Wednesday, July 29, 2009

How to Issue Phony Financial Reports and Mislead Investors – Overstock.com and Patrick M. Byrne Style

In three previous blog posts, I detailed how Overstock.com (NASDAQ: OSTK) violated Generally Accepted Accounting Principles (GAAP) and SEC disclosure rules by improperly deferring the recognition of an accounting error to create a cookie jar reserve to inflate future profits. On October 24, 2008, Overstock.com revealed that it underbilled fulfillment partners in periods prior to Q3 2008 because of customer refund and credit errors. The company improperly chose to recognize future recoveries from underbilling its fulfillment partners on a cash basis (non-GAAP) rather than restating previously issued financial reports to correct the material accounting error (GAAP). Note: Details of my previous blog posts here, here, and here).

More recently, I provided Overstock.com with a series of questions to answer about its accounting errors during its Q2 2009 earnings call (Details here). Rather than answer each of my questions, CEO Patrick Byrne went on a ranting diatribe as described by investigative journalist Gary Weiss in his blog (Details here).

The reason for avoiding any meaningful discussion of Overstock.com’s questionable financial disclosures is clear. Overstock.com and Patrick Byrne are desperately trying to avoid restating the company’s financial reports due to accounting errors for the third time in three years.

I will come back to this point later in this blog post. However, first let’s examine Overstock.com’s consistent pattern of financial reporting irregularities and lies by management to investors.

Overstock.com’s history is littered with a consistent pattern of false and misleading financial disclosures and lies by management about the company’s financial performance and compliance with securities laws

Since, its inception in 1999, Overstock.com is has yet to produce a financial report that has not at least initially violated GAAP and SEC disclosure rules. In fact, certain financial reports from 2003 to 2005 were restated twice to correct accounting errors.

From December 2000 to March 2002, Patrick Byrne lied about Overstock.com’s financial performance in a series of interviews on national television and in various publications prior to the company’s initial public offering in March 2002. Patrick Byrne deceptively used pro forma non-GAAP “gross value merchandise value sales” (instead of the lower GAAP commission revenue) to hype the company’s top-line performance in order to falsely claim that Overstock.com was profitable, when it never was profitable (Details here).

In April 2004, Patrick Byrne appeared on the Kudlow and Cramer show on CNBC and commented about GAAP and a non-GAAP pro forma measure called "Earnings before interest, depreciation, and amortization" or EBITDA:

Well, first of all, I’m all about GAAP. I have been so critical of the companies that do–I don’t believe in one-time charges; I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook.

Note: Bold print and italics added by me.

In October 2004, Patrick Byrne bragged, "We don't resort to any pro forma accounting tricks to make the numbers look better." In January 2006, Patrick Byrne made the following comment about EBITDA to Tom Mullaney from Business Week in an email, "…I think “EBITDA” is the stupidest thing I ever heard emanate from Wall Street (no small feat)...."

Over the next few years, it became clear that Overstock.com never issued a financial report for any quarterly reporting period that initially conformed to GAAP or SEC disclosure rules, despite Byrne's April 2004 claim that he was "all about GAAP." Overstock.com even resorted to reporting a non-compliant EBITDA that violated SEC rules. As I will demonstrate below, Overstock.com did not comply with both GAAP and allowable non-GAAP financial measures (such as EBITDA) under SEC rules. In other words, investors are cautioned to be skeptical of any disclosure coming from Overstock.com and its management team led by corporate miscreant Patrick Byrne.

In February 2006, Overstock.com restated financial reports dating from 2002 to 2005 due to inventory accounting errors. Only because of Overstock.com's inventory build up at that time, the timing of Overstock.com's inventory accounting error disclosure enabled Patrick Byrne to boast that the company's numbers were too conservative. However, Overstock.com's later restatement of financial reports announced in October 2008 wiped out previous positive adjustments to income from correcting its inventory accounting error by a factor of three.

In Q4 2006, Overstock.com took advantage of record losses and inflated inventory reserves. Former company President Jason C. Lindsey told investors that, "we used the fourth quarter to get rid of all the slow-moving inventory. I am quite pleased with the inventory balances we have now. ...I am pleased that the fourth quarter is now over. We have sold it."

However, Overstock.com later disclosed that inventory reserves had actually increased in both relative and absolute amounts. If Overstock.com had actually sold "all the slow-moving inventory as claimed by Lindsey, there is no way that inventory reserves can increase in both absolute and relative terms. The company overstated its inventory reserves to create a cookie jar reserve so it could increase profits in fiscal year 2007 (Details here).

From Q2 2007 to Q2 2008, Overstock.com violated SEC Regulation G by reporting a non-compliant “Earnings before interest, taxes, depreciation and amortization” or EBITDA to materially overstate its financial performance.

As I detailed above, Patrick Byrne had previously claimed that "I don’t believe in EBITDA. If somebody talks EBITDA, put your hand on your wallet; they’re a crook." He said that “EBITDA is the stupidest thing I ever heard emanate from Wall Street." Therefore, Patrick Byrne is "stupid" and a "crook" by his own definition, since Overstock.com used a non-compliant EBITDA to materially overstate its financial performance in violation of SEC Regulation G.

Despite Byrne's prior statements, Overstock.com improperly reconciled its non-compliant EBITDA to operating income rather than net income and improperly excluded stock-based compensation costs from its non-compliant EBITDA measure. When pressed by me to discuss Overstock.com's non-compliant EBITDA disclosures, CEO Patrick Byrne, company President Jonathan E. Johnson, former CFO David Chidester, now demoted by the company, lied to investors in a conference call about Overstock.com’s compliance with SEC Regulation G (Details here).

Lee Webb from Stockwatch chronicled my year long battle with Overstock.com to successfully force the company to comply with SEC Regulation G for certain non-GAAP financial disclosures and my ongoing battle to force the company to comply with GAAP and SEC rules in reporting certain accounting errors (Details here).

In January 2008, former company President Jason C. Lindsey backdated his resignation (Details here).

In January 2008, the Securities and Exchange Commission discovered that Overstock.com's revenue accounting failed to comply with GAAP and SEC disclosure rules, from the company's inception (Details here). This blog detailed how 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.

In April 2008, Company President Jonathan E. Johnson lied to Wired.com about Overstock.com’s GAAP compliance in reporting revenues. In a financial report, Overstock.com compared Q1 2008 GAAP revenues to non-GAAP Q1 2007 revenues. At that time Overstock.com failed to restate Q1 2007 revenues to correct material revenue accounting errors uncovered by the SEC (Details here). Shortly afterwards, Johnson sold almost $1 million in stock (Details here). The next month, now demoted CFO David Chidester cashed out about $77,000 from selling his Overstock.com shares. Several months later, Overstock.com had to restate Q1 2007 revenues.

On October 24, 2008, Overstock.com disclosed new customer refund and credit errors and it 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 used to correct its revenue accounting errors and also restated all financial statements to correct those errors, as I previously recommended.

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.

Since Overstock.com had previously reported an increase in accumulated losses from its revenue accounting error of $2.1 million (see above), its new customer refund and credit errors resulted in an additional $8.2 million in accumulated losses in prior reporting periods.

It was the second time in three years that Overstock.com had to restate its financial reports and the company filed amended reports with the SEC. In addition, Overstock.com corrected its non-compliant EBITDA measure (as described above) in those amended financial reports. However, the explanatory note to those amended financial reports filed with the SEC, Overstock.com only made reference to corrections of its revenue accounting errors customer refund and credit errors, but made no reference to correcting its non-compliant EBITDA to comply with SEC Regulation G.

