such fulfillment partners (up to a few months, if necessary) to recover underbilling errors. did not have to reach an agreement with its fulfillment partners on underbilled amounts as it claimed, since its supplier agreement already allowed for such offsets (Source: correspondence to SEC Division of Corporation Finance). In addition, the greatest amount of the underbillings would certainly be attributable to its higher volume fulfillment partners who sold the most merchandise and are likely to be long time and current company suppliers.

Therefore,'s ability to recoup a substantial share of previous underbillings to fulfillment partners could have been reasonably estimated, as required by Statement of Financial Accounting Principles No. 5. In many ways,'s recovery of underbilled amounts due from its fulfillment partners was far more certain than recouping money in ordinary credit card disputes from its average customers.

In the eighteen months prior to disclosing its accounting error, the gross potential amount the company underbilled its fulfillment partners was about $4.7 million (See my calculations here). Over $3 million of such amounts due from underbilling its fulfillment partners was actually recovered within weeks and months after the company initially discovered the underbilling errors. and PWC should have also considered subsequent corrected billings to and collections from fulfillment partners after the cutoff date of each financial report and before it filed its respective Q3 2008 10-Q and full year 2008 10-K reports with the SEC.

In other words, if new information, known as "subsequent events" is received after the cut-off date of a financial report but before the filing of such report which affects either assets or income in that financial report, a company must adjust its financial report to reflect that new information. (See: SAS No. 1 Paragraph 1, 2, 3, and 7 and Letter from SEC Chief Accountant entitled "Audit Risk").

Therefore, no gain contingency existed since underbilled amounts due from fulfillment partners was already earned, the fulfillment partners were already contractually required to pay such underbilled amounts, and a substantial amount due to the company from underbilling fulfillment partners was reasonably assured, contrary to company disclosures.

In any case, Securities and Exchange Commission’s interpretation of accounting rules is that “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”). cannot defer income from underbilling its fulfillment partners to future accounting periods.

New Evidence of a botched audit by PWC and's failure to take into account subsequent events

In its Q3 2008 10-Q report, fiscal year 2008 10-K/A report, and Q1 2009 10-Q report, made no subsequent events disclosure. However, in Q2 2009 10-Q report, the company finally made such a disclosure (Footnote 15, page 22):

Management evaluated activity of through July 31, 2009 (the issue date of the Unaudited Consolidated Financial Statements) and concluded that no subsequent events have occurred that would require recognition in the Unaudited Consolidated Financial Statements or disclosure in the Notes to the Unaudited Consolidated Financial Statements.

Note: Bold print and italics added by me.

Why was the subsequent events disclosure omitted from prior financial reports? As I detailed above, failed to consider subsequent corrected billings to and collections from its fulfillment partners.'s 2008 10-K/A financial report was audited by PricewaterhouseCoopers and the 2009 10-K financial report will be audited by Grant Thornton.

Note: A reader has alerted me that’s subsequent events disclosure in Q2 2009 is new required disclosure under SFAS 165. In any case, was required to take into account those subsequent events (corrected billings to and collections from its fulfillment partners) and the company was required to make subsequent events adjustments and disclosures under existing accounting guidance and SEC rules at the time financial reports were issued for Q3 2008, Q4 2008, and Q1 2009. In addition, as I detailed above, no gain contingency existed for underbilled amounts due from fulfillment partners as claimed by the company. Therefore, PWC still botched the 2008 audit.

Grant Thornton

Grant Thornton, will face a dilemma.’s GAAP violations in 2008 caused material errors in 2009 financial reports that Grant Thornton must audit. Will Grant Thornton will go out on a limb and risk issuing a clean audit opinion without restating financial reports to correct its GAAP violations?

Written by:

Sam E. Antar


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 securities short or long. My research on 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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