Overstock.com inflates losses from an accounting error to create a cookie jar reserve to increase income in future accounting periods

As I will detail below, Overstock.com’s additional accumulated losses of $8.2 million in prior reporting periods from its customer refund and credit errors were improperly overstated by at least $3.0 million dollars to create a cookie jar reserve to inflate future earnings. In its restatement of prior period financial reports, Overstock.com failed to include accruals of income for amounts due to the company from underbilling its fulfillment partners for offsetting costs and reimbursements, less a reasonable estimate of uncollectible amounts, as required by GAAP.

Instead, Overstock.com improperly recognized over $3 million of such underbilling recoveries over three future quarters (Q4 2008, Q1 2009 and Q2 2009) as income on a cash basis. As a result, Overstock.com improperly deferred recognition of an accounting error over future periods and materially inflated income during those periods. In effect, Overstock.com wrongfully corrected an accounting error over two or more periods by using a cookie jar reserve.

The SEC does not permit the correction of an accounting error “prospectively, over two of more periods”

In a “cease and desist order” issued “In the matter of Carl M. Apel,” the Securities and Exchange Commission took the following position:

The correction of error, including erroneous estimates related to loss contingencies, should be disclosed in the period in which the error is discovered. The correction is accounted for and reported as a prior period adjustment, that is, by restating the financial statements of the affected prior periods. See FAS 16, Prior Period Adjustments (June 1977) [as partially superseded by FAS 109, Accounting For Income Taxes (February 1992) ¶288(n)]; APB 20, ¶¶13, 36 and 37; and APB 9, Reporting the Results of Operations (December 1966) ¶¶18 and 26.

As these provisions make clear, GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error. If a change in estimate affects one period only, the change may not be accounted for over two or more periods in order to diminish the effect of the change on income, or for any other purpose. Correction of error may not be accounted for prospectively, or over two or more periods, in order to diminish the effect of the correction on any one period.

Note: Bold print and italics added by me.

As the SEC makes clear, “GAAP do not allow for the deferral of accounting adjustments arising from a change in estimate or the correction of error” and “Correction of error may not be accounted for prospectively, or over two or more periods, in order to diminish the effect of the correction on any one period.” However, Overstock.com prospectively corrected its accounting errors from underbilling fulfillment partners over three periods and violated GAAP and SEC rules.

After my original blog post exposed Overstock.com’s latest financial reporting violations, the company is desperately trying to avoid a third restatement of its financial reports due to the improper deferral of income from recovering offsetting cost reimbursements and fees against its customer refund and credit errors from its fulfillment partners.

Q4 2008: Overstock.com’s improper accounting of customer refund and credit errors

On January 30, 2009, Overstock.com reported a net profit of $1 million profit and $.04 earnings per share for Q4 2008, after 15 consecutive quarterly losses and it beat mean analysts’ consensus expectations of negative $0.04 earnings per share. CEO Patrick Byrne gloated to investors, "After a tough three years, returning to GAAP profitability is a relief."

However, Overstock.com's press release failed to disclose that its $1 million reported profit resulted from a one-time gain of $1.8 million relating to payments received from fulfillment partners for amounts previously underbilled them. Later, during the earnings call, CFO Steve Chesnut finally admitted to investors that:

Gross profit dollars were $43.6 million, a 6% decrease. This included a one-time gain of $1.8 million relating to payments from partners who were under-billed earlier in the year.

Note: Bold print and italics added by me.

As I detailed above, Overstock.com already disclosed in an October 24, 2008 press release that it failed to bill its fulfillment partners for offsetting cost reimbursements and fees resulting from its customer refund and credit errors. The company claimed to have already corrected those errors by restating all financial reports issued prior to Q3 2008 and it increased accumulated losses by $10.3 million.

As it turned out, Overstock.com improperly failed to include in its restatement of previously issued financial reports an accrual of amounts due the company from underbilling its fulfillment partners for offsetting costs and reimbursements, less a reasonable estimate of uncollectible amounts.

After the earnings call, I wrote blog post explaining that if Overstock.com properly followed accounting rules, it would have reported an $800,000 loss instead of a $1 million profit, it would have reported sixteen consecutive losses instead of 15 consecutive losses, and it would have failed to meet mean analysts’ consensus expectation for earnings per share (anyone of three materiality yardsticks under SEC Staff Accounting Bulletin No. 99 that would have triggered a restatement of prior year’s effected financial reports).

Patrick Byrne responded to me on a stock market chat board

On February 6, 2009, Patrick M. Byrne responded to my blog post and tried to rationalize Overstock.com’s treatment of the “one-time gain” in an unsigned post, using an alias, on an internet stock market chat board. Byrne’s chat board post was later removed and re-posted with his name attached to it, after I complained to the SEC. Here is what Patrick Byrne told readers on the chat board:

Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.

For example: when one discovers that one underpaid some suppliers $1 million and overpaid others $1 million. For those whom one underpaid, one immediately recognizes a $1 million liability, and cleans it up by paying. For those one overpaid, one does not immediately book an asset of a $1 million receivable: instead, one books that as the monies flow in. Simple conservatism demands this (If we went to book the asset the moment we found it, how much should we book? The whole $1 million? An estimate of the portion of it we think we'll be able to collect?) The result is asymmetric treatment. Yet Antar is screaming his head off about this, while never once addressing this simple principle. Of course, if we had booked the found asset the moment we found it, he would have screamed his head off about that. Behind everything this guy writes, there is a gross obfuscation like this. His purpose is just to get as much noise out there as he can.

Note: Bold print and italics added by me.

Actually, Patrick Byrne confirmed that I was correct in saying that Overstock.com improperly used cash basis accounting (non-GAAP) rather than accrual basis accounting (GAAP) to correct its accounting error. In a follow up blog post, I criticized Byrne’s response noting that:

… Overstock.com recognized the "one-time of $1.8 million" using cash-basis accounting when it "received payments from partners who were under-billed earlier in the year" instead of accrual basis accounting, which requires income to be recognized when earned. A public company is not permitted to correct any accounting error using cash-basis accounting.

Patrick Byrne claimed that “…one books that as the monies flow in. Simple conservatism demands this…”

However, the SEC’s position is that you cannot abuse “conservatism” to “understate net assets and profits” or by overstating a loss from an accounting error to create a cookie jar reserve to increase income in future reporting periods. However, that's exactly what Overstock.com did.

SEC Chief Accountant’s position on abusing “conservatism”

In 1999, the SEC’s Chief Accountant concerned about “earnings management” by companies warned issuers against using “conservatism” to deliberately understate “net assets and profits” or, in effect, overstate losses. See below:

The SEC staff also has noted that some believe that conservatism is a characteristic that should be discussed. However, in SFAC 2 the FASB noted:

“Since a preference that possible errors in measurement be in the direction of understatement rather than overstatement of net income and net assets introduces a bias into financial reporting, conservatism tends to conflict with significant qualitative factors such as representational faithfulness, neutrality, and comparability (including consistency)...Conservatism in financial reporting should no longer connote deliberate, consistent understatement of net assets and profits...The Board emphasizes that any attempt to understate results consistently is likely to raise questions about the reliability and integrity of the information about those results and will probably be self-defeating in the long run.”

Accordingly, the consistent understating of results (i.e., conservatism) or overly optimistic estimates of realization (i.e., lack of conservatism or aggressiveness) are inconsistent with the characteristics of quality financial reporting needed for transparent reporting in today’s markets. As some have noted, an analogy can be made to the game of golf. One desires to hit the ball down the middle of the fairway to get the best result and longest drive. While staying in the fairway is acceptable, the quality of the drive is determined by how close to the middle one gets. The staff believes that it is important for financial management and auditors to communicate with the audit committee whether, and where, the ball is on the fairway.

Note: Bold print and italics added by me.

After Patrick Byrne’s chat board remarks confirming improper cash basis accounting, Overstock.com concocted a new excuse to justify Patrick Byrne’s stock market chat board ramblings.

How Overstock.com tried to justify using non-GAAP cash basis accounting to improperly defer correcting an accounting error in Q4 2008, Q1 2009, and Q2 2009

On February 23, 2009, Overstock.com filed its fiscal year 2008 10-K with the SEC and that report included Q4 2008’s quarterly numbers. The company tried to justify using cash basis accounting to correct its accounting error by saying that “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.” See below:

In addition, during Q4 2008, we reduced Cost of Goods Sold by $1.8 million for billing recoveries from partners who were underbilled earlier in the year for certain fees and charges that they were contractually obligated to pay. 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.

In Q1 2009, Overstock.com continued to claim that it could recognize income from recovering previous underbillings of its fulfillment partners on a cash basis due to a "gain contingency." In addition, the company disclosed yet another accounting error originating in Q4 2008 resulting from overbillings by a freight carrier. Overstock.com improperly recognized that accounting error as income in Q2 2009, rather than restate its Q4 2008 financial report as required by GAAP:

In Q1 2009, we reduced total cost of goods sold by $1.9 million for recoveries from partners who were underbilled in 2008 for certain fees and charges that they were contractually obligated to pay and a refund due of overbillings by a freight carrier for charges from Q4 2008.

During the earnings call that followed Overstock.com’s Q1 2009 press release, Patrick Byrne gave a fuzzy quantification of the “overbilling by a freight carrier for charges from Q4 2008. He said:

…we did get the benefit of a shipping billing benefit of some several hundred thousand dollars and so forth.

In Q2 2009, Overstock.com collected another $87,000 from fulfillment partners. During the earnings call, Patrick Byrne reiterated Overstock.com's claim that a "gain contingency" existed for underbilled amounts due from fulfillment partners:

First question is when the under-billing was originally discovered, we determined that the recovery of such amounts was not assured and consequently the potential recovery constituted a gain contingency.

That's correct, as we unraveled in the fourth quarter last year, and so Sam then asks a whole bunch of questions about this.

But the short answer is we unraveled this in the fourth quarter. It all came about simultaneously with the facts leading to the restatement. And when you discover that you owe people money, or that you're not owed money that you thought you were owed, you announce that immediately when you discover that you think you've under-billed other people, that's called a contingent gain, and you don't get to book the entire thing as an asset immediately, because you got to go and collect it.

Note: Bold print and italics added by me.

According to claims in Overstock.com’s financial disclosures to the SEC and Byrne’s comments during the Q2 2009 earnings call, the decision to consider future recoveries from underbilling fulfillment partners as a "gain contingency" was made at the time the underbilling error was discovered. If that is really true, the date such discovery had to have been much earlier than October 20, 2008, the date that the Board of Directors approved the company's restatement of previously issued financial reports to correct customer refund and credit errors (Source: 8-K report page 5).

However, auditing and SEC rules require that a company take into account material events affecting the measurement or realization of assets in a financial report up to the date that either the final 10-Q report or 10-K report is filed with the commission (See: SAS No. 1 Paragraph 1, 2, 3, and 7 and Letter from SEC Chief Accountant entitled "Audit Risk"). In other words, if new information is received after the cut-off date that affects either assets or income in a financial report, a company must adjust its financial report to reflect that new information.

If Overstock.com's explanation of a gain contingency is to be believed, the company improperly determined that a gain contingency existed when it first discovered underbilling its fulfillment partners, instead of spending any time trying to determine the recoverability of such underbilled amounts.

Overstock.com should have waited at least until November 7, 2008 (or 38 days into the fourth quarter) when it filed its Q3 2008 10-Q report before making a final determination as to the collectibility of underbilled amounts due from fulfillment partners as of the end of Q3 2008.

In fact, the company could have waited an additional seven days to determine the collectibility of underbilled amounts due from fulfillment partners and still filed its 10-Q report on time. If management truly wanted to make a reasonable estimate as to the collectibility of underbilled amounts due from fulfillment partners, Overstock.com could have properly filed a late 10-Q report by explaining the circumstances. It didn't. Apparently, management deliberately tried to avoid restating its financial reports for a third time in three years.

In any case, no gain contingency existed at all and Overstock.com collected $1.8 million in underbilled amounts from its fulfillment partners during Q4 2008. Since Overstock.com filed its Q3 2008 10-Q report 38 days into the fourth quarter, management had to know that large amounts due from underbilling its fulfillment partners were in fact collectible.

Therefore, Overstock.com cannot claim that "we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency". In fact, the recovery of large amounts of previously underbilled amounts was "assured" since the company quickly recovered $1.8 million in Q4 2008.

Why Overstock.com’s claimed “gain contingency” is a false representation to investors

Overstock.com had already earned those "fees and charges" in prior periods from fulfillment partners. It simply underbilled them. Those fulfillment partners were already "contractually obligated to pay" such underbilled amounts. In addition, there was no question that Overstock.com was owed money from its fulfillment partners and that the recovery of substantial amounts was assured. Therefore, no gain contingency existed under accounting rules.

If there was any question as to the recovery of any amounts owed the company, management is required to make a reasonable estimate of uncollectible amounts (loss contingency) and book an appropriate reserve against amounts due from fulfillment partners. By immediately considering underbilled amounts due from fulfillment partners as a gain contingency, the company failed to make a reasonable estimate of such uncollectible amounts and violated accounting rules or GAAP (See SFAS No. 5 paragraph 1, 2, 8, 22, and 23).

Statement of Financial Accounting Standards No. 154 requires Overstock.com to restate affected prior period financial reports to reflect when the underbilled cost reimbursements and fees were actually earned by the company (accrual basis or GAAP). Statement of Financial Accounting Standards No.5 requires Overstock.com to offset such accrued income in each restated financial period with a reasonable estimate of uncollectible underbilled amounts.

Therefore, Overstock.com overstated its customer refund and credit accounting error by failing restate its prior affected financial reports and accrue underbilled amounts due from its fulfillment partners as income in the appropriate accounting periods, less a reasonable reserve for unrecoverable amounts. By improperly deferring recognition of income until underbilled amounts were collected, the company used non-GAAP cash basis accounting to effectively create a "cookie jar" reserve to increase future earnings.

In addition, Overstock.com improperly failed to disclose any potential “gain contingency” in its Q3 2008 10-Q report, when it disclosed that it underbilled its fulfillment partners (See SFAS No. 5 Paragraph 17b). Was management's claimed "gain contingency" a backdated made up attempt to cover up the company's improper treatment of an accounting error? The "gain contingency" disclosure only appeared in Overstock.com's fiscal year 2008 10-K after I criticized its improper treatment of the underbilling error in my blog.

The only way that Overstock.com could recognize income from underbilling its fulfillment partners in future accounting periods is if there was a “significant uncertainty as to collection” of all underbilled amounts (See SFAS No. 5 paragraph 23). As it turns out, a large portion of the underbilled amounts to fulfillment partners was easily recoverable within a very brief period of time. Therefore, no “significant uncertainty as to collection” existed.

During Q4 2008, Overstock.com collected a total of “$1.8 million relating to payments from partners who were underbilled earlier in the year.” Overstock.com filed its Q3 2008 10-Q report 38 days into that quarter and clearly should have known by that time that significant amounts owed by fulfillment partners from underbilling them in the past was actually collectible and that no gain contingency existed as to such amounts.

On February 23, 2009, Overstock.com filed its annual audited 10-K report with the SEC. By that time, Overstock.com clearly knew that $1.8 million in underbilled amounts due from fulfillment partners was collected by December 31, 2008. In addition, Overstock.com collected over $1.5 million in underbilled amounts during Q1 2009. Since Overstock.com issued its 10-K report 54 days into Q1 2009, the auditors should have known that no gain contingency existed for underbilled amounts due from fulfillment partners. Overstock.com "dismissed" PricewaterhouseCoopers as its auditors and replaced them with Grant Thornton, shortly thereafter.

To summarize the material financial distortions caused by Overstock.com’s improper deferral of income from an accounting error, see the chart below:

In $000s

Q4 2008

Q1 2009

Q2 2009

Total Trailing Nine Months

Net income or loss (as reported)

1,014

(2,099)

389

(696)

Improper deferral of accounting error from underbilling fulfillment partners in prior reporting periods or before Q3 2008 (estimated for Q1 2009 based on Byrne's earnings call comments)

(1,800)

(1,411)

(87)

(3,298)

Q4 2008 overbilling by a freight carrier recognized as income in Q1 2009 in Q4 2008 (estimated amount based on Byrne's earnings call remarks)

500

(500)

0

0

Net income or loss (under GAAP)

(286)

(4,010)

302

(3,994)

Taking advantage of convertible debt holders and other one-time items aid Overstock.com's financial performance.

In November 2004, Overstock.com raised new cash through the issuance of convertible debt securities. Since that offering, Overstock.com restated its financial reports from 2003 to 2004 two times. In other words, Overstock.com's convertible debt holders relied on financial reports that violated GAAP and SEC disclosure rules.

In Q1 2009, and Q2 2009, Overstock.com reported gains of $1.926 million and $0.884 million respectively from buying back such debt at a discount to its face value, thereby taking advantage of those investors who relied on financial reports that violated GAAP and SEC rules.

In Q1 and Q2 2009, Overstock.com benefited from the reimbursement of legal fees due to an insurance settlement in the amount of $0.6 million each quarter.

In Q1 2009, Overstock.com made a one-time exit payment departing director James. V. Joyce.

In Q2 2009, Overstock.com benefited from one-time adjustments relating to a change of estimate involving past accrued restructuring charges totaling $0.218 million.

See the chart below:

In $000s

Q4 2008

Q1 2009

Q2 2009

Total Trailing Nine Months

Net income or loss (as reported)

1,014

(2,099)

389

(696)

Improper deferral of accounting error from underbilling fulfillment partners in prior reporting periods or before Q3 2008 (estimated for Q1 2009 based on Byrne's earnings call comments)

(1,800)

(1,411)

(87)

(3,298)

Q4 2008 overbilling by a freight carrier recognized as income in Q1 2009 in Q4 2008 (estimated based on Byrne's earnings call remarks)

500

(500)

0

0

Net income or loss (under GAAP)

(286)

(4.010)

302

(3,994)

Gain from repurchasing convertible debt at a discount

0

(1,926)

(884)

(2,810)

Gain from settlement with insurer on legal fees

0

(600)

(600)

(1,200)

Gain from change in estimate of restructuring charges

0

0

(218)

(218)

Exit payment to departing director

0

1,250

0

1,250

Net income or loss (excluding various items above)

(286)

(5,286)

(1,400)

(6,972)

As the above chart demonstrates, Overstock.com only reported profits in Q4 2008 and Q2 2009 due to GAAP violations, buying back debt issued under false pretenses at a profit, and other one-time benefits. Overstock.com has never reported a profitable year during its entire existence and has accumulated losses of over $266 million. The company has a negative net worth of $4 million.

To be continued.....

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.

Monday, July 13, 2009

InterOil, John Thomas Financial, and Clarion Finanz: Anatomy of a Stock Market Manipulation Scheme

In this blog post, I will provide evidence of what I believe is a stock market manipulation scheme involving InterOil (NYSE: IOC), John Thomas Financial, and Clarion Finanz AG. I believe that InterOil with the assistance of Clarion Finanz concealed John Thomas Financial’s involvement in helping it raise $95 million through a private placement of convertible debt securities.

Clarion Finanz acted as a buffer between InterOil and John Thomas Financial to help InterOil hide John Thomas Financial's role in raising funds. Afterwards, InterOil filed false and misleading reports with the Securities and Exchange Commission in an effort to conceal John Thomas Financial’s role in helping the company raise $95 million in convertible debt.

Carl Caserta, who in 1991 was barred by the Securities and Exchange Commission from “association with any broker, dealer, or investment advisor” played a role in helping InterOil use John Thomas Financial to obtain funds from investors. InterOil, John Thomas Financial, and Clarion Finanz concealed Caserta's role in helping the company raise $95 million in convertible debt.

About a year later, John Thomas Financial helped InterOil improperly inflate the price of its common shares above $32.50 per share to force the conversion of debt to equity. Wayne Kaufman from John Thomas Financial appeared on CNBC and called InterOil "Our favorite stock" and falsely disclosed that his company and InterOil had no prior business relationship.

A couple of days later, John Thomas Financial issued a press release hyping Kaufman's CNBC appearance and his recommendation of InterOil and that press release also failed to disclose any prior relationship between the companies. Brokers from John Thomas Financial cold-called customers to get them to buy InterOil common shares and pump up the price of InterOil common shares.

Right after John Thomas Financial started pumping InterOil shares to investors, without making conflict of interest disclosures, InterOil common shares traded over $32.50 per share for fifteen consecutive days, enabling the company to force the conversion of all convertible debt to equity. Clarion Finanz is a major shareholder of InterOil and the value of its stock holdings rose as a result of the illegal scheme.

Investigation by Fraud Discovery Institute with Research Help from Me Documents the Scheme

My conclusions are based on a two month investigation by convicted felon turned fraud fighter and short seller Barry Minkow (co-founder of the Fraud Discovery Institute) with additional research assistance from me.

Evidence of the stock market manipulation scheme was pieced together from InterOil filings with the Securities and Exchange Commission. I compared InterOil financial disclosures with Court filings and affidavits involving a lawsuit brought by William Ziegler against John Dolan and two of his entities (Carey International Ltd and John Thomas Structured Finance - unrelated to John Thomas Financial above).

Dolan had assisted InterOil in raising funds for the $95 million convertible debenture private placement and raised $20 million from Ziegler. However, Ziegler's lawsuit claims that he is owed certain fees from Dolan and his companies.

Note: Download lawsuit here, download exhibits here, download John Dolan affidavit here, download Thomas Belisis (John Thomas Financial) affidavit here, and download Neil Dolinsky (InterOil Affidavit) here.
In addition, I obtained certain documentation from reliable sources that confirms my belief of a stock market manipulation scheme between InterOil, Clarion Finanz, and John Thomas Financial. That documentation was delivered by me to securities regulators.

Details of the scheme are below.

Private Placement of $95 million in Convertible Debt

On May 3, 2006, InterOil entered into a two year $130 million loan agreement with Merrill Lynch Capital Corporation and Clarion Finanz. Merrill Lynch provided InterOil with $70 million and Clarion Finanz provided the company with $60 million under the said loan.

By March 31, 2008, InterOil had drawn down all of the funds under the loan agreement and lacked enough funds to pay back the $130 million loan. On May 1, 2008, InterOil extended the loan maturity date to May 12. (See Page 10, Note 3). On May 6, 2008, Clarion Finanz converted its $60 million share of the $130 million loan to 2,649,007 shares of common stock, including 79,470 shares issued as a fee, based on a price of $22.65 per share (See Annual Information Form Page 45 and 46).

InterOil required a $95 million cash infusion to pay back $70 million of debt still due to Merrill Lynch by May 12. In addition, the company needed to raise an additional $25 million of working capital to fund its operations. As of March 31, 2009, InterOil reported working capital of only $61.2 million and paying back such debt would have wiped out its working capital (See Consolidated Balance Sheet).

The company prepared to raise that $95 million through a private placement of convertible debt securities. Reliable information received by me and passed on to securities regulators, shows that InterOil initially sought the help of John Thomas Financial, who in turn brought in Carey International to assist the company in raising funds. According to court documents filed in the Ziegler lawsuit, John Thomas Financial received a "royalty fee" or finder's fee from Carey International.

Other documentation shows that InterOil CEO Phil Mulacek's brother Pierre Mulacek, President of Arkanova (OTC BB: AKVA.OB) had a previous investment banking relationship in March 2008 with John Thomas Financial when Arkanova paid a finder's $40,000 fee to John Thomas Financial. Pierre Mulacek is a founding shareholder of InterOil.

InterOil used Clarion Finanz as a Buffer to Hide the Role of John Thomas Financial

InterOil chose to hide the role of Carey International and John Thomas Financial in helping the company raise $95 million for its private placement convertible debt offering. Initially InterOil was dealing directly with Carey International and John Thomas Financial. Later, InterOil used Clarion Finanz, headed by Carlo Civelli, as a buffer between InterOil on one side and Carey International and John Thomas Financial on the other side of the transaction.

According to the New York Times, "InterOil has obtained millions of dollars in loans from Clarion Finanz AG, the investment firm of Carlo Civelli, a Swiss businessman who has worked with Mr. Mulacek since 1996 as an investor or adviser." Carey International and its principal John Dolan did not know that they were being used as buffer as part of a stock market manipulation scheme.

Other information obtained by me and passed on to securities regulators show that Carl Caserta played a role in helping the InterOil with the assistance of John Thomas Financial raise $95 million in convertible debt. In 1991, Caserta was barred by the Securities and Exchange Commission from “association with any broker, dealer, or investment advisor."

In a previous blog post, I detailed how in New York Times in 2007 reported that, Caserta "stopped working for InterOil" in 2005. According to the article, InterOil claimed that it "was not aware of Mr. Caserta's history when he was retained." However, an investigation by Fraud Discovery Institute co-founder Barry Minkow revealed that Caserta retained an active email address at InterOil up to the day of my blog post.

InterOil decided to directly pay Clarion Finanz $5.7 million in convertible debentures for its role in helping the company raise $95 in its private placement of convertible debentures and have Clarion Finanz enter into a separate agreement with Carey International and John Thomas Financial:

IOC issued to Clarion 228,000 restricted shares of its common stock as a finders fee, valued at $25 per share, equating to a total value of $5.7 million. (Source: InterOil Special Projects Manager Neil Dolinsky affidavit from Zeigler v Dolan et al).

On April 24, 2008, Clarion Finanz entered into a separate Investment Banking Consulting Agreement with Carey International for its role in helping Clarion Finanz raise funds for InterOil. The agreement called for Carey International to "receive compensation in the amount equal to five and one half percent (5 1/2%) of gross proceeds...." of funds it helped Clarion Finanz raise on behalf of InterOil. In addition, the agreement stated that "Carey International Ltd and/or assigns will pay a royalty fee of approximately 20% to John Thomas Financial and/or assigns."

By May 12, 2008, John Dolan and his company Carey International raised $20 million in funds from William Ziegler for the $95 million private placement of convertible debentures. (Note: As described above, in September 2008, Ziegler sued Dolan and his companies claiming that he was owed part of their fees.)

Court documents show that Carey International received 44,000 of the 228,000 restricted common shares due to Clarion Finanz from InterOil. Those shares were issued directly from InterOil to Carey International and John Thomas Financial instead of being paid to them directly by Clarion Finanz. Carey International’s convertible debt shares were valued at $25 per share (total value of $1.1 million or 5.5% of the $20 million raised by Carey). From those 44,000 restricted common shares due Carey International, John Thomas Financial received 20% of such shares as a "royalty fee" or 8,800 restricted common shares valued at $25 per share or $220,000.

InterOil $95 Million Private Placement and False Disclosures

On May 12, 2008, InterOil announced a private placement of $95 million in convertible debt securities to institutional investors and issued the following press release:

INTEROIL ANNOUNCES $95 MILLION PRIVATE PLACEMENT
May 12, 2008 — InterOil Corporation (IOL:TSX)(IOC:AMEX) (IOC:POMSoX), a Canadian company with operations in Papua New Guinea, announced that it has closed on gross proceeds of US$95 million from the sale to institutional investors of 8% Subordinated Convertible Debentures due 2013. InterOil used the proceeds today to fully repay all outstanding indebtedness (US$70 million) under its credit facility with Merrill Lynch Capital Corporation. InterOil will use any remaining proceeds to drill and develop oil and gas wells on the Elk/Antelope structures in Papua New Guinea and for general corporate purposes.
The Convertible Subordinated Debentures carry an 8% coupon rate with a conversion price of US$25.00 per share. In some cases, interest payments may be made in common shares. If the daily volume-weighted average price of the Company’s common shares equals or exceeds US$32.50 for at least 15 consecutive trading days, InterOil may require the investors to convert the debentures into common shares. InterOil may also be required to repurchase the debentures for cash, at 101% of the face value plus accrued and unpaid interest, upon the occurrence of certain change of control events.

The $5.7 million finder’s fee payable to Clarion Finanz was not disclosed in Interoil’s press release detailed above.

On May 28, 2008, InterOil filed Form D with the Securities and Exchange Commission which required the company to disclose sales commissions and finder's fees paid in connection with the $95 million convertible debt offering (See Section C, Item 4 on page 5 of 10). InterOil estimated that no sales commissions or finder's fees would be paid in connection with the offering.

However, Court documents show that InterOil had prior knowledge that such commissions or finder's fees were paid despite the company's failure to disclose them in its May 12 press release and May 28 Form D filing with the SEC. According to an affidavit filed by Neil Dolinsky (InterOil Special Projects Manager) in connection with Ziegler's lawsuit against Dolan and his companies, InterOil agreed to pay Clarion $5.7 million in convertible securities for its role in helping the company raise $95 million in its private placement of convertible securities and that “IOC issued to Clarion 228,000 restricted shares of its common stock as a finders fee, valued at $25 per share, equating to a total value of $5.7 million."

In addition, InterOil knew of the separate agreement entered into between Clarion Finanz and Carey International before its press release and SEC Form D filing. According to that agreement, Carey International was required to pay a "royalty fee" or finder's fee to John Thomas Financial.

In InterOil's 2008 annual report, the company finally disclosed that it paid $5.7 million pursuant to the $95 million convertible debenture offering without mentioning Clarion and cleverly tried to hide such fees as payments to investors (See footnote 23):

The placement fee of $5,700,000 paid to the investors in common shares of the Company was treated to be in the nature of a debt discount and was offset against the liability component. The transaction costs relating to the issue amounting to $219,966 has been split based on the percentages allocated to the liability and equity components; the costs relating to the liability component of $189,711 has been offset against the liability component, and costs relating to the equity component of $30,255 have been allocated against the equity component recognized. [Emphasis added.]

However, $1.1 million of such fees were not paid to "investors" as claimed by InterOil and was instead paid directly to Carey International and John Thomas Financial. Neither John Dolan nor Carey International invested any money in InterOil and therefore, such fees cannot possibly be a part of the $5,700,000 paid to “investors.” Yet, that is exactly where Mr. Dolan’s 44,000 shares, valued at $1.1 million, came from. Ultimately, Carey's shares were divided up into 35,200 shares made payable to Cary International (John Dolan’s group) and 8,800 shares John Thomas Financial (as a royalty fee).

In addition, InterOil provided no disclosure of Clarion’s role in the transaction, unlike other material disclosures relating to Clarion such as on:

Page 37 “Midstream Liquefaction Operating Review” Page 47 “Financing Activities” Page 90 Footnote 19 “Secured loan”

Interoil’s “Annual Report Form” lists various disclosures under the caption, “Material Contracts.” However, InterOil omitted any disclosure relating to Clarion's roles in the $95 million private placement while disclosing Clarion's role in other transactions.

John Thomas Financial’s Orchestrated Campaign to Hype InterOil Common shares Without Disclosing Its Role in the $95 Million Convertible Debt Private Placement

Apparently, there was a very good reason to hide any direct role by John Thomas Financial in raising $95 million of convertible debt. As I will detail below, John Thomas Financial orchestrated a public campaign to hype InterOil stock, without disclosing to investors its conflict of interest from helping InterOil raise convertible debt.

On April 28, 2009, Wayne Kaufman appeared on CNBC and said (see video link):

Our favorite stock is something called InterOil which I recommended on the air before.
Note: Above quote appears 3 minutes and 55 seconds into video clip.

Worst yet, 4 minutes and 6 seconds into the video clip, CNBC shows a screen called "Analyst Disclosure" that checks off the following items as "no."

Stock Ownership: No
Analyst: No
Analyst's Family: No
Analysts's Firm > 1%: No
Investment Banking Client: No
Other Conflicts: No
[Emphasis added.]

See the image below:




Contrary to the disclosure above on CNBC that John Thomas Financial had no investment banking relationship with InterOil, such relationship was cleverly hidden by InterOil using Clarion Finanz AZ as a buffer to raise $95 million for its private placement and have Clarion deal with John Thomas Finance through Carey International.

After Wayne Kaufman’s appearance on CNBC, InterOil common stock closed at $30.39 per share, up $1.14 from the previous day. On April 30, 2009, InterOil common stock closed at $32.29 per share, up $1.90 from the previous day. Brokers from John Thomas Financial were cold calling investors to buy InterOil stock and price of InterOil shares continued to rise.

On May 1, 2009, John Thomas Financial issued a press release touting Wayne Kaufman’s CNBC appearance and featuring his InterOil recommendation without disclosing their broker/dealer relationship with InterOil that was cleverly disguised by false SEC filings as detailed above.

May 01, 2009 14:57 ETSell in May?
CNBC Once Again Features Wayne Kaufman, CMT at John Thomas Financial, Inc. NEW YORK, NY--(Marketwire - May 1, 2009) - John Thomas Financial, Inc., a licensed, full service broker dealer offering client-centric retail brokerage and investment banking services, today announced that Wayne S. Kaufman, CMT and Chief Market Analyst at John Thomas Financial was a featured analyst on CNBC from the floor of the New York Stock Exchange debating whether the "sell in May" indicator will hold true this year, with Jeffrey Hirsch, Wayne Kaufman and CNBC's Rebecca Jarvis.
When asked if this market will keep going, Kaufman remarked that he sees "Nothing that says we can't keep going up. Sellers don't seem to be around and Governments around the world are pumping money into the market. I am looking for a continuation of stocks that have been strong in the tech and energy areas such as Interoil Corp, Symbol IOC on the NYSE."
Thomas Belesis, Founder and CEO of John Thomas Financial, commented, "When the public needs great information they call on the years of experience, technical and analytical skills of Mr. Kaufman."
Kaufman authors the popular daily market letter, "The Kaufman Report," which includes technical and fundamental analysis of the U.S. equities markets, general investment philosophies and reviews of prevailing political, economic and business trends that are impacting the financial markets.
With over 10 years experience as a technical and fundamental market analyst with several Wall Street firms, Kaufman has been widely quoted in the financial media, including CNBC, Bloomberg Radio, Barron's and the Wall Street Journal. Holding the designation of Chartered Market Technician (CMT) and a licensed Research Analyst, Kaufman has served as an online instructor teaching CMT candidates "Level 3" coursework for the Market Technicians Associations (MTA), the leading national organization of technical analysts in the United States. The MTA's CMT program is considered the industry's gold standard in technical analysis. Kaufman graduated from the University of Michigan where he earned a Bachelors degree in Liberal Arts.
To see Wayne's full comments from the show click on the following link:
http://www.cnbc.com/id/15840232?video=1105892699
About John Thomas Financial, Inc.
John Thomas Financial, member of the FINRA and SIPC, is an independent broker dealer and investment banking firm headquartered in New York City's Wall Street district, with a growing network of branch offices throughout the country. Emphasizing a client-centric approach to managing all aspects of its business, the firm offers a full complement of retail brokerage and corporate advisory services tailored to the unique needs of its clients. For more information on the firm, please visit http://www.johnthomasbd.com/ or contact our strategic business development center below. [Emphasis added.].
Information obtained by me and turned over to securities regulators clearly shows that John Thomas Financial's compliance personnel knew from April 2008 about the prior business relationship with InterOil, but they apparently did nothing to disclose the conflict of interest with CNBC or in the above press release. As described above, John Thomas Financial's relationship with InterOil was subsequently papered over to use Clarion Finanz as a buffer between InterOil and John Thomas Financial.

On May 1, 2009, InterOil common stock closed at $35.22, up $2.93 from the previous day. Starting on May 1, 2009 and for 14 consecutive trading days thereafter, InterOil common shares closed above $32.50 per share. InterOil common stock continued to close at above $32.50 per share to May 21, 2009 (Source: NASDAQ).

The $95 million convertible debt private placement had called for a forced conversion of the debt to equity by InterOil under certain circumstances. According to InterOil’s May 12, 2008 press release about the convertible debt:

The Convertible Subordinated Debentures carry an 8% coupon rate with a conversion price of US$25.00 per share. In some cases, interest payments may be made in common shares. If the daily volume-weighted average price of the Company’s common shares equals or exceeds US$32.50 for at least 15 consecutive trading days, InterOil may require the investors to convert the debentures into common shares.

On May 22, 2009, InterOil announced the forced conversion of the its convertible debentures to equity, exactly 15 trading days after John Thomas Financial issued a press release touting Wayne Kaufman’s appearance on CNBC where he called InterOil, “Our favorite stock” without disclosing any prior relationships between the companies.

Meanwhile, Clarion Finanz received about 2.6 million shares on May 6, 2008 from converting its $60 million loan to common stock valued at $22.65 per share. In addition, Clarion received a net amount of 184,000 restricted common shares valued at $25 per share for its role in helping InterOil raise $95 million in convertible debt on May 12, 2008. By May 21, 2009, Clarion Finanz's common shares were valued at $36.23 per share.

For other details of Fraud Discovery Institute's investigation of InterOil, please visit InterNoOil.com.
To be continued....

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 family members mastermind one of the largest securities frauds uncovered during the 1980s. I pleaded guilty to three felonies.

I am assisting Barry Minkow and Fraud Discovery Institute in researching InterOil and Minkow has a short position in InterOil. I have no position in InterOil securities, long or short.

Sunday, July 12, 2009

Overstock.com Issues Unregistered Shares to 401-K Plan


Overstock.com (NASDAQ: OSTK), led by masquerading stock market reformer CEO Patrick Byrne (pictured slobbering drunk to the right), can’t seem to maintain proper internal controls for financial reporting. Just last Friday, Overstock.com disclosed that it improperly issued an extra 201,421 unregistered shares of common stock in connection with the company’s 401-K Plan. The company had to file a new registration statement with the Securities and Exchange Commission relating to those improperly issued unregistered shares. In addition, the company disclosed that it “may be subject to civil and other penalties by regulatory authorities as a result of the failure to register these transactions.” See below:

Note 8 — Unregistered Shares of Overstock.com

In June 2009, the Company discovered that it inadvertently issued 201,421 more shares of the Company’s common stock in connection with the Plan than were registered on the previously filed Registration Statement on Form S-8 (File No. 333-123540) relating to the Plan. Because the Company sponsors the Plan, it is required to register transactions in the Plan related to shares of Overstock.com common stock. In July 2009, the Company filed a new registration statement on Form S-8 (File No. 333-160512) to register future transactions in the Plan.

The Company has always treated the shares issued in transactions with the Plan as outstanding for financial reporting purposes.

The Company believes that it has always provided the employee-participants in the Plan with the same information they would have received had the additional shares been registered. Original purchasers of the Shares may have rescission rights with respect to such Shares under applicable federal securities laws for up to one year following the date of acquisition of the shares. These rescission rights represent a contingent liability of the Company. In addition, the Company may be subject to civil and other penalties by regulatory authorities as a result of the failure to register these transactions.

Note: Bold print and italics added by me.

Two weeks ago, I tipped off AOL syndicated blogger Zac Bissonnette that Overstock.com filed Form 12b-5 "Notification of Late Filing" due to the company's issuance of unregistered shares into its 401-K Plan. Bissonnette reported:

Here's today's update from the irony department -- special thanks to Sam E. Antar for e-mailing it to me. From a FORM 12b-25 filed with the SEC on June 30th:

"The Company recently discovered that it inadvertently issued more shares of the Company common stock in connection with its 401(k) Plan than were registered on the Registration Statement on Form S-8 (File No. 333-123540) relating to the plan. The Company needs additional time to ascertain the facts relating to this issue and to analyze the effects, if any, on the plan."

This would be a funny little accounting screw-up at any company, but that it happened at Overstock.com (NASDAQ: OSTK) makes it especially hilarious: This is a company whose CEO has complained to anyone would listen of a massive conspiracy to counterfeit shares of his company's stock and then sell them into the market -- driving down the stock price and allowing short sellers to profit.

And now we find out that Overstock itself was issuing shares beyond what had been registered with the SEC!

Note: Bold print and italics added by me.

This blog has exposed other Overstock.com financial reporting irregularities in the past.

For example, I discovered that from Q2 2007 to Q3 2008, Overstock.com improperly used a non-compliant EBITDA (Earnings before interest, taxes, depreciation, and amortization) in violation of Securities and Exchange Commission Regulation G governing non-GAAP financial measures. Overstock.com improperly reconciled EBITDA to operating income, rather than net income and improperly excluded stock-based compensation expense from its non-compliant EBITDA. As a result of violating SEC Regulation G, Overstock.com materially overstated its financial performance from Q2 2008 to Q2 2008.

In late 2007, I notified Overstock.com and the SEC of the company's violation of Regulation G. However the company stubbornly refused to comply with Regulation G and report a compliant EBITDA until it filed its Q3 2008 10-Q report with the SEC (Details here).

More recently, I discovered that Overstock.com violated Generally Accepted Accounting Principles (GAAP) by using accounting errors arising in previous reporting periods to improperly and materially overstate reported income in later accounting periods (Q4 2008 and Q1 2009 so far) in violation of Statement of Accounting Standards No. 154 (Details here). I notified Overstock.com and the SEC of the company's GAAP violation. So far, Overstock.com has failed to comply with GAAP and the SEC cannot comment about the issue as per their policy. In the mean time, let's see if Overstock.com stubbornly digs itself into a deeper hole when its reports Q2 2009 financial results.

To be continued....

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 family members mastermind one of the largest securities frauds uncovered during the 1980s. I pleaded guilty to three felonies.

I have no position in Overstock.com securities, long or short. My research on Overstock.com is a freebie for securities regulators to help me try to get into heaven for my past sins, though I doubt I can ever make up for my past evil acts.

Saturday, July 11, 2009

To Bidz.com: Thank you for the subpoena and the check, too!

Memo to Bidz.com CEO David Zinberg:

As you can see by the enclosed picture, I gladly accepted a subpoena from Bidz.com to testify in a class action lawsuit alleging consumer fraud by your company.

My research on Bidz.com (NASDAQ: BIDZ) is a freebie for securities regulators to help me try to get into heaven for past crimes at Crazy Eddie, though I doubt I can ever make up for my past evil acts. My blog posts on Bidz.com's inventory disclosures caused the Securities and Exchange Commission to investigate your company.

Therefore, I thank you for the $44 witness check as a small reward for my efforts, since no one else has paid me to research or write about your company. In fact, when a person from my former office told me that your company was trying to serve me with a subpoena and the attached witness check, I quickly took the subway downtown to accept service and your check.

Kindest regards,

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 family members mastermind one of the largest securities frauds uncovered during the 1980s. I pleaded guilty to three felonies.

I have no position in Bidz.com securities, long or short.

Other Information:

List of White Collar Fraud Blog Posts (Date Order)

Media Reaction to my Blog

Thursday, July 09, 2009

InterOil: How a Deceitful Company Made a Very Dumb Deal, Too

So far this blog has shown how InterOil (NYSE: IOC) filed false and misleading reports with the Securities and Exchange Commission and lied to the New York Times about its dealings with Carl Caserta who was banned by the SEC from the securities industry. As I will detail in this blog post, besides InterOil management being deceitful to investors and the press, they seem to be very dumb, too.

On June 1, 2008, InterOil sold its 43.130% interest petroleum retention lease 4 (PRL 4) for $5 million and its 28.56% interest in petroleum retention lease 5 (PRL 5) for $1.5 million to a wholly owned subsidiary of Horizon Oil Ltd. (ASX: HZN). On May 20, 2009, Horizon Oil Ltd, in turn, sold a 50% interest in PRL 4 and a 24.82% interest in PRL 5 to Thailand based P3 Global Energy Co. Ltd. (P3GE) for $55 million. Therefore, Horizon sold a slightly higher combined stake in PRL 4 and 5 to P3 Global Energy Co. Ltd for over eight times the amount it paid InterOil to acquire those interests in less than one year!

In June 2008, Santos Ltd. (NASDAQ: STOSY) owned a 50.353% interest in PRL 5, alongside InterOil’s 28.56% interest. On June 3, 2009, Santos sold its 50.353% interest in PRL 5 to P3 Global Energy Company Ltd for $20 million. Therefore, P3 Global owned 75.17% of PRL 5, after buying a 24.82% interest from Horizon and 50.35% interest from Santos.

If InterOil had waited less than a year to sell its interest in PRL 5, they could have sold it to P3 Global for $11,343,912, on a relative basis. Instead, InterOil sold its 28.56% interest in PRL 5 to Horizon Oil for just a mere $1.5 million in May 2008. InterOil could have received over seven times that sum had it waited to sell its interest to P3 Global.

When InterOil announced its sale of PRL 4 and PRL 5 to Horizon Oil, InterOil CEO Phil Mulacek claimed, “We are selling our interests in PRL’s 4 and 5 in order to focus our resources and efforts on appraisal and development activities in the Elk/Antelope field. Despite all the hype disseminated by InterOil, its cronies at John Thomas Financial, and an anonymous web site called Shareholdersunite.com (out of the Netherlands) surrounding InterOil's Elk/Antelope field, the company has yet to report any proven commercially exploitable oil and gas reserves. Instead the company passed on huge potential profits on PRL 4 and PRL 5 to fund an uncertain energy project that as of today has no proven reserves.

In a previous blog post, I detailed how in April 2008 InterOil papered-over Carey International and John Thomas Financial's involvement in raising funds for a $95 million private placement convertible debt offering. InterOil used Clarion Finanz AG to act as a buffer between the company on one side and Carey and John Thomas Financial on the other side. On April 28, 2009, Wayne Kaufman from John Thomas Financial appeared on CNBC and pumped InterOil as "Our favorite stock...." and failed to disclose his company's relationship conflict with InterOil.

In another blog post, I detailed how InterOil lied to the New York Times about its relationship with Carl Caserta, who was banned from the securities industry by the SEC. InterOil continued to use Caserta to raise funds for the company and Caserta had an active InterOil email address, despite InterOil telling the New York Times that he stopped working for the company in 2005.

InterOil, like other deceitful companies followed in this blog, such as Overstock.com (NASDAQ: OSTK) and Bidz.com (NASDAQ: BIDZ), are a securities regulator's wet dream. Every time I take a look at their disclosures, I find even more questionable issues. InterOil, Overstock.com, and Bidz.com are like an axis of evil for investors.

One must ask the obvious: What else is the senior management of IOC concealing, papering over, not disclosing and hyping to the detriment of company stockholders?

To be continued....

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 family members mastermind one of the largest securities frauds uncovered during the 1980s. I pleaded guilty to three felonies.

I am assisting Barry Minkow and Fraud Discovery Institute in researching InterOil and Minkow has a short position in InterOil. I have no position in InterOil, Overstock.com, and Bidz.com securities, long or short. My research on Overstock.com and Bidz.com are freebies for securities regulators to help me try to get into heaven for past sins, though I doubt I can ever make up for my past evil acts.

Other information:

Fraud Discovery Institute Investigation of InterOil

Monday, July 06, 2009

Diamonds Are Not Forever For Two Key Bidz.com Insiders

Company buys back stock while two key insiders sell their shares

On July 1, 2009, Bidz.com announced that in its latest quarter ended June 30 (Q2 2009), the company repurchased 714,000 common shares at an average price of $3.50 per share for a total cost of approximately $2.5 million. The press release went on to hype the company's future prospects:
"With the price of our stock continuing to trade below what we believe to be a reasonable valuation, our Board of Directors believe that the continued aggressive repurchase of our Company's shares is an excellent use of capital," said, David Zinberg, the Company's Chairman and Chief Executive Officer. "The combination of our liquidity, profitability and our ability to successfully execute our business strategy gives us confidence that the continued repurchase of our shares will help to deliver long-term shareholder value."
Meanwhile, during that same quarter David Zinberg (Bidz.com CEO) and his sister Marina Zinberg (Bidz.com Vice President) sold a combined amount of 162,417 shares and pocketed gross proceeds of approximately $595,512. David Zinberg sold 30,000 shares at an average price of $3.83 per share for total proceeds of $114,941, while Marina Zinberg sold 132,417 shares at an average price of $3.63 per share for total proceeds of $480,571 (Source: Various SEC Form 4's).

Therefore, while Bidz.com is telling investors that the price of its stock is "continuing to trade below what we believe to be a reasonable valuation," the company's two key insiders are selling their shares. Apparently, David and Marina Zinberg are not voting for their company's long term prospects with their pocketbooks.

All of David Zinberg's and all but the last two of Marina Zinberg's stock sales during Q2 2009 were completed under a 10b5-1 plan that helps executives defend against potential allegations of insider-trading by removing their discretion as to when their stock is sold (Details here and here). However, as I will describe below, David Zinberg continued to de-facto control his discretion in selling Bidz.com stock by first adapting a 10b5-1 plan, terminating it before its expiration, and later selling stock under an apparently new 10b5-1 plan.

David Zinberg goes in and out of 10b5-1 plans and flip flops on salary

On August 15, 2007, Bidz.com announced that David Zinberg adopted a 10b5-1 plan. The company disclosed:
Rule 10b5-1 allows officers and directors of public companies to adopt written pre-arranged stock trading plans when they are not in possession of material, nonpublic information. Once a Rule 10b5-1 trading plan is established, the insider retains no discretion over sales under the plan, and the trades are executed through a broker in accordance with the terms of the plan at later dates without regard to any subsequent material non-public information that the insider may receive.
In addition, Bidz.com disclosed that Zinberg's $290,000 annual salary was, "...voluntarily being reduced to $1 per year and he is not expected to receive any bonus or stock option grants." The plan was due to terminate on July, 31, 2008.

On February 28, 2008, the company reported that Zinberg terminated his 10b5-1 trading plan "effective immediately" or five months before the termination date of July 31, 2008:
...David Zinberg’s Rule 10b5-1 Trading Plan has been terminated effective immediately. This plan was originally implemented in August 2007, after Mr. Zinberg voluntarily reduced his annual salary to $1, with no stock option grants. The Board of Directors has reinstated Mr. Zinberg’s annual salary of $290,000 per annum, as well as his eligibility to earn an annual bonus, effective March 1, 2008.
Note: Bold print and italics added by me.
However, on December 17, 2008, David Zinberg resumed selling his stock "as part of a 10b5-1 plan." I could not find any press release or report filed with the SEC that disclosed when David Zinberg resumed his terminated 10b5-1 plan or started a new plan. In any case, David Zinberg sold more stock under a 10b5-1 plan after the Bidz.com reported the early termination of his original 10b5-1 plan.

According to Bidz.com's recent proxy statement filed with the SEC:
As of August 16, 2007, Mr. Zinberg voluntarily reduced his annual salary to $1 per year. Mr. Zinberg’s annual salary of $290,000 per annum, as well as his eligibility to earn an annual bonus, resumed as of March 1, 2008. Effective April 1, 2009, Mr. Zinberg’s employment agreement was amended to increase his base salary to $500,000 per annum.
Note: Bold print and italics added by me.
Now David Zinberg has his cake and can eat it, too. His salary increased from $1 per year to $500,000 per year and he is still selling stock under a 10b5-1 plan. Both David and Marina Zinberg control over 10 million shares of Bidz.com's 22.8 million outstanding shares and have effective control of the company. In addition, David Zinberg's initial adoption of a 10b5-1 plan, his later termination of such plan, and still later sales of stock under a 10b5-1 plan seems to be an end around to paper over his discretion to sell stock and avoid potential insider trading liability.

Hopefully, the company can provide some clarification on this issue.

Marina Zinberg has a 10b5-1 plan but sells stock outside the plan

Marina Zinberg's last two disclosed stock sales during Q2 2009, on June 26 and June 29, were not sold under a 10b5-1 plan. Therefore, she exercised her own discretion to sell her stock. On June 26, Marina Zinberg sold 4,567 shares at $3 per share for total proceeds of $13,701 and on June 29 she sold 7,850 shares at $2.94 per share and pocketed proceeds totaling $23,079. A few days after Marina sold those shares, Bidz.com issued the press release (above) claiming that the stock was undervalued and "confidence that the continued repurchase of our shares will help to deliver long-term shareholder value."

David and Marina Zinberg sell even more stock during Q3 2009

Just today, new SEC Form 4 filings revealed that both David Zinberg and Marina Zinberg sold even more stock after Q2 2009 pursuant to their 10b5-1 plans. David Zinberg sold another 10,000 shares and pocketed $29,240 in proceeds from July 1 to July 6. While Marina Zinberg sold another 18,900 shares and pocketed $53,537 in proceeds from July 1 to July 6 (Source: David Zinberg Form 4 and Marina Zinberg Form 4).

Should Bidz.com buyback stock with weak fundamentals?

In Q1 2009, Bidz.com reported revenues of $31.2 million compared to $61.9 million during the previous year period or about a 50% decline in revenues. The company also reported net income of $1.5 million compared to $4.6 million during the previous year period or about a 67% decline in net income (Source: 10-Q report).

At the end of Q1 2009, Bidz.com reported a cash balance of a mere $3.16 million. Working capital was reported at $33.4 million. Inventory, which is a key component of working capital, was reported at $38.5 million and it takes Bidz.com over 150 days to turnover its inventory. During Q1 2009, reported inventory loss reserves ballooned from $820k to $1.35 million or from 2.1% of gross inventory at the end of Q4 2008 to 3.3% of gross inventory at the end of Q1 2009, over a 50% increase in relative terms.

Bidz.com has not reported Q2 2009 financial results as of this blog post. The average analyst estimate for Q2 2009 sales growth is minus 45.4% and the average estimate of earnings per share growth is about minus 65%.

Today, Bidz.com common stock closed at $2.71 per share, far below the average price paid by the company to repurchase its shares and below the average selling price of both David and Marina Zinberg's shares during the latest quarter.

It seems like Bidz.com shareholders are getting the raw end of the deal as the company wastes precious resources by buying back stock during this time of economic uncertainty, while David and Marina Zinberg continue to cash out their stockholdings. Those Bidz.com stock buybacks seem to benefit the Zinberg's on the backs of other company shareholders.

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 family members mastermind one of the largest securities frauds uncovered during the 1980s. I pleaded guilty to three felonies.

I do not own any Bidz.com securities, long or short.